Rs 500 and Rs 1,000 notes scrapped: Govt releases FAQ to help you make sense of it all

1. Why is this scheme (in place)?
The incidence of fake Indian currency notes in higher denomination has increased. For ordinary persons, the fake notes look similar to genuine notes, even though no security feature has been copied. The fake notes are used for anti-national and illegal activities. High denomination notes have been misused by terrorists and for hoarding black money. India remains a cash based economy hence the circulation of Fake Indian Currency Notes continues to be a menace. In order to contain the rising incidence of fake notes and black money, the scheme to withdraw has been introduced.

2. What is this scheme?
The legal tender character of the notes in denominations of Rs 500 and Rs 1,000 stands withdrawn. In consequence thereof withdrawn old high denomination (OHD) notes cannot be used for transacting business and/or store of value for future usage. The OHD notes can be exchanged for value at any of the 19 offices of the Reserve Bank of India or at any of the bank branches or at any Head Post Office or Sub-Post Office.

Representational image. AFP

3. How much value will I get?
You will get value for the entire volume of notes tendered at the bank branches / RBI offices.

4. Can I get all in cash?
No. You will get upto Rs 4,000 per person in cash irrespective of the size of tender and anything over and above that will be receivable by way of credit to bank account.

5. Why I cannot get the entire amount in cash when I have surrendered everything in cash?
The Scheme of withdrawal of old high denomination (OHD) notes does not provide for it, given its objectives.

6. Rs 4000 cash is insufficient for my need. What to do?
You can use balances in bank accounts to pay for other requirements by cheque or through electronic means of payments such as Internet banking, mobile wallets, IMPS, credit/debit cards etc.

7. What if I don’t have any bank account?
You can always open a bank account by approaching a bank branch with necessary documents required for fulfilling the KYC requirements.

8. What if I have only JDY ( jan dhan yojna ) account?
A JDY account holder can avail the exchange facility subject to the caps and other laid down limits in accord with norms and procedures.

9. Where can I go to exchange the notes?
The exchange facility is available at all Issue Offices of RBI and branches of commercial banks/RRBS/UCBs/State Co-op banks or at any Head Post Office or Sub-Post Office.

10. Need I go to my bank branch only?
For exchange upto Rs 4,000 in cash you may go to any bank branch with valid identity proof.

For exchange over Rs 4,000, which will be accorded through credit to Bank account only, you may go to the branch where you have an account or to any other branch of the same bank.

In case you want to go to a branch of any other bank where you are not maintaining an account, you will have to furnish valid identity proof and bank account details required for electronic fund transfer to your account.

11. Can I go to any branch of my bank?

Yes you can go to any branch of your bank.

12. Can I go to any branch of any other bank?
Yes, you can go to any branch of any other bank. In that case you have to furnish valid identity proof for exchange in cash; both valid identity proof and bank account details will be required for electronic fund transfer in case the amount to be exchanged exceeds Rs 4,000.

13. I have no account but my relative/friend has an account, can I get my notes exchanged into that account?
Yes, you can do that if the account holder relative/friend etc gives you permission in writing. While exchanging, you should provide to the bank, evidence of permission given by the account holder and your valid identity proof.

14. Should I go to bank personally or can I send the notes through my representative?
Personal visit to the branch is preferable. In case it is not possible for you to visit the branch you may send your representative with an express mandate i.e. a written authorisation. The representative should produce authority letter and his/her valid identity proof while tendering the notes.

15. Can I withdraw from ATM?
It may take a while for the banks to recalibrate their ATMs. Once the ATMs are functional, you can withdraw from ATMs upto a maximum of Rs 2,000 per card per day upto 18 November, 2016. The limit will be raised to Rs 4,000 per day per card from 19 November, 2016 onwards.

16. Can I withdraw cash against cheque?
Yes, you can withdraw cash against withdrawal slip or cheque subject to ceiling of Rs 10,000 in a day within an overall limit of Rs 20,000 in a week (including withdrawals from ATMs) for the first fortnight ie upto 24 November, 2016.

17. Can I deposit withdrawn notes through ATMs, Cash Deposit Machine or cash Recycler?
Yes, OHD notes can be deposited in Cash Deposits machines / Cash Recyclers.

18. Can I make use of electronic (NEFT/RTGS /IMPS/ Internet Banking / Mobile banking etc.) mode?
You can use NEFT/RTGS/IMPS/Internet Banking/Mobile Banking or any other electronic/ non-cash mode of payment.

19. How much time do I have to exchange the notes?
The scheme closes on 30 December, 2016. The OHD banknotes can be exchanged at branches of commercial banks, Regional Rural Banks, Urban Cooperative banks, State Cooperative Banks and RBI till 30 December, 2016.

For those who are unable to exchange their Old High Denomination Banknotes on or before 30 December, 2016, an opportunity will be given to them to do so at specified offices of the RBI, along with necessary documentation as may be specified by the Reserve Bank of India.

20. I am right now not in India, what should I do?
If you have OHD banknotes in India, you may authorise in writing enabling another person in India to deposit the notes into your bank account. The person so authorised has to come to the bank branch with the OHD banknotes, the authority letter given by you and a valid identity proof (Valid Identity proof is any of the following: Aadhaar Card, Driving License, Voter ID Card, Pass Port, NREGA Card, PAN Card, Identity Card Issued by Government Department, Public Sector Unit to its Staff)

21. I am an NRI and hold NRO account, can the exchange value be deposited in my account?
Yes, you can deposit the OHD banknotes to your NRO account.

22. I am a foreign tourist, I have these notes. What should I do?
You can purchase foreign exchange equivalent to Rs 5,000 using these OHD notes at airport exchange counters within 72 hours after the notification, provided you present proof of purchasing the OHD notes.

23. I have emergency needs of cash (hospitalisation, travel, life saving medicines) then what I should do?
You can use the OHD notes for paying for your hospitalisation charges at government hospitals, for purchasing bus tickets at government bus stands for travel by state government or state PSU buses, train tickets at railway stations, and air tickets at airports, within 72 hours after the notification.

24. What is proof of identity?
Valid Identity proof is any of the following: Aadhaar Card, Driving License, Voter ID Card, Pass Port, NREGA Card, PAN Card, Identity Card Issued by Government Department, Public Sector Unit to its Staff.

25. Where can I get more information on this scheme?
Further information is available at our website (www.rbi.org.in)

Outlets that will accept Rs 1,000 and Rs 500 notes in next 72 hours 

1. Government hospitals will accept these notes from November 9 till November 11, and in government dispensaries with doctor's prescription. 

2. Old notes will be accepted for buying train and airline tickets. 

3. Government bus stops will accept these notes for the first 72 hours starting midnight of November 8, 2016. 

4. Old notes will be accepted at petrol, diesel and CNG stations run by public sector companies

5. Milk booths and crematoriums .. 

6. Cooperative shops, Kendriya Bhandar, ration shops, Safal shops and dairies recognised by the state government will accept Rs 500 and Rs 1,000 bank notes, but all of these entities will have to maintain a stock register. 

7. International airports will have the facility of exchanging the old notes for foreign tourists and those going to foreign nations till a limit of Rs 5000.

DIWALI WISHES ....

how a company grows from almost nothing to being traded in the stock market

In this post, I will explain how a company grows from almost nothing to being traded in the stock market. I will use this to explain basic finance terms.

Stage 0: Bootstrap Startup Tom and Ian start a lemonade business. The business involves buying lemon, sugar, cups and ice cubes. They buy these raw items at the start of the day and then sell the end product (lemonade) throughout the day. 

They need money for three things:

1.    The lemonade stand, juicer, ice box. This is called the fixed assets or Capital.You can use the same stand & juicer for making a long time. Thus, make this investment one time and can enjoy the benefits for a long time. The term "capital" is the central part of entrpreneurship and is the root for "Capitalism".

2.   The raw materials they buy at the start of the day. The raw material gets used up as you make the final product. The raw material and juice you have made it in a pitcher before selling is together called an inventory.

3.   Keep some change in the register for people who are paying with bigger denomination currency. This is called just cash.

Together the fixed assets + inventory + cash is called the company assets.

To get these assets they need to use some money - called an investment. It all costs about $100. Tom and Ian put $50 each. They shared the investment and the profits 50:50. In other words, each owned 50% shares in the company.

They use 10 lemons, 5 sugar packets, 10 ice cubes, 50 cups to produce  50 glasses of lemonade per hour. The raw materials cost $10 and they sell lemonade at $0.25/cup. This provides them 50 * $0.25 = $12.50 in total money got from the customers. This is called revenues. 

They spent $10 on raw material. This is called Cost of Goods Sold. 

The profit is now $12.50 - $10 = $2.50. This is called earnings. 

How significant is this $2.50? We need to see it as a percentage of the revenues. Profit divided by the revenues is called the margin. In this case the margin is:

Stage 1: External InvestmentBusiness is going ok and they want to grow it even bigger. They realized the following:

1.    Instead of buying lemons every day from a local vendor, they could buy it at wholesale from a distant wholesaler every week. If they buy lemons in bulk, they need to buy a big box to hold them. Bigger Inventory.

2.   Instead of squeezing them in their old juicer, they want to buy an industrial grade juicer. This enables them to produce juice faster and serve more customers. Increased Capital investments.

3.   By producing more lemonade & selling them more they could reduce the overall costs per glass. The same stand and labor could be used for the increased production. The idea that you can reduce your average costs by producing more is termed the economies of scale.

All this requires $100 more in investment. The founders - Tom and Ian don't have that much money. The bank won't lend them anything as they are very new in the business. They go to a local wealthy guy - Rich. 

Rich says he can give $100, but asks for a share of the profits in the business. In short, he wants to a co-owner of the company.

Now, how many shares should Rich get?

Tom and Ian get together to start valuing their company.

Assets:Fixed assets (juicer, stand): $50
Inventory: $50
Past profits (that they have it in the bank): $50

Total assets: $150

There is one thing that is missing here. What about the reputation and brandthey have built? 

1.    TomIan Lemonade Stand is popular among the local public, who frequent it. A lot of people made the drink their part of their daily routine.Brand.

2.   Local shopkeepers give discounts to these guys as they have proven to be trustworthy. Relationships.

3.   They have already set up paperwork with the local corporation and all this required manual work. Relationships.

4.   Through their daily routine, they found faster ways to squeeze the lemons.Intellectual Property & Processes.

What is the value of all this?

It is hard to put a value to all this. However, these items have a big impact on the future revenues.

Together these things are called the Intangible Assets. They are hard to touch and see. But, have a lot of hidden value.

Ian and Tom guess that the value these at $200. Rich scoffs at this and says he sees these are worth only $50. With no other option, they grudgingly take the offer.

Total value of TomIan Stand: $200 ($150 in tangible assets and $50 in intangible assets).

Rich is bringing $100 in new cash. Together the total assets after investment is $300.

Since Rich put $100 in that, he gets 33% in the company:



Tom and Ian share the remaining 66.66% equally among them. These 3 are now called the shareholders - as they all own the share in the company. Rich is not working the lemonade stand and is non-executive owner of the company. Rich is sometimes called the Angel Investor. He is the rich guy who acted like an "angel" to these small entrepreneurs.

Stage 2: GrowthThe business is now going quite well. Using the money from Rich and later a few more wealth people, TomIanRich Lemonade Corporation has increased production and have setup multiple stands in different parts of the city.

Now, they dream really, really big. They want to bottle the lemonade and sell it worldwide. They reason that their unique flavor has already proven to be a hit in their city.

This expansion requires a substantial amount of new money - 100 million dollars. Tom & Ian project that this 100 million investment could provide them a profit of over $500 million in the next 10 years. Sounds attractive.

It would be impossible for them to find that many rich people from their contacts directly. However, they guess that if each person in their state invests $10 in their company, they can easily get that investment. Each of the investor could be given a small percentage of the company & its profits. Since a $100 million in investment could produce $500 million in profits (according to "Estimates) it is likely that an ordinary investor who put $10 could get $50 in the next 10 years if everything goes well.

However, how do they get $10 from 10 million people? Where do they go to?

Stock Markets. 

Stock markets are like an eBay for investors. There are a bunch of people who are selling you shares in their company in return for your money. Just like you buy tomatoes in your regular market, you can buy shares. To make it even more simple, you can both buy and sell at any time. This is called a trade or an exchange. 

What are the functions of the stock markets (also called exchanges):

1.    They bring a large number of investors and good companies in a single place. Thus, investors have a lot of companies to choose from and companies have a lot of investors to provide money. This works the same for any marketplace. A Stock market is a company just like eBay or Amazon that brings different parties together. Just like Craigslist competes with eBay, New York Stock Exchangecompany competes withNasdaq.

2.   They verify the credentials of the company to make sure only really quality companies are listed in the board. The best exchanges allow only the best companies. Thus, it is a mark of honor to be listed on the New York Stock Exchange. 

3.   They provide each ways for transfer of payments & share certificates between the buyers and sellers.

The first time a company enters the stock market is called the IPO or Initial Public Offer. The "public" here refers to the fact that you are raising money from common public (instead of just rich people who are Angel investors). This requires a lot of transparency in your accounting and companies prepare this process for months. Twitter is now rumored to be in this process of preparing for its IPO.

Google executives at its IPO in Nasdaq.

Share price.TomIanRich Corporation has now successfully entered the New York Stock Exchange. They divided the company into 10 million pieces (called the shares) and sold 5 million of them at $20 a piece. This called the share price.

Do you see the value of an item in eBay change? Yes it does. It depends on how hot an item is. If more people are interested in holding the share of a company X, the share prices would go up.

On Dec1, Tom finds a new way to use the lemonade formula for making a lemonade candy. New investors see that and believe that the profits will be moving up. As new investors flock in, the share prices move up.

On Dec 5, Ian finds a major damage in one of their warehouses and announces that this will cause a drop in their profits. Many existing investors sell shares and share prices move down.

On Dec 10, a major healthcare institute announces that lemonade is good for the body. Smart investors understand that this will cause more lemonade consumption, meaning more future profits. This again causes the stock to move up.

In short, the share price moves up and down as investors adjust their profit projections based on the arrival of new news.

What is Value Investing and Its Significance

People keep on saying about investing in stocks, but many few know the meaning of Value Investing.

Value Investing in nothing but knowing about the business of a company i.e. what does company do,studying financial ratios, doing the valuation to check whether the stock is available at cheap price and then taking a call whether to buy a stock or not. In short, it is a deep and easy analysis to buy a stock.

Although Value Investing is easy but it needs a lot of practise, dedication, and hard work. It is an art which requires patience too.

To become A Successful Value Investor You Should Remember And Use the Following points in Your Life:

1) Don’t Speculate Your Hard Earned Money

“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative” – Benjamin Graham

I have seen many people who speculate about the company and invest their hard earned money without doing any home work. It is important to take stock market investing as a business. If you are not sure about the company it is better you don’t speculate about the business of a company.

2) Value Investing Is a Long-Term Investment

Value Investing is slow but rewarding technique. If you know about the business of a company and the numbers of a company are also good then you can invest your money in the company. Remember, value Investing is a long-term investment where your money will appreciate after few years.

So don’t get into short-term trading where you buy a share today and sell it either today,tomorrow, after few weeks or  months. Just wait and let money work for you. As it is rightly said-“Rome wasn’t build in a day”.

3) Understand The Intrinsic Value

For many people it is a new word,don’t worry I will explain you in a simple way. Intrinsic value is nothing but the true value of a company i.e. what the company is really worth.

For example, If you buy a Company For $1000, but its true worth is $500, then you have overpaid for buying the company. It means that you have paid more than the company’s true worth. Most Important point while analysing a company is to understand its intrinsic value.

4) Margin Of Safety

“Margin Of safety is buying 1 dollar for 50 cents” – Warren Buffet

One of the most important and used term  in Value Investing. It was invented by Benjamin Graham in his Book“The Intelligent Investor”, who is considered as a father of value investing.

For Example, If you buy a share of a company for $100 and the Intrinsic Value of a company is $150. It means there is a margin of safety of $50. Margin Of safety is important because valuation is an imprecise technique and future is also unpredictable. This technique gives us extra safety for our mistakes as a human being.

So when you see a price of a share of a company, first determine the intrinsic value of a company and if it is lower than the price then apply some margin of safety to it for more cushion to your investment. I hope you have understood the concept. 

5)  Don’t Forecast About The Market

It is difficult to forecast about our life, then why to waste our time in forecasting about the market. Future is always unpredictable and if you have understood the business and done a thorough analysis, measured the intrinsic value and applied the margin of safety then you will surely become successful in a stock market.

6) Don’t Follow the Crowd

It is very easy to get influenced by what other people are saying. Be careful while listening to the expert in the stock market because at the end of the day it is your decision whether to buy or not a stock.

If you do your own independent research , there are more chances that you will beat the market and earn a good return.

What was the Harshad Mehta scam?

Who was Harshad mehta ?

Harshad Shantilal Mehta was born in a Gujarati Jain family of modest means. His early childhood was spent in Mumbai where his father was a small-time businessman. Later, the family moved to Raipur in Madhya Pradesh after doctors advised his father to move to a drier place on account of his indifferent health. But Raipur could not hold back Mehta for long and he was back in the city after completing his schooling, much against his father’s wishes.

Mehta first started working as a dispatch clerk in the New India Assurance Company. Over the years, he got interested in the stock markets and along with brother Ashwin, who by then had left his job with the Industrial Credit and Investment Corporation of India, started investing heavily in the stock market.

As they learnt the ropes of the trade, they went from boom to bust a couple of times and survived.

Mehta gradually rose to become a stock broker on the Bombay Stock Exchange, who did very well for himself. At his peak, he lived almost like a movie star in a 15,000 square feet house, which had a swimming pool as well as a golf patch. He also had a taste for flashy cars, which ultimately led to his downfall.

“The year was 1990. Years had gone by and the driving ambitions of a young man in the faceless crowd had been realised. Harshad Mehta was making waves in the stock market. He had been buying shares heavily since the beginning of 1990. The shares which attracted attention were those of Associated Cement Company (ACC),” write the authors. The price of ACC was bid up to Rs 10,000. For those who asked, Mehta had the replacement cost theory as an explanation. The theory basically argues that old companies should be valued on the basis of the amount of money which would be required to create another such company.

Through the second half of 1991, Mehta was the darling of the business media and earned the sobriquet of the ‘Big Bull’, who was said to have started the bull run. But, where was Mehta getting his endless supply of money from? Nobody had a clue.

What was the Harshad Mehta scam?

Let's say we have three banks A, B and C. And a broker X. And obviously, the government.

Now the banks want to make as much profit as they can by using the money just the way they want. And the government wants to regulate them by making it compulsory for them to invest some of the money in Government bonds. So the government puts a simple rule that at the end of every day, A,B and C have to show them a balance sheet and a minimum amount has to be invested in bonds. 

The banks do it for some time but they ask the government for some kind of relaxation. So a new rule comes where you need to show the balance sheet only on Fridays. The average amount per day in the bonds has to be over the fixed amount, however, there is no such limit on the daily amount now.

Now X comes into the scenario. Since A would sell some bonds to invest elsewhere and B may buy some bonds as well, the banks will now have different amounts of money invested in bonds everyday and some will have less while some will have more. But all of them need to have that minimum amount on Friday, so the banks with lesser amounts, i.e, A in this case, would need to buy the bonds to keep up with the average. 

So what does A do? It contacts X to get it some bonds from either B or C. 

X is a trusted broker and all the banks know him pretty well. So X tells A that he'll get the bonds but right now he isn't sure that from whom will the bonds come, B or C. So instead of making the cheque on the bank's name, A should sign the cheque for X. (Which was illegal, BTW). 

So A does that. Now X goes to B and ask for the bonds and using the power of trust, X tells B that he'll pay the money the next day to which B agrees because he also offered a good return on the money. See, bonds are important, money may come later too.

Using this trick, X makes sure he always has some money with him. 

Now comes part two. The money he had, he invested heavily in the stock market to create a turmoil, specifically for a few companies like ACC. The market saw a huge run like never before and share prices of ACC and some others went over the tops. 

Once he knew the market was at a peak, he started profit making and markets crashed. The bank people who were involved with him in the illegal acts panicked and one of them even committed suicide. 

Prof. Shivanand Mankekar, The Genius Stock Picker With A Concentrated Portfolio

Prof. Shivanand Shankar Mankekar has always been a believer in the merits of a concentrated portfolio with only a few high conviction stocks in it. However, this time he has outdone himself with 70+% of his net worth in a single stock.

When you study the portfolio of Prof. Mankekar, his wife Laxmi Shivanand Mankekar, his son, Kedar Mankekar and company, Om Kedar Investments, three things become apparent. One, the Prof likes to takes concentrated bets on a few stocks. Two, the Prof is not looking for “cheap” stocks. He wants stocks that are proven out-performers and he is prepared to pay the full price for them. Three, the Prof likes to periodically shuffle his portfolio to weed out the non-performers.

Prof. Mankekar made his first big fortune in Pantaloon (now known as ‘Future Retail’), a company promoted by Kishore Biyani. In Biyani’s book “It happened in India” Prof. Mankekar talks about what fascinated him about Pantaloon. He says that when he went to see the ‘Big Bazaar’ mall in Bangalore, he was very excited and he rushed to the hotel, called the broker and asked him to buy 4% of the equity capital of Pantaloon. Interestingly, Prof. Mankekar says that “We didn’t do any of the typical things expected from finance professors, i.e. analyze the balance sheet or meet the management. The simple reason for this was that the Big Bazaar outlet spoke much more, it screamed out that here was a guy who really understood retailing the Indian way”.

Prof. Mankekar also recollects that when he met Kishore Biyani, he told him that Pantaloon would have a market capitalisation of Rs. 1 lakh crore in 13 years. Kishore Biyani did not believe this and laughed it off because Pantaloon’s market capitalisation then was barely Rs. 50 crore.

Prof. Mankekar’s prediction come partly true because Pantaloon Retail did become a blockbuster multibagger. While the Prof. bought the stock in 2002 at about Rs. 9 (adjusted for rights & bonus), the stock touched a peak of Rs. 800 in January 2008, giving an incredible return of nearly 90 times in just 6 years.

Wockhardt, Prof. Mankekar’s second mega stock pick, is a classic example of his brilliant stock picking ability. However, ironically, it also represents a classic example of how multi-bagger profits can slip out of your hands and remain on paper if you don’t encash them on time.

How the Prof homed in on Wockhardt out of the hundreds of pharma stocks in the universe is a big mystery. Nobody knows the answer but it must be the same intuition that was at work in Pantaloon.

Magically, soon after the Mankekars (actually Laxmi Mankekar) began aggressively buying Wockhardt stock (at the peak in June 2012, she held 22,00,063 shares, comprising 2.01% of the capital), it began its vertical climb. While Laxmi Mankekar bought the bulk of the stock in the September – December 2011 Quarter, when the price was about Rs. 240, the stock surged to an all-time high of Rs. 2,166 in March 2013. At the peak, Mankekar’s holding in Wockhardt was worth nearly Rs. 470 crore, nearly a ten-bagger.

Now, in hindsight, one can lament that the Mankekars should have booked some gains because when the fall came, it was swift and brutal. Over concerns raised due to the FDA warnings, Wockhardt’s stock price went into a free fall and plunged to a low of Rs. 340 in August 2013. Desperate investors wanting to bail out worsened the situation. The Mankekar’s were caught in the stampede and trampled upon. They sold off all their holdings by September 2013, without much to show for the brilliant stock picking and holding of 4 years.

The Wockhardt episode reveals a serious chink in Prof. Mankekar’s armour. How is it a visionary like him did not anticipate the FDA risk factor for Wockhardt when it is well known that this is the biggest risk factor for pharma companies? Also, was not the Prof over-confident in not booking some profits when the going was good? Surely, he should have sensed that such quick gains cannot be sustained and he should have encashed some of it.

However, the other aspect that the Wockhardt episode reveals is the absolute emotion-less approach that Prof. Mankekar has towards investments. After the debilitating loss in Wockhardt, a lesser person would have crumpled and sworn off concentrated bets.

Prof. Mankekar remained unmoved. He did not spend a moment ruing the lost opportunity in the Wockhardt debacle. Instead, he was busy scouting for the next stock in which he could make a concentrated bet.

And he found it in United Spirits.

Here again, the surprising aspect is the timing of Prof. Mankekar’s purchase. A lot of savvy investors had foreseen that due to Vijay Mallya’s profligacy and imminent bankruptcy, he would have to sell his stake in United Spirits sooner or later to Diageo or some other liquor behemoth and they had begun cornering the stock when it was at Rs. 600. For instance, S. P. Tulsian and N. Jayakumar of Prime Securities openly declared that they were heavily buying United Spirits’ stock in anticipation of a stake sale by Vijay Mallya. Even Rakesh Jhunjhunwala bought huge volumes of the stock at Rs. 900 levels.

Instead, Prof. Mankekar waited till 12th November 2012, a week after Diageo Plc had announced that it would buy 53.4 per cent stake in United Spirits at Rs. 1,440 each, for Rs 11,166.5 crore. The frenzy was at its’ peak at that time, with the stock having surged 35% in one trading session. Prof. Mankekar bought 1.45 lakh shares at about Rs. 1,540 each.

Now, this is surprising for two reasons. First, Prof. Mankekar would have had his eye on United Spirits for a long time and would have known that big-ticket investors were loading onto the stock. Why did he not buy the stock at that time? Secondly, his buying the stock immediately after the official announcement is odd because conventional wisdom tells you that you must wait for the frenzy to cool down before you buy the stock. Also, the stock was then quoting at a frightening P/E of 158 times its TTM EPS.

Of course, as it turned out, Prof. Mankekar was lucky to have grabbed the stock when he did because even when the frenzy cooled down, the stock never went back to the price of Rs. 1,540. He later bought his balance holding of 15 lakh shares by the June 2013 quarter, paying a much higher price than what he paid for his first purchase.

One way to rationalize Prof Mankekar’s buying decision is that he had anticipated that the open offer announced by Diageo to buy the stock at Rs. 1,440 would fail given the sharp run up in the price. As Diageo had indicated its keenness to take control over United Spirits, it was only a matter of time before Diageo announced a second open offer, at a much higher price.

If so, it was a brilliant strategy and it came true on 15th April 2014 when Diageo announced an open offer to buy a 26% stake in United Spirits at Rs. 3,030 each, for a total consideration of Rs. 11,448 crore ($1.9B). The price now offered by Diageo is more than twice the price that it offered in November 2012.

The result: Shivanand Mankekar, one of the largest individual shareholders in United Spirits, sold his 1.09 per cent stake in the liquor maker between April and June 2014 . The unassuming investor, who is also a management professor, may have pocketed a neat profit of Rs 150 crore .

Stock Market VS Mutual Funds

Stocks

In the simplest of terms, stock/share/equity is an instrument that allows you to buy ownership in a company. So when you buy 100 shares of a particular company, you are basically sharing ownership in that company’s assets and future earnings with all the other people who have bought its shares. You can buy/sell stocks of listed companies on a stock exchange (which is nothing but a marketplace) where buyers and sellers decide the price at which they are willing to buy/sell those shares. The fundamental dynamics of demand and supply determine if the price of a stock goes up or down over time.

Mutual Funds

The dictionary definition of a mutual fund is “an investment program funded by shareholders that trades in diversified holdings and is professionally managed.” Huh!?

Without the jargon? A mutual fund is a product that takes money from a lot of people (shareholders), pools it all together and invests that money in financial markets with the aim to provide returns. Each fund will have its own investment objective. This defines the ground rules of where the money can/will be invested within that fund. So depending on the objectives, you can have a bunch of different kinds of funds - open/closed ended, equity, debt, hybrid, money market, diversified, etc.

Typically, the each fund will have a fund manager responsible for deciding where, when and how all the money gets invested - so long as he sticks within the parameters of the investment objective. Since the investing decisions are being taken by a person, we call this an actively/professionally managed fund.

BTW, since we are comparing stocks and mutual funds, I will use the term “mutual funds” to mean “equity mutual funds” because debt/liquid funds etc. are a completely different asset class and hence not within the scope of this comparison.

Stocks vs. Mutual Funds

So now that we have figured out what these are, the question is “which is a better investment option”?

Like most real world problems, the answer here is not a simple black or white. Both these investments have pros and cons and their suitability depends on the individual. So let’s start by comparing them across a few important criteria -

1: Returns - When we talk about investing, returns are probably the first thing that comes to mind. So how does investing in stocks compare with mutual funds? Although there are exceptions, most actively managed mutual funds are not able to provide higher returns than the benchmark index over long periods. Below is a table comparing the average performance of Large Cap, Small/Mid Cap and Diversified equity mutual funds with the Nifty 50 Index over 1, 2, 3 and 5 years (source: Moneycontrol.com).

The index has actually outperformed all three categories over 5 years. You might be tempted to say that the top 10 mutual funds give much better returns than the average fund so all you have to do is invest in the top 2–3 funds in order to beat the market. Well that is true, but only if you have a time machine. The problem is that it is very unlikely for funds to keep giving above average returns over multiple years. So the funds that gave the best returns from 2011–2016 won’t be the same that would give the best returns from 2016–2021. So unless you have a time machine in your garage, how do you pick the 2–3 “top” funds to invest in today?

By comparison, you could invest in a well-researched and diversified stock portfolio that will be able to provide better than benchmark returns over long periods of time (more on this later).

2: Risk - The second most important factor to consider is risk (some might argue that this is actually more important than returns, and they are right to some extent). Investing in mutual funds is considered much less riskier than stocks. There are 2 primary arguments in favor of this -

1. Professionally managed - It is widely believed that since an expert is making the decisions of where to invest, it is less riskier than investing in stocks on your own.
2. Diversification - A single equity mutual fund will invest money across a large number of stocks. In other words, they invest in “diversified portfolios” in order to reduce risk.

These are 2 valid points in favor of mutual funds. A lot of retail investors who invest directly in stocks are not able to manage their risk because building and keeping track of a strong, well-diversified stock portfolio requires more time and energy than most people can afford to spend.

3: Cost of investment - This one goes clearly in the favor of stocks. The only cost is the brokerage that you have to pay at the time of buying/selling. In comparison, mutual funds charge a hefty sum of 2–3% each year to manage your investments. Although this seems like a small number, but over long periods of time, this fees can accumulate into a large amount. For instance, a 2% annual fees paid over 20 years will reduce your returns by as much as 5-times your initial investment.

There are no free lunches. So the question is how much a mutual fund can charge? Is it one time in nature or regular?

There are broadly two types of charges:

1.One time charges:

Entry Load: The charges that are levied when the units are being purchased. The mutual fund would sell the unit price higher than the NAV. At present Mutual Funds cannot charge entry load.

Exit Load: The mutual fund would buy back the units at rate lower than the NAV. There are no fixed exit loads which are charged. It varies based on the scheme. The current practice is the funds could charge any way from 0.50% to 3.00% depending on the holding period. If the investors continue to hold the investment beyond the specified period, no exit load is charged.

For eg: An equity fund currently at an NAV of Rs. 72/- per unit charges exit load of 1% if the investor exits within 1 year of investment. If an investor wants to sell his mutual fund units, which were bought 7 months back the redemption NAV for such investor would be Rs.71.20/-

If the investor has sold 1000units, the total exit load applicable would be Rs.720/-. A Mutual Fund cannot use these charges for paying commission or meeting any of their expenses. This Rs. 720/ should be invested back to the fund, which would benefit the investors who remain invested for long term.

If the investor redeems after 1 year, there is no exit load.

Transaction Charges: These charges are one time charges applicable when the money is invested. This is applicable for the investments of over Rs. 10,000/-. This would be paid to the distributor/intermediary who is selling the fund.

The transaction charges of Rs. 100/- is charged for the SIP commitment of Rs. 10,000/- or above (not monthly SIP amount). The SIP transaction charges are deducted over 4 installments starting from 2^nd installment to 5^th installment.

2.Recurring Charges (Ongoing expenses/Fund Running Expenses):

The expenses are charged on Daily Net Assets of the specific mutual fund. The guideline rates are given by the regulator and Mutual Funds cannot charge more than the stipulated structure. The expenses are deducted every day from the Net Assets of the fund and NAV declared is after adjusting the expenses.

Does the expense ratio vary between funds?

There are two category of diversified equity funds offered by different mutual fund companies. Fund A has a total size of Rs. 1000crs and Fund B has a total size of Rs. 100/- crs. Does it make the difference in-terms of the total expenses charged by the fund?

Even though the expense ratio structure is stipulated by the regulator, it varies based on the size of the net assets of the fund. Higher the net assets, lower expense ratio and lower the net assets higher the expense ratio.This, in turn impacts the returns generated by the respective mutual fund. In case of funds like Liquid funds, the difference in expense ratio would be one factor.

4: Ease of investment - At first glance, investing in a mutual fund can seem very simple. You just pick the “best” 2–3 funds and simply allocate equal amount across them. But as we have seen in my first point, the hard part here is to identify the “best” fund. The human element that comes from active management of funds makes it nearly impossible to predict the “top” funds of the future!

Of course, investing directly in stocks is no walk in the park. As I have pointed out earlier, most individual investors will find it impossible to keep up with the amount of time and resources needed to manage their stock portfolio investments over long term.

In conclusion…

So just to summarize, stock portfolios have the ability to outperform mutual funds in terms of returns, the risk in both investments can be “managed” equally well, the cost of investment is much lower in stocks but the ease of investment is higher in mutual funds.