Do companies respect shareholders?

The Crompton Greaves stock lost nearly a fourth of its value in just two trading sessions. Investors slammed the stock after they heard that the Thapar-owned engineering firm was picking up a 41 per cent stake in a group company, Avantha Power. Avantha Power is into power generation.

To be fair, Crompton has not violated any rules or laws of corporate governance. But what has put off shareholders is that a fair amount of the listed company's cash -- around Rs 225 crore (Rs 2.25 billion) -- is being channelled into a business that needs large amounts of money but returns from which could take their time coming; the cash, they feel should have been reserved for Crompton especially at a time when things aren't going too well in the US and Europe.

Even if the company didn't have use for the money immediately, it could have come in handy for acquisitions. How could the promoters, without so much as a by-your-leave, decide to use the cash for their own company?

Analysts also questioned the value of the acquisition; J P Morgan believed it was difficult to value Avantha for more than Rs 250-Rs 300 crore (Rs 2.5-Rs 3 billion) with most of the capacity still in the pipeline. At Rs 550 crore (Rs 5.5 billion), Crompton had valued the business at nearly twice that amount.

Valuation can be a matter of opinion but managements need to be far more forthcoming with shareholders and far more transparent when they're dealing with cash. The Crompton management didn't even think it necessary to put out any financial details about Avantha at the time of the announcement.

Unfortunately, more and more companies seem to care less and less about the interests of minority shareholders. A couple of months back, shareholders slammed the Siemens stock after the multinational announced that it was spinning off its infotech subsidiary to its parent Siemens AG.

It was surprising, analysts pointed out, how the operating margins of the infotech business had weakened just before the divestment and how there had been a similar occurrence earlier when another subsidiary had been spun off. Late last year, the J P Associates stock lost around 10 per cent in a single session after it announced a group restructuring.

While none of these companies may be skirting the law, what is happening is that companies are increasingly getting away with decisions that are not necessarily in favour of minority shareholders.

In September last year, the promoters of Sterlite wanted to transfer the high-quality aluminium business to group company Malco in return for high-cost and reportedly low-quality copper Konkola mines. After the stock lost 18 per cent, the management gave up the idea but only after some foreign institutional investors kicked up a fuss.

Take also the case of Larsen and Toubro. The company initially denied that it had an interest in picking up a stake in Satyam [ Get Quote ] and only later conceded that it was planning to bid for it -- around Rs 650 crore (Rs 6.5 billion) from the L&T balance sheet had been spent on a 12 per cent stake without anyone having an inkling of what was going on. Not surprisingly, the stock has been thrashed.

In most instances the management may be well within its rights to restructure the business -- it's not that the moves are always regressive, but there are far too many cases where minority shareholders are losing out. Companies seem to have little respect for shareholders' money. With this kind of behaviour, the attempt to improve corporate governance practices seems almost a farce.

Grant Thornton and FICCI have just finished talking to a clutch of midmarket-listed smaller companies on the subject. The findings are politically correct.

Most companies say they see significant value in adopting the corporate governance practices prescribed, and 84 per cent of the 500 respondents say that 'compliance with section 49 enhances the perception of their stakeholders on the conduct of the company's business.'

Judging by the actions of most companies, you wouldn't think they cared two hoots what shareholders thought or didn't think! Most of them felt that Clause 49 was 'adequate to bring the requisite levels of transparency to the business.' Of course! The fact is that the rules don't prevent promoters from doing related-party transactions -- like the Satyam-Maytas and Crompton deals -- and allow them to get away with pulling out cash or transferring a business.

The point is that related-party transactions need to brought under the scanner and the laws suitably changed so that these deals are run past shareholders. Since it won't help if the promoters own a majority share, the transaction should be voted on only by minority shareholders as is the case in several countries. Unless this is made compulsory, promoters will continue to play truant.

For all their fascination with corporate governance, not too many seem to be doing much about it -- the survey revealed that just 9 per cent of the companies spoken to were 'in the process of developing a suitable strategy to comply with clause 49.' That's not surprising. Given how the bigger lot is getting away doing as it pleases, why would smaller companies want to even try?

More selling than buying by company insiders

Srividhya Sivakumar

Can stocks continue higher from here, or have they already risen too far for comfort?

That debate may still be on. But company ‘insiders’, in quite a few cases, seem to think that the time is ripe to sell their holdings.

Insider sales reported to the stock exchanges have outnumbered their “buys” in the past month. From the bluechip names such as ACC, L&T, Wipro and Suzlon Energy to the smaller ones such as DCW, IRB Infrastructure and Peninsula Land, data disclosed to the stock exchanges show that company insiders have been selling into the rally. Insider trades are tracked closely because company insiders are usually assumed to have more information about their company’s prospects than anyone else.

A trickle of sales

Top executives, board members and promoter families of a few large companies appear to have sold shares so far this month.

In the case of L&T, the company’s Chairman and Managing Director and the Whole-time Director & President (Construction) sold 1.8 per cent (40,000 shares) and 5 per cent (10,000 shares) of their total holdings respectively.

For ACC, it was a board member who parted with 18,000 shares.

Kotak Mahindra Bank too reported quite a few insider transactions. Apart from relatively small sales by some of its top executives, the bank saw over 8.5 lakh shares sold by Ms Anuradha Mahindra (wife of Mr Anand Mahindra). That Mr Anand Mahindra has ceased to be the promoter of Kotak Mahindra Bank (announced early June), may offer some explanation.

Mid-cap action

However, with the recent leg of the rally being driven by the small and mid-cap companies, it is the insiders of these companies who featured more prominently in list. Top executives in smaller companies such as OnMobile Global, Page Industries, Peninsula Land, Allied Digital, Marksans Pharma and Apollo Hospitals reported insider selling to the exchanges.

A Director of IRB Infrastructure also parted with a chunk of his shares, even as brokerages were dishing out “buy” reports on the company. Petronet LNG, Ambuja Cements, Gremach Infrastructure and JM Financial were among other companies in which insiders resorted to selling their shares.

Companies cash out

Insider selling apart, there have also been quite a few instances of companies using the recent surge in prices to unlock the value of their equity investments. Cases such as L&T selling 11.49 per cent stake in Ultra Tech Cement through the open market, IBN18 Broadcast offloading treasury stock to institutions and Tata Motors selling half its equity stake in Tata Steel to its promoter group to raise funds have cropped up in the past week. This could also be a signal that these companies believe that current stock prices offer an attractive exit point.

While it may be too early to call it a trend, that these insiders and companies aren’t waiting for their stocks to head higher and are instead seizing the opportunity now, suggest that the gains from here on may be capped. At least that’s what they seem to believe.

How investing in stocks can make you rich

Stocks are volatile, which is another way of saying they're likely to experience wide swings in value. However, over long periods of time, there's good reason and evidence to believe stocks also will appreciate dramatically faster than any other type of asset. That makes it easier to attain your long-term wealth goals.

When you buy a share, or stock, you are buying a piece of the issuing company. Admittedly, it's probably a small piece, but that share you purchase gives you the right to participate in the company's wealth (or fiscal decline) and vote on matters of some importance - directors, company auditors, and some shifts in cor­porate policy.

In some cases, you are also entitled to dividends - payments of cash or stock to shareholders. Some companies also provide their shareholders with perquisites, such as tickets to the company's theme parks or discounts on its merchandise.

Why share prices go up

Because companies tend to grow and prosper over time - and because a share of stock allows you to participate in the prosperity - stock prices, in the aggregate, tend to appreciate over long periods of time. However, individually, some companies prosper; others fail.

If you buy a share in a loser, you could lose all, or a significant portion, of your initial investment. In other words, when you invest in stocks, you risk losing your initial investment, but because you are taking a bigger risk, you get the opportunity to earn far bigger rewards.

How big a reward? In the case of the US, for example, the Chicago-based research company Ibbotson Associates has tracked the performance of US stocks from 1926 onwards. The period till the turn of the century included the Great Depression, the New Deal, World War II, the Korean conflict, the Vietnam War, the Kennedy assassination, Reaganomics, and the Gulf War, not to mention the lunar landing, the break-up of Ma Bell, the Watergate scandal, and the dismantling of the Iron Curtain.

In other words, it is a fairly diverse period that has had its share of ups and downs, just like any period in history. During that time, the average annual return on small-company US stocks was about 12.4 per cent. The average annual return on big-company stocks was 11.2 per cent. Over the same period, inflation rose 3.1 per cent per year, and the return on U.S. Treasury bills was 3.77 per cent.

To put it another way: If you had a diversified portfolio of large-company stocks during that period, the value of your investment portfolio rose 8.1 percentage points faster than the rate of inflation. For every $100 you put in the market, you hiked your buying power by $8.10 each year. At the end of twenty years, your real (inflation-adjusted) buying power increased fivefold, to $503 from $100, without any additional payments from you.

Although investing is as much an art as a science, it's reasonable to expect that future investment returns will mirror historic returns over long periods. In other words, it's reasonable to assume that stocks will continue to appreciate faster than the rate of inflation and other types of traditional investments.

The downside: it is also reasonable to assume that stocks could repeat their short-term historic performance over shorter periods, too. And that's been far less illustrious than the long-term performance. To be specific: the market crash of 1929 so depressed stock prices that investors who put $100 in the market then saw the value of their securities fall to less than $20 at the market's nadir in 1932.

It took roughly eight years before securities prices rose back to ground zero, where $ 100 invested in 1929 was worth $100 again. And then the market took another sickening slide, from which it didn't recover until after World War II had ended. From start to finish, it was a full fifteen years of pain for stock market investors.

The market also took a sharp, decade-long dive in 1969. And it experienced short-term 'crashes' in 1987, 1989, and 1990. But its performance in 1995 was enough to make an investor beam. Stock values as measured by the Standard and Poor's 500 index were up more than 37 per cent.

The following years till 2000 were almost as impressive. Big-company stocks posted a 23 per cent gain in 1996, a 33 per cent gain in 1997, a 28 per cent gain in 1998, and a 21 percent gain in 1999.

Incidentally, although investors in small companies have done better than investors in large companies over the long haul (average annual returns of 12.4 per cent versus 11.2 per cent, respectively), at various points in time, small-company stocks do worse than big-company stocks. They fall farther and faster, and they stay depressed longer.

How to deal with price yo-yos

These heady climbs and sickening slumps are called volatility. When an investment is as volatile as the stock market, it is unwise to invest unless you have a fairly long time horizon that allows you to wait out the price swings and go for the long-term price appreciation.

How long is a 'fairly long' time horizon? That depends on you and why you are investing. Let's say you want to buy a house in five years, and you're trying to determine where to invest the down-payment money.

The stock market would be a good place for all or part of that money if you wouldn't be crushed if your home-buying plans had to be put off because of a market slump that depressed the value of your investment portfolio and thus reduced the amount you had saved for the down payment.

What if you would be crushed if you couldn't buy the home as planned? Then put the down payment money in bonds that mature (or pay back their principal) at the same time as your plans do.

Stocks are also ideal to have in your retirement portfolio. The younger and farther from retirement you are, the more stocks you can handle. And they're a good choice for college funds for young children.

However, if you are investing in individual stocks rather than mutual funds, you must diversify your portfolio by buying stocks in several different companies that do business in several different industries. That ensures that your net worth won't crash if one industry, whether it's oil, technology, or retailing, hits a slump.

Experts suggest you own shares in at least eight to ten different companies. Ideally, those companies should be operating in substantially different industries.

Do it the equity mutual fund way

Mutual funds are investment companies that pool the money of many investors and buy securities in bulk. The securities that a fund buys are determined by the fund's investment objectives. These investment objectives are spelled out in the prospectus and by the fund manager, who makes the investment decisions.

So-called equity funds - also known as growth or aggressive growth funds - buy stock in companies. When you buy a share in an equity fund, you're actually buying an interest in all of the different stocks held by that fund.

That gives you the ben­efit of broad diversification, which reduces the risk that your investment portfolio will be savaged by a single bad stock. In essence, if you buy the right mutual fund, you may not need to diversify the stock portion of your portfolio further. One fund could do it all.

There are lots of other benefits and tricks to buying mutual funds. However, let it suffice to say that investing in equity mutual funds is an alternative to investing in individual stocks. It is a particularly good alternative for those who don't want to spend a lot of time picking individual shares or for those who are starting out and don't have a lot of money.

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Boom-time: Sectors to watch out for

Banking

Analysts are not ruling out a possibility of an increase in the non-performing assets of the public sector banks, going ahead.

Further, the Congress manifesto adds that it will strive to provide interest subsidy for agriculture, small and medium industries and education sectors. Thus, the government's dependence on the banking sector may be sustained in the future as well.

With the government borrowing programme at around Rs 3.6 lakh crore (Rs 3.6 trillion) in the first half of the year, bond yields are likely to stiffen and curtail treasury profits (mainly for PSU banks).

On the positive side, with the Left out of the picture, the government may open up the banking sector to foreign players and consolidate PSU banks.

For example, SBI has already merged one of its associate with itself and the government might consolidate other SBI associates with the parent.

Any moves to increase FDI limit in insurance from 26 per cent to 49 per cent will help financial institutions like ICICI Bank and HDFC to raise additional capital. Increased voting rights of foreign banks, which have more than 10 per cent stake in Indian banks, will bring the stocks of private banks into play.

Infrastructure

Most analysts believe that the market will give a thumbs up to infrastructure stocks as the Congress manifesto lists economic revival and restoring high growth as its immediate priority.

It also mentions that public expenditure on agriculture and infrastructure will be stepped up. The continuation of policies in the infrastructure space and expected increase in the liquidity should augur well for the sector.

Considering the Congress party's focus on the rural sector, investors need to look at companies in the rural infrastructure space such as IVRCL, Nagarjuna Construction and HCC.

Analysts believe that companies will now find it relatively easy to raise funds given the increasing confidence of the investors and flow of money from the FIIs and through the FDI route.

The decision-making process on projects related to infrastructure is likely to be expedited helping companies in this sector. Renewed buying is likely in infra stocks as valuations were beaten down due to growth concerns and credit crunch.

Real Estate

Improvement in the liquidity situation could be the biggest positive for this sector Analysts are expecting stability at the Centre and continuation of policies will attract more money from foreign investors.

Realty majors will now be able to raise funds through Qualified Institutional Placements or debt or through further equity issues. India's largest realty companies--DLF and Unitech--have already raised over a billion dollars in the recent past and chances are that others might follow.

Nirmal Jain, chairman, India Infoline, said "indications are that formation of a stable government will trigger flow of foreign capital in equity as well as debt. This would mean appreciation of the rupee and revival of liquidity-starved sectors such as real estate."

Analysts now believe that since the UPA can form the government without the support of the Left parties who were opposed to the idea of foreign direct investment, special economic zone projects, which were stalled, could get a fresh lease of life.

How to make money in shares

Everyone wants a piece of the stock market. And why not?

But do you know how shares reward an investor?

If you are a shareholder, there are two ways you can benefit from the profits of a company: capital appreciation or dividend. Read on to understand how shares reward you.

Dividends, dividends!

Usually, a company distributes part of the profit it earns as dividend.

Say a company earned a profit of Rs 1 crore (Rs 10 million) in 2004-05.

It keeps half that amount within the company. This is used for a variety of purposes -- buying more machinery, land or raw materials, building a new factory or setting up a new office. It could even be used to repay loans.

The other half is to be distributed as dividend.

Assume the company has 10,000 shares. This would mean half the profit -- ie Rs 50 lakh (Rs 5 million) -- would be divided by 10,000 shares.

So each share would earn Rs 500. The dividend would then be Rs 500 per share.

If you own 100 shares of the company, you get a cheque of Rs 50,000 (100 shares x Rs 500) from the company.

I have never got such a high dividend!

Let's retract a bit. When the company issues shares, it gives a basic value to each share -- say Rs 10. This is called the face value of the share.

When the share is traded at the stock market, however, this value may go up or down, depending on the supply and demand for the stock.

The value of a share in the market at any point of time is called the price of the share or the market value of a stock.

A share with a face value of Rs 10, may be quoted at Rs 55 (higher than the face value), or even Rs 9 (lower than the face value).

Companies often decide to give the dividend as a percentage. So the company can declare a dividend of 50%. This dividend is a percentage of the share's face value.

This means if the face value of your share is Rs 10, a 50% dividend would mean a dividend of Rs 5 per share.

But chances are you would not have paid Rs 10 (the face value) for the share.

Let's say you paid Rs 100 (the then market value). But you will only get Rs 5 as your dividend for every share you own.

That, in percentage terms, means you got just 5% percent as your dividend and not the 50% the company announced.

Let's say you paid Rs 9 (the then market value). You will still get Rs 5 per share as dividend. That means, in percentage terms, you got 55.55% as dividend yield and not the 50% the company announced.

It all depends on how much you paid for the shares.

There is money in holding and selling

When you buy the shares of a company, you invest in its business. As the company expands and grows and profits increase, its value increases.

This, in turn, drives up the value of the stock. So when you sell, you will receive a premium over (more than) what you paid.

It is not as easy as it sounds. A stock's price is always on the move. It could either appreciate (increase in value) or depreciate (decrease in value) with respect to the price at which you purchased it.

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, your return from that stock is Rs 10, or 100%.

Or if you buy a stock for Rs 10 and sell it for Rs 9, you lose Re 1, or your loss is 10%.

You have to look at both

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, your return from that stock is Rs 10 or 100%.

Now add the Rs 5 per share you have received as dividend.

Your total return will be Rs 15 (Rs 10 + Rs 5) or 150% (Rs 15 / by Rs 10 x 100).

If you buy a stock for Rs 10 and sell it for Rs 9 after a year, you would lose Re 1 per share.

However, you would have got Rs 5 as dividend. So you would net Rs 4 as earnings from the company.

In percentage terms, your return would be 40% (Rs 4 / Rs 10 x 100).

The tax factor

There is no tax on dividend.

When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.

If you sell your shares after a year, the profit you make is referred to as long-term capital gain. There is no tax on long-term capital gain.

If you sell it within a year of buying, it is referred to as short-term capital gain and taxed at 10%.

On a closing note

It is purely up to the company's discretion whether or not to declare a dividend and how much it should be. Normally, the dividend earnings do not amount to much.

People make their money in shares via capital appreciation. This means the share value rises over time and can be sold at a profit.

That is why shares are a long-term investment of at least a few years. From the tax angle, too, it pays to invest for the long-term.

Do remember that you are investing in a business. And businesses do fail. Shares are a risky investment!