Aakash Babu Suresh - ProfitablePursuits

Investment Alchemy: Choosing Between Stocks and Mutual Funds Made Easy.

Unveiling the Art of Stock Investing: Expertise, Dedication, and the Gift of Time

Delving into the world of stock investing requires a blend of expertise, dedication, and a generous investment of time. Firstly, becoming adept at analyzing businesses is akin to becoming a detective. It involves scrutinizing a company’s financial statements – the balance sheet, income statement, and cash flow statement – to understand its health. This financial sleuthing also extends to assessing a company’s growth potential, competitive positioning, and the broader sector trends in which it operates. This expertise doesn’t happen overnight; it’s a continuous learning process.

Dedication is the backbone of successful investing. Monitoring the stock market demands a commitment to staying informed about global and industry-specific news, economic changes, and shifts in market sentiment. Understanding the intricacies of financial markets and developing a keen sense for when to act or hold requires persistent effort.

Time is the unsung hero of the investing journey. Just as Rome wasn’t built in a day, a well-constructed stock portfolio takes time to evolve. Patience is crucial, as markets can be unpredictable in the short term. Regularly reviewing and adjusting your investment strategy, and being prepared for the long haul, is part of the time investment required.

In essence, becoming a savvy stock investor is not just about buying and selling; it’s about honing analytical skills, staying dedicated to the market’s pulse, and giving investments the time they need to flourish. This trio of expertise, dedication, and time is the winning combination for those navigating the exciting yet complex world of stock investing.

A great way to start this journey is here.

Simplicity in Diversity: The Effortless Journey of Investing in Mutual Funds

Investing in mutual funds offers a straightforward and user-friendly path for those seeking a hands-off approach to building wealth. The process begins with selecting a mutual fund that aligns with your financial goals, time horizon, and risk tolerance. Unlike scrutinizing individual stocks, this involves evaluating the fund’s historical performance, expense ratio, and the expertise of the fund manager. Effort is considerably reduced as you’re essentially placing your trust in the hands of experienced professionals who manage the fund’s portfolio.

Once the choice is made, purchasing mutual fund shares is a breeze, often just a few clicks away through an online platform or with the assistance of a financial advisor. The beauty of mutual funds lies in their inherent diversification – your investment is spread across a variety of assets, reducing the impact of a poor-performing individual investment.

Tracking a mutual fund is simpler compared to managing a portfolio of individual stocks. Regular updates on the fund’s performance are readily available, allowing investors to gauge how well it aligns with their objectives. The fund manager takes on the responsibility of adjusting the portfolio to maximize returns within the fund’s defined strategy.

Selling mutual fund shares is also uncomplicated. Investors can redeem their shares at the current net asset value (NAV), providing liquidity and flexibility. The exit decision is often tied to changes in your financial goals, time horizon, or risk tolerance.

The icing on the cake is having an experienced fund manager at the helm, making tactical decisions on behalf of investors. Despite the expertise involved, mutual funds typically charge a modest management fee, allowing investors to benefit from professional management while keeping costs reasonable. In essence, investing in mutual funds offers a hassle-free experience, combining the simplicity of the process with the expertise of a seasoned fund manager to navigate the financial markets on your behalf.

You can read more about Mutual Funds here and then here

Why I choose Direct Stock Investing over Mutual Funds and why I don’t blindly recommend my approach for all ?

Certainly! Here’s a refined version of your idea with improved grammar, sentence formation, and spelling:

Upon analyzing the financial landscape, a compelling argument surfaces in the realm of investment strategies. Consider a scenario where one invests directly in stocks, allocating 1 lakh per year for 30 years, with an assumed annual growth rate of 12%. The outcome is a substantial 2.7 Crores at the end of the period. Contrastingly, envision investing in a mutual fund, maneuvering through various funds while maintaining the same growth rate of 12%. However, factor in the 2% annual toll for entry criteria, expense ratio, and exit load to the mutual fund house. The result? A take-home amount of 1.7 Crores, marking a staggering loss of over 1 Crore, translating to nearly a 30% deficit.

While one might argue that transaction frequency might be lower or the charges could be less than the stipulated 2%, the counterargument asserts that diligent analysis can potentially yield more substantial returns in direct stock investing. The crux of the debate lies in the significance of a 30% surplus post 30 years versus the present commitment of time and effort required for understanding, investing, and tracking.

For individuals like me who are coming from a lower-middle-class background, the prospect of 30% additional funds after three decades holds paramount importance. It not only secures financial stability but also offers a competitive advantage. The time spent from in-depth financial analysis can be redirected towards self-improvement in diverse areas such as economics, geopolitics, resource optimization, and leadership skills. This multifaceted skill set can contribute to career growth, potentially leading to increased income. With the newfound financial flexibility, one could even enhance their SIP contributions over the years, generating substantial returns upon retirement.

However, it’s crucial to acknowledge that this perspective may not resonate universally. Individuals who prioritize present-day time constraints, value simplicity, and are uninterested in delving into the complexities of business analysis may find comfort in the ease of mutual fund investments. The choice between direct stock investments and mutual funds ultimately hinges on personal preferences, financial goals, and the perceived trade-off between immediate convenience and long-term financial gains.

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Disclaimer: This blog post is intended for informational purposes only and should not be considered as financial advice. Always conduct thorough research and consult with a qualified financial professional before making investment decision.

Fundamental Investing: 3 Golden Rules that I inherited and swear by

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Introduction

Are you curious to discover the key principles that have steered my financial journey towards success? In this blog post, I’m not here to offer advice, but rather to share three golden rules that have personally guided my investments and contributed to my financial well-being. These rules have stood the test of time and have proven effective for me. I’m excited to share them with you, so you can incorporate them into your own investment strategy, keeping things straightforward and appealing.

1. Rule of Profit Potential

Have you ever wondered what lies at the heart of every successful business venture? Well, it’s not magic, but a powerful equation that can transform your understanding of profit generation. Let’s delve into the Profit Equation. It’s a key piece of knowledge that every business owner should have in their toolkit.

P = Q * (S-C) —- (Profit Equation)

Now, let’s break it down. P represents the profit in any given year, Q is the number of units of products sold, S stands for the selling price of those products, and C represents the cost at which the products were acquired or made by the company. In simple terms, this equation tells the story of how your business can turn a profit.

Imagine you’re in the business of selling apples. If you buy apples for 50 Rs each, sell them at 100 Rs each, and manage to sell 20 apples in a year, your profit can be calculated as follows: Profit = 20 * (100 – 50) = 1000 Rs for the year.

Here is a concise summary of the key factors that i consider in the context of the profit equation:

Product Relevance: Ensure that the company’s products remain in demand and relevant for the long term, securing a steady/growing consumer base.
Innovative Growth: Look for efforts to increase sales (Q) through product innovation / Quality and by adding unique value to the product, which can subsequently boost profits.
Cost Optimization: Evaluate the company’s strategies for reducing production or purchase costs (C) through wise capital allocation in to efficient machines , adapting supply chains, Training the labor etc.
Pricing Power: Assess the company’s ability to adjust selling prices (S) when production or purchase costs (C) rise. This demonstrates pricing power and a potential competitive advantage in the market.

Thanks to my Grandfather who thought me this !

2. Rule of Credibility

One of my uncles started a clothing shop when I was 13-14 years old, and I asked him how he measured the success of his business. The answer he gave me has had a profound influence on me to this day, and I am confident it will serve as a guiding light for me and future generations. He said, ‘I will buy clothes worth 10 lakh rupees and I am certain I can make a monthly profit of 8,300 rupees, thus generating around 10% return on my investment. If I start making less, there’s no point in continuing because I could simply place that money in the bank as Fixed Deposit (FD), which would pay me 8% interest anyway. So, all he was concerned about was the right allocation of capital and targeting returns on his equity.”

ROE = LR * ATR * NPM —– (Return on Equity)

Although this equation may appear complex at first glance, it is relatively straightforward. A business can achieve a higher Return on Equity (ROE) by employing one or a combination of the following strategies:

1. LR – Leverage Ratio: This involves taking on leverage and using it wisely, often referred to as ‘good debt.’ For example, if my uncle’s shop is successful, even if he doesn’t have the necessary capital, banks would likely be willing to lend him 10 lakhs, which he could borrow at a 9% interest rate to establish a new shop in a neighboring town. If he can generate a 10% return from it, pay 9% to the bank, and enjoy the 1% difference as additional profits.

2. ATR – Asset Turnover Ratio: My uncle doesn’t need to utilize all his capital to achieve a 10k monthly profit. He can optimize his inventory over time by learning about customer tastes, preferences, and seasonal trends. By keeping only 4-5 lakhs worth of clothing in stock at any given time and investing the rest in fixed deposits (FDs) at the bank, he can generate additional returns. This, of course, requires time and market insight to achieve.

3. NPM – Net Profit Margin: This can be a bit challenging to achieve. Instead of buying clothing from the same vendor, my uncle can explore alternative suppliers who offer a limited range at a lower cost. However, he must tread carefully, as this could potentially impact sales if customers seek a wider variety or the latest fashion trends. Alternatively, he might consider increasing the selling price, but this would require a unique selling proposition or a near-monopoly in the town.”

After witnessing my uncle’s success over the years, I couldn’t help but contemplate suggesting an alternative to borrowing money from the bank. Why not use my 10 lakhs to start another shop in a new town, with the aim of enjoying returns higher than what traditional FDs could offer? However, before making such a decision, I considered several factors carefully:

Town Selection: Is he choosing a town with significant potential for sales and growth?
Trustworthiness: Can I trust my uncle’s commitment to the business, especially in light of his past borrowing and repayment history with other individuals?
Equity Fairness: Is he treating me fairly as a minority shareholder in his business, ensuring that he doesn’t allocate excessive expenses for his personal gain, thus diminishing my returns?

These considerations mirror the questions we must ask ourselves before investing in a company in the stock market. Trust, potential for growth, and fairness are crucial aspects in both scenarios.

Thanks to my Uncle who thought me this !

3. Rule of Risk-Adjusted Returns

Although I understood how a business is created and executed, I did not have the right method for valuation. In fact, I didn’t even know what valuation was until I started investing in the stock market and buying shares in businesses.

Thanks to Ben Graham, Uncle Warren, and Aswath Damodaran, they have made a deep impact on my thinking when it comes to valuations. Ben Graham taught me what a margin of safety is, Uncle Warren taught me how to understand it along with the economy, and Aswath Damodaran taught me a whole host of things, including discounted cash flow, which is one of the primary tools I use today.

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I promise to write a dedicated blog on valuation , describing it here will take a lot of space and doesn’t make the blog a pleasure to read

Bank Balance vs. Investment Portfolio: The Choice That Transformed My Finances.

In the early days of my career, I realized something important. I learned that if you just keep your money sitting around doing nothing, it loses value over time because prices go up (that’s called inflation). So, instead of keeping a lot of cash or easily accessible money, I decided to use most of my money by investing it. I put it into things that can grow in value and make me more money, in addition to what I earn from my job.

In my upcoming blog post, I want to share what I’ve learned over the years about inflation, how to protect your money, and how to make it work for you. It’s all about making your money grow and securing a better financial future. I’ll explain it all in simple terms, so it’s easy to understand and apply to your own life.

Unlocking Inflation: Beyond Single-Item Price Hikes to Understand Your True Purchasing Power.

To truly grasp the impact of inflation, we can’t rely on the price increase of a single item. Consider this: ten years ago, a refreshing tender coconut cost you just 20Rs, and today it’s 50Rs – a 2.5-fold increase. If you thought 100Rs in 2013 should now be worth 40Rs, you’d be mistaken. That’s because not all goods and services inflate at the same rate. For instance, while photocopying 10 sheets used to cost 8Rs back then, it’s only 10Rs today.

To gain a more accurate understanding of how inflation affects your life, look beyond individual items. Instead, assess how much you spent on your overall cost of living in 2013 compared to today. If your lifestyle hasn’t drastically changed, this can provide a clearer picture. For example, if you were spending 30,000Rs per month in 2013 for the same standard of living that now costs you 60,000Rs per month, it indicates that the value of the Rupee has effectively halved in the past decade.

And if you haven’t meticulously tracked your expenses, you can turn to government data, like the Consumer Price Inflation (CPI), which illustrates how the Rupee’s purchasing power diminishes year by year. This broader perspective offers a more meaningful insight into the erosion of your purchasing power over time due to inflation.

This is not specific to India but a generic concern across the glob , For instance have a look at how the USD has lost its purchasing power over a century.

Cash is indeed an asset, but it loses value over time due to inflation. – This raises important questions:

Should I keep any cash on hand? -If so, how much cash should I keep?
What alternatives can safeguard our money from inflation?
- Can our investments generate returns exceeding inflation to build wealth?

Balancing Liquidity: How Much Cash do I Keep?

When addressing the questions of whether to keep any cash on hand and how much, it’s crucial to differentiate between liquid and non-liquid assets. Liquid assets, such as cash, gold (not ornaments), and certain online-accessible fixed deposits, are those that can be easily converted into cash with minimal loss of value. Non-liquid assets, on the other hand, include investments like real estate, stocks, or long-term bonds, which can’t be quickly converted to cash without potential financial loss.

For me, ensuring a cash reserve covering two months’ worth of living expenses falls under Cash category. Additionally, I allocate an amount equal to my anticipated expenses over the next two years in the form of liquid assets. The remainder of my wealth is then strategically invested in these non-liquid assets, aiming to generate returns that surpass inflation.

Converting money to Gold / Fixed Deposits give you some returns like 3-4% which might not cover the inflation fully which is normally at 6% in India but protects your money to some extent.

Inflation-Proofing Your Finances: Strategies and Investments.

When it comes to protecting your money from the erosive effects of inflation, there are several strategies to consider. First and foremost, I believe that the most valuable investment one can make is in themselves. This entails continuous learning, acquiring new skills, and staying updated with the ever-evolving opportunities that the world offers. Pursuing certifications, participating in educational courses, devouring books, and applying newfound knowledge through experimentation has been a cornerstone of my financial journey.

Following personal growth, I delve into the world of stocks. Extensive research into listed businesses, meticulous analysis of annual reports, scrutiny of financial statements, and summaries of conference calls are essential steps. I seek companies with strong long-term potential, backed by a robust track record, and hold onto these investments for extended periods. However, for those less experienced or inclined toward active stock market participation, mutual funds present a convenient option. With a skilled fund manager overseeing the portfolio, they provide exposure to diversified investments, albeit with a management fee.

Another avenue worth exploring is real estate, though it’s one I have personally refrained from due to limited digitization in transactions and concerns about fraudulent activities. Nonetheless, real estate can be a valuable non-liquid asset for those who understand the intricacies of the market. Historically, real estate has generally kept pace with inflation, and in some instances, even outperformed it, as attested by those deeply involved in the real estate sector.

The Road to Wealth: Unconventional Investments in an Inflationary World.

When it comes to surpassing inflation and building wealth through investments, the landscape has evolved beyond traditional options. Beyond stocks and real estate, today’s investors have an array of choices, from cryptocurrencies to art and diamonds. Some of these alternative investments have not only shielded against the erosion of the Rupee’s value due to inflation but have outperformed it significantly, boasting annual returns ranging from 20% to a staggering 80%. However, it’s crucial to delve into the ‘why’ behind these investments’ meteoric rise and assess whether they will continue to appreciate in the long term. As the adage goes, “High-risk, high-return,” but it’s equally important to remember that the odds of achieving those returns can be slim.

Financial Success: Tracking Your CAGR and XIRR.

Introduction: The Importance of Tracking Returns for Financial Success.

Investing wisely is a key aspect of personal finance, but it’s equally vital to track and understand the returns on your investments. This tracking provides valuable insights into the growth of our wealth and helps us make informed financial decisions. In this guide, we’ll explore two essential tools for measuring returns: CAGR (Compound Annual Growth Rate) for lump-sum investments and XIRR (Extended Internal Rate of Return) for periodic investments. With a firm grasp of these concepts, we’ll be better equipped to navigate the world of personal finance and investing.

CAGR (Compound Annual Growth Rate): Calculating Returns for Lumpsum Investments.

Let’s start with CAGR, a fundamental metric for evaluating the performance of a lumpsum investment over a specific period. Imagine you invested a sum of money, say $10,000, in a stock portfolio a decade ago. Now, you want to know how well your investment has performed. CAGR comes to the rescue. It calculates the average annual growth rate of your investment, smoothing out the volatility of the market.

CAGR = ((EV/BV)^(1/n)) -1

Where:

EV is the Ending Value of the investment.
BV is the Beginning Value
n is the number of compounding periods (in years).

By applying the CAGR formula, you can determine the average annual growth rate of your investment. This empowers you to make informed decisions based on your investment’s historical performance.

Let’s calculate CAGR using an example:

Suppose you invested Rs 10,000 in a stock portfolio in 2013, and it grew to Rs 18,000 in 2023.

Year	Investment Value (Rs)
2013	Rs 10,000
2023	Rs 18,000

BV (Beginning Value) = Rs 10,000
EV (Ending Value) = Rs 18,000
n (Number of years) = 2023 – 2013 = 10

Using the CAGR formula:

CAGR=(18,000/10,000)^(1/10)−1

= 0.06447 { or } 6.45%

So, the CAGR for your investment over the ten-year period is approximately 6.45%.

Unlocking Wealth with XIRR: Evaluating Periodic Investments.

Now, let’s shift our focus to XIRR, a tool essential for analyzing periodic investments. Imagine you’re contributing varying amounts to your retirement fund each year for ten years. XIRR helps you calculate the annualized rate of return on this irregular investment pattern, providing a more accurate picture of your wealth’s growth.

Let’s consider an example where you make periodic investments in a retirement fund:

Year	Investment Amount (Rs)
2013	Rs 5,000
2014	Rs 6,000
2015	Rs 7,500
…	…
2022	Rs 12,000

To calculate the XIRR, you would use a spreadsheet software like Excel. Here’s how you would set it up:

In an Excel worksheet, list the years in column A and the investment amounts in column B.
In a cell, use the formula =XIRR(B2:B11, A2:A11). This calculates the XIRR for the given investments over the respective years.

Using this formula in Excel, you would find that the XIRR for this periodic investment pattern is approximately 8.72%.( Assumption)

Excel Guide to use XIRR formulae can be found here.

Conclusion: Empowering Your Financial Journey.

In conclusion, tracking our investment returns through CAGR and XIRR is paramount in achieving our financial goals. Whether you’re making lump sum investments or contributing periodically, these tools offer valuable insights into your wealth’s growth. With the knowledge gained from this guide, we’ll not only be equipped to make informed financial decisions but also have the tools to create our own financial tracking system in Excel. So, lets take charge of our financial future and watch your wealth grow!

Summary.

In this comprehensive guide, we delved into the significance of tracking investment returns in personal finance. We demystified the concepts of CAGR and XIRR, providing real-world examples and tables for better understanding. Additionally, we empowered you with the knowledge to develop your own Excel tools for calculating these essential metrics. By mastering CAGR and XIRR, you’ll have the insights and tools needed to make informed financial decisions and achieve your wealth-building goals. So, embark on your financial journey with confidence and watch your investments flourish.

Money Metamorphosis: Embracing ‘Enough’ for a Fulfilling Life.

Introduction: Lost in the Race, Forgotten ‘Enough’.

In the relentless pursuit of wealth, we find ourselves caught in the rat race, often forgetting to pause and ask a fundamental question: how much is truly enough? Reflecting on my own journey, I recall that as a child, I believed having 10 lakhs would make life heavenly. However, with time, my aspirations escalated; from dreaming of 1 crore, I eventually aimed for 100 crores, influenced by societal notions of luxury. Reading “The Psychology of Money” by Morgan Housel unveiled a universal truth – this desire for more is an endless cycle. Even the wealthy yearn for greater wealth: Michael Jordan eyes Jeff Bezos, and Bezos eyes Elon Musk.

In a moment of contemplation, a lingering question emerged within me: “What is the threshold of sufficiency?” Turning to the wisdom of my guru, Acharya Chanakya, I discovered his profound insight: “

the moist important thing for a happy life is satisfaction. If you are satisfied with life then there will be no problem in your life.”To be satisfied , one must know how to control his senses. No one is happier than the person who is satisfied by controlling his senses.”

Thus began my quest to explore the concept of “enough.”

The Cost of Chasing More: Tragedies Unveiled.

Conversations with my friends opened my eyes to some harsh realities. One friend had spent ten years building up money, but lost it all in just a few months by trading in ways that were very risky. He was convinced by his colleagues that he could make more money quickly by trading instead of saving for a small piece of land.

Another friend shared that their family ran a chit fund, but things went wrong and they lost all the money they were taking care of for others. This led them to bankruptcy.

While growing up, I saw many people from lower middle-class families lose everything because they hoped to get rich quickly. They gambled all their money, even the little they had, just to avoid the shame of being broke.

My own family also struggled with money. We had times when we had to walk a long way to save a small amount of money, just to buy a simple snack.

Seeing all of these situations shaped how I handle money. It made me wonder: Is it really worth it to chase after money so much that we lose out on life, time for ourselves, and our self-respect?.

Purpose and Passion: The Dual Pathways of Life.

As we progress through life, our selection of business or profession naturally transforms. For certain individuals, their work becomes a channel through which they find a profound sense of purpose and fulfillment. However, contrasting this, there are those who find themselves trapped in roles that bring about dissatisfaction and resentment.

Irrespective of the specific circumstances, the notion of constructing a financial corpus gains paramount importance. This corpus serves as a reservoir of financial resources, a reservoir that is integral to attaining a state of financial independence. This state liberates individuals from the compulsion to work solely for monetary gain, thereby affording them the luxury to delve into their passions and interests with unbridled enthusiasm.

In essence, the strategic accumulation of wealth doesn’t solely cater to material acquisitions, but rather, it acts as a conduit to a more profound form of freedom. This freedom extends beyond merely quitting a disliked job; it empowers one to explore their innate potential, nurture their creative endeavors, and lead a life aligned with their true aspirations.

Unleashing the Potential: The Miraculous 2 Crore Corpus.

Let’s consider a scenario where an individual, through ethical means, manages to accumulate 2 crores in their business or profession. Imagine this sum being invested in an Indian index fund, which hypothetically yields a 9% year-on-year return (being conservative here, considering that historically NIFTY has averaged 12%). Suppose this person withdraws 1 lakh every month for 30 years, allowing the remainder to continue compounding. Surprisingly, at the end of these 30 years, the corpus would still amount to a substantial 10 crores!

This prompts us to question: do we truly require such a substantial amount of money? With age, our need for extravagant luxury often diminishes. By having comprehensive health insurance in place, monthly expenses could be significantly reduced.

After conducting this thought experiment, I found myself taken aback and pushed to delve deeper. Could I realistically aim to amass 2 crores and attain a form of financial independence? Certainly, this wouldn’t imply ceasing work, but rather, it would infuse a heightened sense of confidence and contentment into life. Wouldn’t that be a valuable achievement?

I’m not certain if 2 crores is “The” figure that applies to me. What I wish to emphasize to the reader is that each individual should take a pen and paper to ascertain this number. Without doing so, breaking free from the rat race can seem nearly impossible.

Here is a tool that could help you to speedup in the process https://cleartax.in/s/swp-calculator.

Embracing Authenticity: Escaping Unfulfilling Pursuits.

Upon reaching the juncture where our accumulated corpus is capable of consistently generating the desired monthly revenue while also undergoing substantial compounding, a pivotal decision arises. This crossroads invites us to consider bidding farewell to the professions that evoke our disdain or the jobs that no longer kindle our interest. The financial security provided by the self-sustaining corpus can empower us to relinquish roles that once held us captive in the pursuit of monetary gains, paving the way for new chapters aligned with our genuine passions and aspirations. This transition signifies a transformative shift from obligation to choice, from the compulsion of necessity to the liberation of fulfillment.

Dharma’s Light: Transforming Desires into Destiny.

Here come the natural question how do i find my passion?

Well its not that easy to answer , but not difficult either …

I can only quote some awakening links from the Sanathana Dharma.

Dharma is your unique purpose in life. It is the process by which you use your unique skills and passions to serve your community and the world.

There is a phrase in the Upanishads, one of the great Indian texts, that says:

” You are what your deepest desire is,

As is your desire, so is your intent,

As is your intent, so is your will,

As is your will, so is your deed,

As is your deed, so is your destiny. “

Wisdom from Mahabharata: Navigating the Battle Within for a Noble Life.

As we embark on the quest to discover a meaningful purpose for our lives, it’s crucial to bear in mind the insightful encapsulation of the Mahabharata by a wise individual:

“Mahabharata in a metaphorical way: the battle of Mahabharata is, actually, the battle between the good and evil present in ourselves; this means that we are composed out of forces of evil and of good. Our mental condition is not void: forces of evil and of good are present in us. Therefore, we cannot wait and see: we ought to take a decision on our moral constitution.”

Unleashing Prosperity: The Mighty Role of Banks in Economic Empowerment.

Imagine the Bank as a Village Marketplace:

Think of a bank as a bustling village marketplace where people come to both buy and sell. The bank acts as a bridge between those who have extra money to spare (sellers) and those who need money (buyers). Let’s break down the two main services banks provide: lending and depositing.

Lending Services – The Loaning Booth:

The Story of Raj’s Dream Car: Meet Raj, who dreams of owning his first car but lacks enough money. He visits the bank’s “Loaning Booth” and asks for a loan to buy the car. The bank agrees to lend him the money, which he agrees to pay back over time.

Interest: The Bank’s Reward: Here’s where the bank makes money. When the bank lends Raj the money, it adds a little extra charge called “interest.” This is like a small fee for Raj to borrow the money. Raj promises to repay the initial loan amount plus interest in manageable installments.

Savings Deposits Fuel Lending: Now, you might wonder, where does the bank get the money to lend to Raj? This is where the deposit services come in.

Deposit Services – The Savings Hut:

Priya’s Savings Story: Enter Priya, who works hard and saves her money. She visits the bank’s “Savings Hut” and opens a savings account. She deposits her savings there.

Banks Borrow from Savers: The bank doesn’t simply store Priya’s money; it uses some of it to lend to people like Raj who need loans. The bank borrows Priya’s money, agreeing to pay her interest for using her money.

Difference in Interest: The bank charges a higher interest rate on loans (like Raj’s car loan) than it pays to savers (like Priya). This difference in interest rates is one way the bank makes money. The higher interest earned from loans helps cover the interest paid to savers and results in a profit for the bank.

How Banks Manage Cash and Assist the Government and People.

Banks play a crucial role in managing money flow in the economy. They help the government and people by offering safety for their funds, assisting with payments, and supporting financial planning. For instance, when the government collects taxes or pays salaries, banks are involved in routing these funds securely. Similarly, when you pay your electricity bill online, the bank ensures the money reaches the right place. Banks also provide services like fixed deposits, helping people save money and earn interest over time.

Banks’ Role in Recording and Facilitating Transactions.

Banks help record and facilitate transactions by providing account statements, receipts, and transaction histories. Think of your bank account as a digital diary of all your financial activities. When you receive your salary or make a purchase, the bank keeps a record. This record-keeping helps you and the bank track your spending and income. If you ever need to prove that you paid a bill or received money, your bank statement is like your evidence.

Banks’ Relationship with Central Banks, Repo Rate, and Reverse Repo Rate.

Banks have a special connection with a “big boss” bank known as the Central Bank. This big boss, called the Reserve Bank of India (RBI), makes important decisions about the country’s money and interest rates. Two crucial interest rates are the “Repo Rate” and “Reverse Repo Rate.” Think of these rates as levers the RBI uses to control the economy’s speed.

Repo Rate: When the economy needs a boost, the RBI lowers the Repo Rate. This encourages banks to borrow money from the RBI at a lower cost. The banks then have more money to lend to people like Raj who want loans for cars or homes.
Reverse Repo Rate: When the economy is growing too fast, the RBI increases the Reverse Repo Rate. This makes it more attractive for banks to deposit money with the RBI instead of lending it. As a result, there’s less money available for people to borrow, which helps slow down the economy.

So, just like a parent steering a bicycle, the RBI uses these rates to keep the economy balanced and moving at a healthy pace.

By using relatable Indian names and examples, you can make these concepts more accessible to readers with limited understanding of the financial system.

Summary:

Banks are the powerhouse of our financial world, connecting dreams to reality. From lending a hand to aspiring car owners like Raj, to safeguarding the earnings of diligent savers like Priya, banks bridge the gap between aspirations and achievements. By strategically managing cash flow, facilitating transactions, and collaborating with central banks, they play a pivotal role in maintaining a healthy economic engine.

The Power of Patience: Unlocking Wealth with Compounding in Long-Term Investing.

Image credit : Tradebrains.in

Understanding Stock Movements: Long-Term Business Growth vs. Short-Term Speculation.

When it comes to stock movements, investors often witness two main driving forces: long-term business growth and short-term speculation. Business growth refers to the underlying performance of a company, including revenue growth, profitability, market share, and expansion plans. These factors influence the stock’s value over the long run and attract investors seeking sustainable returns.

On the other hand, short-term speculation is driven by market sentiments, news, rumors, or macroeconomic factors that cause rapid price fluctuations. Speculative investors aim to capitalize on short-lived price movements and often trade frequently based on these transient factors.

Understanding the distinction between these two forces is crucial for successful investing. Long-term investors focus on the fundamentals of the business, studying its competitive advantage, management team, industry trends, and growth potential. They ride the ups and downs, confident that the company’s strong fundamentals will drive the stock price over time.

Weathering the Storm: The Initial 5-10% Stock Dip.

One of the most nerve-wracking experiences for investors is witnessing their newly invested stock take a nosedive shortly after buying it. It’s essential to remember that the stock market is highly volatile and influenced by a myriad of factors, including investor emotions and speculative activities. A short-term dip in stock price doesn’t necessarily reflect the true value of the company or its long-term prospects.

To navigate these turbulent waters, investors must resist making impulsive decisions driven by fear and instead remain focused on their investment thesis. They should evaluate the reasons for the dip, discerning whether it’s related to business fundamentals or merely market sentiment. Often, such temporary declines present an excellent opportunity to accumulate more shares at a discounted price, amplifying future gains when the stock eventually rebounds.

The Long Horizon: The Importance of Conviction in Investing.

Investing with conviction means having complete faith in the companies you invest in and their long-term growth potential. Conviction-driven investors don’t panic during short-term market fluctuations because they have extensively researched the company’s financial health, competitive landscape, and management credibility.

When investors adopt a long-term perspective, they align their goals with the company’s growth trajectory, understanding that businesses experience ups and downs over time. Warren Buffet, one of the most successful investors, famously said, “Our favorite holding period is forever.” This approach emphasizes the value of patience, allowing the compounding effect to work its magic over extended periods.

Unveiling the Magic of Compounding Effect: A Tale of Two Investments with a small difference of returns per year.

A small investment of 15,000 INR per month consistently for 15 years in an asset that is generating 15% per annum would make one a “CROREPATI.” The key lies in selecting the right asset and staying the course consistently. Despite the investment being only around 27lakhs, the power of compounding and the choice of a high-yielding asset can lead to extraordinary wealth.
The only difference between Investment 1 and Investment 2 is the asset yield. In Investment 1, it was 15%, while in Investment 2, it was 14%. At first glance, this might seem like a small difference, but over the course of 10 years, it has made a significant impact, resulting in a difference of around 10lakhs in the final cumulative value. This underscores the remarkable effect even a slight variation in returns can have on long-term investments.

Embracing the Einstein Effect: The Power of Compound Interest.

Albert Einstein famously said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” This statement not only applies to financial investments but resonates in various aspects of life.

Whether in relationships, knowledge acquisition, or building healthy habits, compounding plays a crucial role. The earlier you start investing, the more time compounding has to work in your favor. This concept underscores the importance of starting early, being patient, and staying committed to the process.

In conclusion, the path to financial success lies in embracing the power of patience and compounding in investing. By understanding the true drivers of stock movements, maintaining conviction in solid investments, and harnessing the magic of compounding, investors can unlock the full potential of their wealth. Remember, fortune favors the patient and disciplined, and the wonders of compounding can transform your financial journey into an extraordinary one.

Warren Buffet’s Million-Dollar Challenge: Index Investing vs. Hedge Funds

In 2008, Warren Buffet, the renowned investor and CEO of Berkshire Hathaway, issued a daring challenge to Ted Seides, a prominent hedge fund manager. Buffet offered Seides a staggering sum of 1 million USD and proposed a decade-long bet to determine which investment strategy would reign supreme: index investing or hedge funds. This captivating challenge was born out of Buffet’s strong belief in the merits of index investing and his desire to shed light on the often-controversial world of hedge funds.

Overview of Hedge Funds and Index Investing:

Hedge funds and index funds represent two distinct approaches to investing in the financial markets. Hedge funds are private investment funds managed by skilled professionals who aim to generate substantial returns for their clients. These managers often employ various strategies, including leveraging, which involves borrowing money to amplify potential returns. While leverage can magnify gains, it also significantly increases risk, potentially leading to substantial losses if the market moves against the fund’s positions. This approach can be appealing to some investors seeking higher returns, but it comes with higher levels of complexity and risk.

On the other hand, index investing, epitomized by funds that track well-established market indices like the S&P 500, adopts a more passive approach. Instead of attempting to beat the market, index investing seeks to replicate its performance, offering investors exposure to a diverse portfolio of stocks in proportion to their representation in the index. This strategy typically involves minimal leverage and lower costs compared to actively managed hedge funds.

It is important to note that while hedge funds are prevalent in many parts of the world, including the United States, they are not widely present in India due to regulations set by the Securities and Exchange Board of India (SEBI). SEBI has been cautious about allowing hedge funds in India due to concerns about increased risk and potential mismanagement of leverage, as well as the need to protect retail investors from complex and high-risk investment products.

The Decade-Long Battle: A Table of Results

Here’s a summary of the performance of Warren Buffet’s chosen S&P 500 index fund against the hedge fund managed by Ted Seides over the ten-year period:

Summary:

As the dust settled after ten years, Warren Buffet emerged victorious in his legendary wager against the hedge fund manager Ted Seides. The numbers showcased the undeniable power of patience and a long-term perspective in the stock market. Buffet’s index fund, with its steady and consistent growth, outperformed the more complex and actively managed hedge fund. This triumph aptly echoes Buffet’s timeless wisdom that the stock market is a mechanism for transferring wealth from the impatient to the patient, emphasizing the enduring value of index investing as a strategy for long-term success.

Thanks to Sashwath Sawminathan for introducing me to this instance

For More on Mutual Funds Read my Part 1 and Part 2 Blogs.

ROE vs. ROCE: The Ultimate Showdown for Financial Success!

Returns are the lifeblood of any financial endeavor, whether it’s personal finance or running a business. They represent the gains or losses generated from investments or operations over a specific period. In personal finance, returns are essential to measure the performance of investments, savings, and overall financial well-being. For businesses, returns play a crucial role in the Profit and Loss (PnL) statement, indicating how effectively the capital invested is being utilized to generate profits. Analyzing and understanding returns can provide valuable insights into the effectiveness of financial decisions and the potential for growth.

Return on Equity (ROE)

In personal finance, when you book a Fixed Deposit, you expect returns, which are measured as a percentage of the capital deployed. In India, it could range from 5-8%, depending on the economic circumstances. Similarly, companies also invest shareholders’ money into the business, which is called Equity Capital or Shareholders’ Capital, and this is expected to generate returns for the shareholders. This is called Return on Equity (ROE). If the company is generating a lesser ROE than the FD rates, then it simply means that even without running the business, had they just booked that money as an FD, they could have achieved better returns. On the other hand, the company is running a healthy business if the ROE is way beyond the prevailing FD rates.

ROE = Profit After Tax ( PAT) /Equity

(or) ROE = Earnings Per Share (EPS)/ Book Value Per Share (BVPS)

This metric is particularly vital for shareholders and investors as it indicates the company’s ability to reward them with significant returns on their investments.

Return on Capital Employed (ROCE)

If you find an opportunity where you can get a loan at 2% interest, and there is a bank that gives you 5% interest on a Fixed Deposit, wouldn’t you grab this opportunity? This is called Arbitrage, and there are companies who have mastered this and take debt to run the company, in addition to the equity funds from the shareholders. In such scenarios, apart from ROE, an important measure to check is whether the company is generating more money from the capital deployed to pay interest and still retaining some earnings or not. This measure is called Return on Capital Employed (ROCE).

ROCE = Earnings Before Interest and Tax (EBIT) / Capital Employed

(or) ROCE = Earnings Before Interest and Tax (EBIT) / Equity + Debt

ROCE is crucial because it assesses how efficiently a company uses all available capital to generate profits, including both its own and borrowed funds. It is an essential metric for business owners and management as it highlights the company’s operational efficiency and overall financial health.

Typical Values of ROE and ROCE

Typical values of ROE and ROCE can vary significantly across different industries.

Industries with high capital requirements, such as manufacturing or infrastructure, may generally have lower ROE figures due to significant investments in assets. On the other hand, industries that rely heavily on intangible assets, like technology companies, tend to have higher ROEs. A good ROE value varies depending on the company’s size, industry norms, and its growth stage.

As for ROCE, a figure higher than the company’s borrowing costs suggests efficient utilization of capital, while a value lower than the borrowing costs may indicate ineffective capital deployment.

Taking TCS India as Example.

PAT and EBIT can be found in the PnL Statement , Equity and Debt could be found in the Balance Sheet and below is a simple Example .

Financial Summary of TCS can be found here and we could consider for FY 22-23

Parameter	Value ( in Crores)
PAT	42303
EBIT	59259
Equity	366+90058 = 90424
Debt	7688
ROE = PAT / EQUITY	46%
ROCE = EBIT / Debt + Equity	60%

ROE of 46% and ROCE of 60% is really huge because they don’t have huge CAPEX and its in a service industry.

Summary

Both ROE and ROCE are essential financial metrics that provide valuable insights into a company’s performance and efficiency. ROE mainly focuses on the returns generated from shareholders’ investments, making it crucial for investors and shareholders. ROCE, on the other hand, takes a broader view by considering all capital employed, making it more relevant for business owners and management. While ROE is essential for assessing shareholder value, ROCE helps gauge the overall operational efficiency and profitability of a company. Ultimately, understanding both metrics and their implications can empower individuals and businesses to make informed financial decisions and drive sustainable growth.

Unlocking the P&L Statement: A Practical Guide for Non-Finance Investors.

Introduction

While one attempts to analyze the Financial Health of the company, understanding the profit and loss statement (P&L) is essential. Unlike the balance sheet, which reflects a company’s financial position over time, the P&L statement focuses on the efficiency of business execution within a specific year.

Join us as we unravel the construction of a P&L statement from scratch, exploring how it starts anew each year to capture the financial outcomes of the company’s activities. Discover how this dynamic snapshot measures revenue, expenses, and overall profitability, showcasing the current year’s performance.

In this beginner’s guide, we’ll break down the key components of a P&L statement and their significance for stock analysis. Whether you’re new to finance or come from a non-financial background, this guide aims to equip you with the knowledge to interpret and utilize the P&L statement effectively.

Let’s embark on this journey together, demystifying the complexities of the profit and loss statement and empowering you to make informed stock analysis decisions.

Building the Foundation: An Empty Profit and Loss Statement at the Beginning of the Year.

At the start of a new fiscal year, the profit and loss statement (P&L) begins as a blank canvas, waiting to be filled with the financial outcomes of a company’s operations. This empty P&L statement serves as a starting point for recording and organizing revenue, expenses, and ultimately determining the profitability of the business. To help visualize this process, let’s take a look at a simplified table representing an empty P&L statement at the beginning of the year:

Heading	Amount (₹)
Revenue	0
Expenses	0
Net Income/Loss	0

An empty P&L at the beginning of the year.

In this initial state, the table includes three key sections: “Revenue,” “Expenses,” and “Net Income/Loss.” Each section begins with a Zero, indicating that no financial figures have been recorded yet. As the year progresses, revenue and expenses will be added, ultimately resulting in the calculation of net income or loss. The beauty of the P&L statement lies in its ability to capture and summarize the financial performance of the company as events unfold throughout the year.

Recording Transactions: Adding Entries to the Profit and Loss Statement.

To illustrate how transactions are recorded in a profit and loss statement (P&L), let’s examine a scenario where a company engages in various activities. We will update the table accordingly to reflect these transactions. Imagine that the company purchases raw materials worth 1000 Rs, incurs a labor charge of 200 Rs, and pays rent for the workspace amounting to 5000 Rs. Here’s an updated table showcasing these entries in the P&L statement:

Heading	Amount (₹)
Revenue	0
Expenses
– Raw Materials	-1,000
– Labor Charges	-200
– Rent	-5,000
Operating Income/Loss	-6,200

Purchase and Expense related Entries.

In this updated table, we have added three expense entries: “Raw Materials,” “Labor Charges,” and “Rent.” Each expense reflects the corresponding amount spent on the specific transaction. As these entries are recorded, the profit and loss statement gradually takes shape, providing a comprehensive overview of the company’s financial performance. The P&L statement serves as a valuable tool for analyzing the efficiency and profitability of business operations as more transactions and events unfold throughout the year.

Capturing Sales and Revenue: Updating the Profit and Loss Statement.

As the company continues its operations, it’s time to record another transaction that involves the sale of a product previously manufactured. Let’s imagine that the company sells a product for 10000 Rs. This transaction impacts the revenue section of the profit and loss statement (P&L). Let’s update the table to reflect this entry:

Heading	Amount (₹)
Revenue	10,000
Expenses
– Raw Materials	-1,000
– Labor Charges	-200
– Rent	-5,000
Operating Income/Loss	3,800

Sales related Entries.

In this updated table, we can now see a new entry under the “Revenue” section representing the sale of the product. The amount of 10000 Rs reflects the revenue generated from the sale. As more transactions occur and entries are made, the profit and loss statement gradually transforms into a comprehensive financial snapshot, providing insights into the company’s performance. By tracking revenue and expenses, the P&L statement enables analysts to assess the profitability and efficiency of the business.

Finalizing the Year: Taxes, Balance, and the Profit and Loss Statemen.

In our example, it’s time to wrap up the fiscal year and introduce the concept of taxes and the transfer of profit to the balance sheet. Please note that the following example includes simplified transactions for illustrative purposes, while real-world scenarios can be more complex. However, the fundamental principles of recording transactions remain the same.

Let’s assume that at the end of the year, a 25% tax is applicable to the net profit. Additionally, any remaining profit, after deducting taxes, is typically transferred to the balance sheet for future use. Here’s the updated table showcasing these additions:

Heading	Amount (₹)
Revenue	10,000
Expenses
– Raw Materials	-1000
– Labor Charges	-200
– Rent	-5000
Operating Income/Loss	3800
Taxes (25%)	-950
Net Income/Loss(Profit – Balance)	2850

Finalized P&L Statement at the end of the year.

In the updated table, we have introduced two new entries: “Taxes” and “Balance (Profit).” The taxes amount to 25% of the net profit, resulting in a deduction of 950 Rs. The remaining profit, after tax deduction, is referred to as the balance or retained earnings, which in this example amounts to 2850 Rs.

While this example demonstrates a simplified scenario, it highlights the importance of considering taxes and the transfer of profit when finalizing the profit and loss statement. The P&L statement, with its dynamic nature, provides valuable insights into a company’s financial performance, enabling investors and analysts to assess its profitability.

Summary.

Understanding Operating Profit Margin and Net Profit Margin: Key Performance Indicators.

Operating Profit Margin (OPM) and Net Profit Margin (NPM) are essential metrics for evaluating a company’s operational efficiency and profitability. OPM is calculated by dividing operating profit by revenue, while NPM is determined by dividing net income by revenue. In our example, the OPM is 38% (3800/10000), and the NPM is 28.5% (2850/10000). I Consider these figures as extremely good, as achieving an OPM of 15% and an NPM of 8% consistently year over year is challenging for most companies. Monitoring OPM and NPM provides valuable insights into a company’s ability to generate profits and aids in making informed investment decisions.

Future Read.