Impact of RBI policies on stock markets

Interest is nothing more than the cost someone pays for the use of someone else's money. Homeowners, credit cards users etc know about this scenario very well. They borrow money from bank and in return they pay interest to bank for using the privilege. Interest rate is an integral part of our spending habit as we borrow from the bank for buying house, cars, house old items etc. For the business community interest rate is also very important as they borrow money from bank for investment activities like capacity expansion, setting up of plants, acquisitions, modernization etc. So interest rates play a critical role in a business’s profitability and hence, on stock prices.

SO WHAT INTEREST RATE AM I TALKING ABOUT HERE?

REPO RATE. This is the interest rate that applies to investors. This is the cost that banks are charged for borrowing money from The Reserve Bank of India. Why is this number so important? It is the way RBI attempts to control inflation. Inflation is caused by either excess Aggregate Demand or cost push factor (supply side factors), which causes prices to increase. By influencing the amount of money available for purchasing goods, RBI can control inflation. Basically, by increasing the Repo rate, the RBI attempts to lower the supply of money by making it more expensive to obtain. Though sometimes CRR cut also acts a stimulant in lending rate changes, repo rate has an edge over CRR in terms of deciding lending rates.
 

HOW DOES IT AFFECT STOCK PRICES?

Interest rate and stock prices have an inverse relationship or I can say their relationship is like a SEESAW. Changes in the Repo rate affect the behavior of consumers and businesses, but the stock market is also affected. One method of valuing a company is to take the sum of all the expected future cash flows from that company discounted back to the present. To arrive at a stock's price, take the sum of the future discounted cash flow and divide it by the number of shares available. This price fluctuates as a result of the different expectations that people have about the company at different times. Because of those differences, they are willing to buy or sell shares at different prices.

If a company is seen as cutting back on its growth spending or is making less profit - either through higher debt expenses or less revenue from consumers - then the estimated amount of future cash flows will drop. All else being equal, this will lower the price of the company's stock. If enough companies experience declines in their stock prices, the whole market, or the indexes (like the BSE Sensex or NSE Nifty) that many people equate with the market, will go down.

Following points are also worth taking note-

Capital intensive industries such as real estate, automobiles etc are highly sensitive to interest rates but when the interest rates are lower they would be gaining the most.

Companies with a high amount of Debts would be affected very seriously. Interest cost would go up and hence affecting their EPS and ultimately the stock prices.

Pharma sector does not get much affected with the interest rates. Pharma is considered as the defensive sector (now more of a Growth Sector) and investors can invest here during uncertain and volatile market conditions.

In a high interest rate scenario, companies with zero or near zero debts in their balance sheets would be kings. FMCG or fast moving consumer goods is one sector that’s considered as a defensive sector due to its low debt nature.

High rates have an immediate impact on profits, and so affect a bank’s stock price as well. One more major reason is that they have a low Debt Equity ratio. The Spread (the difference between the interest they earn on the money they lend and the interest they pay to the depositors) for banks is likely to increase leading to growth in profits & the stock prices.

The following data depicts the changes made by The RBI since September 2010 and its impact on Sensex.

Date	New Repo rate	Change in Sensex
16-Sep-10	6%	-85
2-Nov-10	6.25%	-10
25-Jan-11	6.50%	-180
17-Mar-11	6.75%	-200
3-May-11	7.25%	-460
16-Jun-11	7.50%	-150
26-Jul-11	8%	-363
16-Sep-11	8.25%	57
24-Oct-11	8.50%	144
16-Apr-12	8%	56
30-Jan-13	7.75%	14
19-Mar-13	7.50%	-285
3-May-13	7.25%	-160
20-Sep-13	7.50%	-352
29-Oct-13	7.75%	359
18-Dec-13	7.75%	265
28-Jan-14	8%	24

The above table shows that Sensex reacted negatively whenever repo rate was hiked post September 2010. As a matter of fact, on 03-May-2010 when The RBI hiked repo rate by 50bps, the Sensex plunged by 460 points. However, when repo rates were upped to 8.25 percent and 8.50 percent respectively from their previous levels, market in fact reacted positively as India was driven by strong economic growth during that time and the rate has reached to its stability. A 50 basis point hike in the rates on 28-Jan-14 failed to create any stimulus in the market as Sensex moved only 24 points.

Change in repo rate has “Mumbo Jumbo” effect on stock market. Increase in repo rate not only increases the cost of debt/capital for business but it also shifts the investment in favour of deposits which offer higher rate of return. The same happens when the repo rate is trimmed. The market may or may not react significantly to a rate cut of 25 bps but the real impact comes over only after a period of time.

2015 will be a good year but not as good as 2014 was since 2015 may not see some wonderful rallies which took Sensex and Nifty to their lifetime high. However one thing that could trigger a rally in Sensex and Nifty will be the possible rate cut by the RBI in the New Year. Apart from Banking and Finance companies being the direct beneficiaries of the rate cut, companies with high debt capital structure will also benefit.  Expecting a rate cut by the RBI, I recommend the readers to consider the following stock:

- Bajaj Electricals

- Future Retail

- Tata Communications

- HDFC Bank Ltd

- ICICI Bank Ltd

DISCLAIMER: Among many other factors to be considered while investing in stocks market, interest rate is one of them. One can never say with confidence, therefore, that an interest rate hike will have an overall negative effect on stock prices.

M&A - the game

Mergers & Acquisitions - Synergies

Synergies refer to expected cost savings, growth opportunities, and other financial benefits that occur as a result of the combination of two companies. A correct estimation of synergies is needed to produce a successful transaction. The combination of two entities will not create value if the value of synergies is zero or negative. The synergy from a merger or an acquisition is the value of the combined entity minus the fair value of the two firms as separate entities. The fair value is the true or intrinsic value of the entity exclusive of any element of value arising from the expectation of a merger or acquisition. The gain in value of the combined entity is the present value of the synergy cash flows.

The size and degree of likelihood of realizing potential synergies plays an important role in framing the purchase price of acquisition. Due to their critical role in valuation and potential to make or break a deal, investment bankers need to understand the nature and magnitude of the expected synergies carefully. The buy-side team (investment bankers on acquirer side) must ensure that the synergies are accurately reflected in the financial model and M&A analysis, as well as in communication to the investors and markets.
Synergies arise from the increase in size of expected future cash flows (the additional cash flows resulting from the combination of assets). The additional cash flow for a given year may arise from:

Revenue Synergies
Revenue synergies refer to the enhanced sales growth opportunities presented by the combination of businesses. A typical revenue synergy is the acquirer’s ability to sell the target’s products through its own distribution channels without cannibalizing existing acquirer or target sales i.e. The post merger combined entity is expected to sell more than the two merged firms separately (selling the same products to more clients, more products to the existing client base, or both). Also, revenue synergies occur as the combined entity may get a larger market share that enables it to raise the price of its products. Another revenue synergy occurs when the acquirer leverages the target’s technology, geography presence, or know-how to enhance or expand its existing product or service offerings.
Revenue synergies tend to be more speculative than cost synergies. As a result, valuation and M&A analysis typically incorporate conservative assumptions regarding revenue synergies.

Cost Synergies
Cost synergies, which are easily quantifiable, tend to have a higher likelihood of success than revenue synergies. Cost synergies are also rewarded by the markets via stock price appreciation. Typical cost synergies include headcount reduction, consolidation of overlapping facilities, and the ability to buy key inputs at lower rates due to increased purchasing power. Increased size of the acquirer provides for economies of scale i.e. larger companies are able to produce and sell more units at a lower cost per unit than smaller competitors.
Decrease in operating costs as a result of the combination (2+2=3): Reduction in overhead expenses (discounts for raw material purchase due to increase in quantity) and economies in marketing and distribution generally lead to an improvement in cost of goods sold and selling and general and administrative expenses.
Decrease in the capital requirements of the combined entity: Capital requirements are the new investments required in working capital and fixed assets. For example, after a merger, the combined entity may be able to use its combined assets more efficiently by cross-using factories on a regional basis.

Likelihood and Timing of Synergies Realization
The business combination will project various benefits, some of which have a very high likelihood of success while others may be long shots. For example, the likelihood that the administrative costs associated with the target’s board of directors can be eliminated is about 100%. Conversely, achieving certain sales goals against stiff competition is probably far less definite. These differences must be noted and allowed for in the forecast.
The timing of synergies realization is very important. The successful and timely delivery of expected synergies is extremely important for the acquirer. Failure to achieve the synergies can result in share price decline as well as weakened support for future acquisitions from shareholders, creditors and rating agencies. A McKinsey study points out – ‘Unless synergies are realized within, say, the first full budget year after consolidation, they might be overtaken by subsequent events and wholly fail to materialize.’

The net present value of synergies can then be valued with the usual discounted-cash-flow model.

Mutual Funds - A beginners guide!

Hello friends, today we will learn about mutual funds in general..

Let's take example of a person..

An Investor has got INR1000 for investment. He wishes to spend his money in buying shares of start-up companies in India since he had been completely bowled over by reading the success stories of people who invested in shares of start-up companies. However, he faced many road blocks for carrying out his decision to invest in the start-ups. Some of them were lack of knowledge about different companies in the start-up sector, illiteracy of technicality in investment in shares, absence of professionals to guide and above all, insufficient amount of money to invest in all the companies.

Here is why Mutual funds become life saver in these types of situations.

Mutual Funds are created and run by companies called Asset Management Company (AMC) which invites people of like-minded financial goals to pool their money. This sum which is now handed over to the AMCs’ will be professionally managed and parked in the appropriate stocks of companies in Start-up sectors which is identified to be potential return-givers to those investors. In short, a layman gets to use his own money in a wise manner with the guidance of professionals in stock markets and for the shares he desired. Profits/returns generated by these AMCs’ will be handed over to these investors after deducting the fees charged for services AMCs’ provided and it will be distributed in the proportion in which investors pooled-in their money. Total value of the market price of stocks included in the mutual fund divided by the number of units of mutual fund distributed to investors is termed as NET-ASSET-VALUE (NAV) on the basis of which each unit of that particular mutual fund is available in the market.

How to go if you want to invest in Mutual funds?

1. Approach the banks or other AMCs’ to open a demat account and a trading account.

2. Submit Photograph, PAN card, Name and Address proof, Bank Account Details and KYC Compliance.

3. Decide the right kind of mutual fund to achieve your financial goals (AMCs’ will guide you in that area).

4. If an equal amount of money is to be consistently invested in the future, it is better to choose SIP investment than investing manually every time. (SIP stands for Systematic Investment planning which allows one to buy units on a given date each month or quarter automatically by a standing instruction from the bank)

5. Keep a track of NAV when bought, number of units purchased and latest value of MF as on date so that you know whether you are on a profit or loss.

Expenses an investor has to incur for mutual funds are entry load (one-time-fee charged at beginning of investment; Rs.100-150/-), Exit load (at the time of redemption; 1%-3%) and recurring charges (during the time period of investment; max.2.5% p.a on AUM).

Mutual funds are not fully risk-insulated since its risk lies on the stocks in which it puts the money. However, one way to assess a fund’s level of risk is to look at how much its returns change from every year. If the fund’s returns vary a lot, it may be considered higher risk because its performance can change quickly in either direction.

Investing in mutual fund gives many benefits in one package like professional guidance, umpteen stock choices, low costs, risks reduction, liquidity etc. However, like every other financial instrument, it requires time and patience to grow your money through mutual funds. Best advice that can be given is START EARLY AS POSSIBLE.