RATIO ANALYSIS

Definition of 'Ratio Analysis' 

A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis.

There are many ratios that can be calculated from the financial statements pertaining to a company's performance, activity, financing and liquidity. Some common ratios include the price-earnings ratio, debt-equity ratio, earnings per share, asset turnover and working capital.

Ratio Analysis is a widely used tool in Financial World. Not, alone for finance management ,even for day-to-day usage and for Business an efficient user. Let us see with an Example.  

                

Let us consider your salary as monthly Rs.35,000 / -.Your savings are monthly 15,000/- That means in ratio your savings are (12,000/35,000) is 34 %.We are comparing your savings with your salary. But your friend who is also earning the same salary is saving Rs.15,000/-, that is 42 %. After thorough analysis and research when comparing your expenses with your friend you can come to a conclusion that you can still save some amount larger than say 35%. So, in future your savings may be 35%. After this ratio analysis you are managing and improving yourself.  

                

Like the same manner, the stocks you ought to buy various ratios are compared with their competitors and you can assess the Efficiency of the purchased stock. Ratio Analysis is a very big ocean and here we are taking some important ratios. The ratios can be classified according to,

1)     Based on gain,

2)     Based on Operations,

3)     Based on Efficiency Management,

4)     Based on Company’s Debts ……etc..  

Let us see the Gain based ratio :-

        

The company BHEL accounts statement ending with the financial year March – 2010, is given below. It is a general format.

a)     Gross sales Turnover – 33226.25 Crores.

b)     Stock Adjustments     -   786.65    Cores.

c)     Total Expenses           -  27913.71 Cores.

d)     Operating Profit          -   6099.19   Cores.  ( 33226.25 + 786.65 – 27913.71)

Operating profit is termed as gain before Interest, Depreciation and Income Tax. It means 

Net sales minus Direct Expenses  = Net Profit.

Now we can see the Operating Profit Margin.

O.P.M      =      Operating Profit / Net Sales.   

According to the above the financial year ending March – 2010, Operating profit Margin is 18.4 % ( 6099.19 / 33226.25 )

        

Likewise Net Profit ( Net gain ) Margin is also very useful.

Net Profit Margin = Net Profit / Gross Income.

Net sales when added with other income with stock adjustments gross income may be obtained. 

For the BHEL Company other income ( Either through Investments, sale on assets, or any other income not connected to the business ) is 

a)     1085.73 Cores

b)     Stock Adjustments – 786.65 Cores,

c)     Total income in that year – 35098.63 Cores,

d)     Net gain  - 4310.64 Cores. 

                        

This ratio between Net gain Vs Total income is Net Profit Margin. BHEL March – 2010, net profit margin is 12.30 % (4310.64 / 35098.63 ) By this ratio for each and every rupee sales, how much gains obtained can be known to us,

Except this 

1)     Ratio between Raw Material Vs Sales

2)     Ratio between Sales, Management, & Common Expenses Vs Sales,

3)     Ratio between Electricity & Fuel Vs Sales.

Based on our Analysis we can going on add the ratios required. Merely calculating is not enough. With calculation, we have to compare with the companies competitors with the ratios. Then only the efficiency of the Organization can be worked out. Like your friend,  

Again some important ratios can be seen below,

1)     Small industries, with their raw materials ( Inventory ) present may consider their business as stronger.

2)     But medium and large scale industries don’t think like that. The main reason is we are talking about hundreds of Cores. (Products)

                        

Apart from these the Japanese people had climbed a step ahead and introduced the “Just in time Inventory Management” which is widely used today. Each and every Organization if try to calculate the rotational cycle (or sales) ten they may be able to work out their Organizations Efficiency in both sales and Gain. 

                

For Example if you are a Provision store Owner. Your daily sales is Rs.10,000/-. You are soling for Rs 36,00,000, assumed per year. At anytime Rs.3,00,000 worth materials are present in your shop. It means your materials (products0 rotation is 36/3 = 12% If you are able to measure this rotation your gain (profit) may definitely increase. Let us see the BHEL Company rotation rate as given below,  

(Inventory Turnover = Annual Sales / Year End Value of inventory products present )  

BHEL Companies

a)     Year end inventory is Rs.9235.46 Cores ( According to Balance Sheet)   

b)     That year net sales is Rs.33226.25 Cores.

So, BHEL Companies inventory turnover is 3.6 ( This inventory turnover being more is much better. It means those times the company had rotated its inventory (Products) 

Like above ratios, a company how much debts received, is very much important for investors like us. Conservative investors would think that the concerns should hold no debts within them. To analyze this a ratio Debt to Equity ratio is used. BHEL Concerns,

a)     Total debts ending March – 2010 – 127.75 Cores,

b)     That years share capital and reserves works out to 15917.36 Cores,

So, its Debt to Equity ratio is 0.008 (Less than 1 %) ( 127.75 / 15917.36) For some Organizations we have heard of even 100% or 200% present. Production based Organizations if debts are largely present , if an Economical Crisis occurs , those Organizations would be pushed to the bottom line.   

Debt to Equity Ratio = Total Debts / Share holders Capital. 

A point should be kept in mind while analyzing ratio Analysis. For each and every sector this ratios must be considered, separately. For Example,

1)     Finance based Organizations

2)     Retail sectors

3)     Production based Organizations

4)     Electricity producing Organizations etc…

For each and every sector the needs may differ. So, the ratios may also differ. 

For Example,

1)     In retail field the turn over ratio will be    -  more.

2)     Finance connected Organizations         -  Debts present will be more.

3)     Electricity Organizations                         -  Debts present will be more.      

So, while analyzing the ratios belonging to same sector with same size would be reasonable.

Traditional Classification of Ratios:

This is traditional method of classifying ratios. Under this category, ratios are classified into:

1. Balance Sheet or Position Statement ratios:

Balance sheet or position statement ratios are those ratios which are derived from two variables appearing in the balance sheet. For example, current ratio, debt equity ratio etc.

2. Profit and Loss Account or Income Statement Ratios:

Sometimes also known as operating ratios are derived from the variables appearing in the manufacturing, trading and profit and loss account. For example, inventory turnover ratio, gross profit ratio, expense ratio etc.

3. Inter Statement Ratios:

Inter statement ratios also known as combined or mixed ratios are such ratios which establish relationship between variables picked up from both the statements i.e. balance sheet and final account. For example debtors turnover, assets turnover, return on capital etc.

Functional Classification or Classification According to Test Specified:

Under this classification, ratios may be grouped in accordance with the type of test they are supposed to perform. Thus, ratios may be grouped as:

1. Liquidity Ratios:

Liquidity ratios are the ratios meant for testing short-term financial position of a business. These are designed to test the ability of the business to meet its short-term obligation promptly. For example, current ratio, quick ratio fall under this group.

2. Solvency Ratios: 

Solvency ratios are also known as leverage ratios. These are meant for testing long term financial soundness of any unit. Primarily these establish and study relationship between owned funds and loaned funds. For example, debt-equity ratio, capital gearing ratio etc., are covered under this group.

3. Efficiency Ratios:

Efficiency ratios are also known as activity ratios. These are meant to study the efficiency with which the resources of the unit have been used. These are also popularly known as turnover ratios. Examples are; inventory turnover ratio, return on investment etc.

Meanings, Nature and Usefulness of Ratios Analysis:

Meanings of Ratio:

According to J. Batty, "The term accounting ratios is used to describe significant relationships which exist between figures shown in a balance sheet, in a profit and loss account, in a budgetary control system or in any other part of the accounting organization"
In simple words, "Ratio" is the numerical relationship between two variables which are connected with each other in some way or the other. Ratios may be expressed in any one of the following manners
As a number the relationship between 500 and 100 may be expressed as 5(500 divided by 100).
As a fraction the above may alternatively be expressed as former being 5 times of the latter or latter being 1/5^thof the former.
As a percentage the relationship between 100 and 500 may be expressed as 20% of the latter (100/500 x 100) = 20%.
As a proportion the relationship between 100 and 500 may be expressed as 1 : 5. Ratio analysis facilitates the presentation of information of financial statements in simplified, concise and summarized form.

Nature of Ratio Analysis:

Ratios, by themselves, are not an end but only one of the means of understanding the financial health of a business entity. Ratio analysis is not capable of providing precise answers to all the problems faced by any business unit. Ratio analysis is basically a technique of:

1.   Establishing meaningful relationship between significant variables of financial
statements and

2.   Interpreting the relationships to form judgment regarding the financial affairs of the unit.

Usefulness of Ratio Analysis:

Usefulness of ratio analysis depends upon identifying:

1.   Objective of analysis

2.   Selection of relevant data

3.   Deciding appropriate ratios to be calculated

4.   Comparing the calculated ratios with norms or standards or forecasts; and

5.   Interpretation of the ratios

Important Factors For Understanding Ratios Analysis:

Quality of Financial Statements:

The reliability of ratios is linked with the quality of financial statements. Financial statements which have been prepared by faithful adherence to generally accepted accounting principles (GAAP). Generally accepted accounting principles are likely to contain reliable data. Calculation of ratios from such financial statements is bound to be more useful and trustworthy.

Purpose of Analysis:

Users of accounting information are different such as short-term and long-term creditors; owners and would be investors; trade unions; tax authorities; competitors etc., object of each group of interested parties is also different such as liquidity or solvency or profitability, etc. So, before undertaking the analysis, one should be clear about the object of analysis. It is the object of analysis which determines the area (liquidity, solvency, profitability, leverage, activity etc.) to be studied, analyzed and interpreted.

Selection of Ratios:

There is no end to the number of ratios which can be calculated. In 1919, Alexander Wall developed an elaborated system of ratio analysis. The same has been extended and modified over the period of time. So the ratios to be calculated should be selected judiciously taking into consideration the object of analysis. The ratios selected should serve the purpose of analysis. For example, short term creditors 'purpose is liquidity whereas owners' purpose may be served by solvency.

Standards to be Applied:

Any ratio in itself i.e. in isolation is meaningless. It must be compared with some standard to arrive at any logical conclusion. The analyst can choose the comparing standard from (a) Rule of thumb (b) past ratios (c) projected standards or (d) industry standards. Selection of standards for the purpose of interpretation will also depend upon the object of the analysis and the capacity of the analyst. For example, management (being the insider) can opt. for project standards whereas any outsider's choice shall be limited to the published information of the unit.

Capability of the Analyst:

Analysis is a tool in the hands of the analyst. Knife (as a tool) in the hands of a criminal may take the life but the knife (as a tool) in the hands of a surgeon may give new life to a patient. Interpretation depends on the educational background; professional skill; experience and intuition of the professional conducting it.

Ratios to be used only as Guide:

Ratios can provide, at the best, the starting point. The analyst, before arriving at the conclusion, should take into consideration all other relevant factors financial and non-financial; macro and micro. For example, general condition of economy; values of society; priorities of the government etc., are the important factors.

Significance and Usefulness of Ratio Analysis:

Ratios as a tool of financial analysis provide symptoms with the help of which any analyst is in a position to diagnose the financial health of the unit. Financial analysis may be compared with biopsy conducted by the doctor on the patient in order to diagnose the causes of illness so that treatment may be prescribed to the patient to help him recover. As, already hinted different groups of persons are interested in the affairs of any business entity, therefore, significance of ratio analysis for various groups is different and may be discussed as follows:

Usefulness to the Management:

1. Decision Making:

Mass of information contained in the financial statements may be unintelligible a confusing. Ratios help in highlighting the areas deserving attention and corrective action facilitating decision making.

2. Financial Forecasting and Planning:

Planning and forecasting can be done only by knowing the past and the present. Ratio help the management in understanding the past and the present of the unit. These also provide useful idea about the existing strength and weaknesses of the unit. This knowledge is vital for the management to plan and forecast the future of the unit.

3. Communication:

Ratios have the capability of communicating the desired information to the relevant persons in a manner easily understood by them to enable them to take stock of the existing situation:

4. Co-ordination is Facilitated:

Being precise, brief and pointing to the specific areas the ratios are likely to attract immediate grasping and attention of all concerned and is likely to result in improved coordination from all quarters of management.

5. Control is more Effective:

System of planning and forecasting establishes budgets, develops forecast statements and lays down standards. Ratios provide actual basis. Actual can be compared with the standards. Variances to be computed an analyzed by reasons and individuals. So it is great help in administering an effective system of control.

Usefulness to the Owners/Shareholders:

Existing as well as prospective owners or shareholders are fundamentally interested in the (a) long-term solvency and (b) profitability of the unit. Ratio analysis can help them by analyzing and interpreting both the aspects of their unit.

Usefulness to the Creditors

Creditors may broadly be classified into short-term and long term. Short-term creditors are trade creditors, bills payables, creditors for expenses etc., they are interested in analyzing the liquidity of the unit. Long-term creditors are financial institutions, debenture holders, mortgage creditors etc., they are interested in analyzing the capacity of the unit to repay periodical interest and repayment of loans on schedule. Ratio analysis provides, both type of creditors, answers to their questions.

Usefulness to Employees:

Employees are interested in fair wages: adequate fringe benefits and bonus linked with productivity/profitability. Ratio analysis provides them adequate information regarding efficiency and profitability of the unit. This knowledge helps them to bargain with the management regarding their demands for improved wages, bonus etc.

Usefulness to the Government:

Govt. is interested in the financial information of the units both at macro as well as micro levels. Individual unit's information regarding production, sales and profit is required for excise duty, sales tax and income tax purposes. Group information for the industry is required for formulating national policies and planning. In the absence of dependable information, Govt. plans and policies may not achieve desired results.

Limitations of Ratios Analysis:

Ratio analysis is a widely used and useful technique to evaluate the financial position and performance of any business unit but it suffers from a number of limitations. These limitations must be kept in mind by the analyst while using this technique.

Reliability is Linked with Accounting Data:

Ratios are calculated on the basis of accounting information. Accounting system has certain in built limitations like historical cost, going concern value, stable monetary value, etc. So, limitations of accounting data affect the quality of ratios also. After, all ratios can't be more reliable than the reliability of data itself.

Qualitative Factors are Ignored:

Ratio analysis is only a quantitative analysis. Sometimes qualitative factors may be  important. For example, management may be justified in making huge purchases of raw material in anticipation of large demand of its product for the coming period. But ratios are not capable of considering qualitative factors.

Isolated Ratios is Meaningless:

Ratios assume significance only when studied in proper context and if compared with norms or over a period. Ratio in itself does not convey any sense.

Ratio Analysis is Historical:

Ratios are based on the facts contained in financial statements. These statements contain
past records. Past may be less important or irrelevant for the management than present and future.

Different Accounting Practice Render Ratios Incomparable:

Accounting permits alternative treatment of many items like depreciation, valuation of tock, deferred expenses etc. Ratios based on statements prepared by following different practices are not comparable.

Price Level Changes Affect the Utility of Ratio Analysis:

Comparison of ratios over a period of time relating to same unit may be misleading. For example, sales may be static in quantity but higher in dollar value due to inflation.

Incompetence or Bias of Analyst:

Much depends upon the skill, integrity and competence of the analyst to use ratios judiciously.

Lack of Adequate Standards:

There are no well-accepted standards or rule of thumb for all ratios which might be expected as norms for comparison. It renders interpretation of ratios difficult and to some extent arbitrary.

Window Dressing:

Financial statements can easily be "window dressed" to depict better than real picture of the enterprise. Moreover the analyst depending only upon published financial statements will not be in a position to get inside information.

    

PASSIVE INVESTING

Passive is a term opposite to active. Passive means absence of speedy action .i.e. slow action.

Active investors after monitoring the Income statement, Balance sheet, like each and every companies Finance statements, Analyses the sectors performance connected with those companies, countries Economy, considering various factors select and pick the stocks.

But Passive investors are opposite to those activities. While the countries economy is better, the complete stock market seems to be good. While performing like that, why we can’t choose the best of buying the Entire indexes of Nifty (or) Sensex ! Why to worry about small things. Efficient market theory explains that other than the market nothing can earn more. Those who are accepting the concept , passive investing is best suited.

Definition of 'passive investing'

An investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance.

Also known as a buy-and-hold or couch potato strategy, passive investing requires good initial research, patience and a well diversified portfolio.

Unlike active investors, passive investors buy a security and typically don't actively attempt to profit from short-term price fluctuations. Passive investors instead rely on their belief that in the long term the investment will be profitable.

What is passive investing ?

Passive investing is a strategy focused on achieving long-term appreciation of portfolio values with limited day-to-day management of the portfolio itself.

Passive investing - often referred to as evidence-based investing, or indexing - seeks to replicate the performance of the market by investing to a pre-determined strategy which focuses on:

a) keeping costs low by avoiding unnecessary trading

b) diversifying across a wide set of asset classes - holding all of the market and avoiding over-exposure in any particular sector

c) taking the long term view - markets can do better in some years and worse in others, but passive investors understand that markets are efficient and operate on the basis of all known information. Long term, you cannot beat the market.

How It Works / Example:

A passive investor is one who limits on-going buying and selling activities. A passive investor purchases securities, builds a portfolio, and generally holds the portfolio for the long term.

Passive investors usually do not actively buy and sell as prices change in the market. The general investment philosophy of passive investors is that their portfolios will grow with the long-term growth of the market.
 
Generally investing in Index Funds and E.T.F’s is denoted as passive Investing. For example Nifty and Sensex. Like that in India several indexes are found, not in India, but in various several Foreign countries also investments are increasing.

In this manner functioning Funds and E.T.F,s based on a specific index , under that index containing various stocks invested in the same ratio. While investing like that “Tracking Error” may occur a small value. In that index altered or percentage changed those index tracking funds may also be altered.

Investing in indexes are done by most passive investors. But some pick and buy the stocks in appropriate time and then forget considering as Assets. In Long term they believe definitely those purchased stocks may produce large returns. Based in this criteria the stocks purchased may not give unfortunate results. Good profits has yielded. This is also a passive investing method.

Some others buy some specific stocks in fixed intervals ( like S.I.P ) They never mind of those stock prices fluctuations. They are also passive investors.

Peoples like Warren Buffet, advice those unknown about stock market can invest in Index fund a passive investing method.

Logic of Passive Investing !

If the stock market is not efficient, should you be an active investor? If stock prices are sometimes wrong, then someone with the skill and expertise required to identify these market inefficiencies might do well. Consider other skill based activities, for example, a free throw competition in basketball. Suppose that you get a dollar for every shot out of ten that goes through the basket, and there is no fee to play. This is a conservative assumption with regard to the stock market because there are in fact "fees" to active investing, like transaction costs and tax inefficiencies, which we will discuss later. Like any analogy, the free-throw competition has its strengths and weaknesses, but one important characteristic of this analogy is that most players in the game will make at least some money. This is a critical characteristic, because the stock market is a "positive sum" game in the sense that investors do, on average, enjoy returns greater than the time value of their money. The compounded annual return on U.S. large-cap stocks since 1926 has been about 11 percent, as reported by Ibbotson Associates. This long-run return, in excess of the time value of money (interest rates), is a reward for risk and represents the new societal wealth that is created by the investment of capital in plant and equipment, employee coordination and training, and technological research. In contrast, sports betting and other forms of gambling are "zero-sum" games. A zero-sum game is one in which the profits of all players sum to zero.

Under the no-fee-to-play condition, you should play the free throw game (and perhaps the stock market) even if your self-assessed basketball talent is marginal. But what if we add the twist that, instead of actively participating in the game, you can take the average score of those that do? Passive investing is just such a twist in the investing game, because a total market index fund contains all stocks, and all stocks have to be held by someone. This often ignored but unassailable fact has important implications. Chief among them is that in the absence of the costs of active investing, the index return over any time period must be the weighted-average performance of all active investors during that time period. Thus, while investing in general is a positive-sum game, active investing is a zero sum game with respect to the alternative of indexing. One active investor's ability to outperform the index has to come at the expense of another investor's underperformance. Unlike the children in Garrison Keillor's Lake Wobegone, all investors cannot be above average.

If you were in the basketball free throw game, and were given the alternative to sit out and take the average score of the other players, what would you do? Your first thought might be to look around and make a guess at how your basketball skills compare to everyone else's. If you think your skills are lower than average (and remember, that must be half of everyone) then the smart thing to do is to not play: to take the average. But what if everyone else takes this approach? Then only those in the top-half of the skill pool will choose to play, and the average score you get by sitting on the sidelines will be based on only the top-half players. From this more rational perspective, you should only choose to play if your skills are in the top 25 percent of all potential players. But what if everyone takes this more rational perspective? Eventually no one but the very best player shoots, and everyone else gets his or her score. If everyone were perfectly rational, and not subject to overconfidence, there would be very few active investors. Thus overconfidence, perhaps the most pervasive of all investor irrationalities, is critical to market liquidity. We will return to the role of overconfidence in the marketplace toward the end of this discussion, but it should be clear that at least half, and perhaps more, of all active investors would be better off indexing.

Why It Matters:

Passive investors rely on slow, steady growth in the market. The passive investor builds his portfolio based on an allocation of assets to match his tolerance for risk. After selecting investments for his portfolio, the passive investor will buy and then hold onto his portfolio for the long term. 

PASSIVE INVESTING WORKS IN ALL MARKETS !

Market efficiency is one of the more controversial ideas in finance. Many academics believe that the stock market is a nearly perfect pricing mechanism for companies. If the market is “efficient” then stocks are correctly priced according to all available information. If stocks are correctly priced according to all available information then there is simply no point in doing any kind of analysis, out performance would be a matter of luck and not skill.

The active funds industry is based on the idea that stocks are not efficiently priced. Analysts search for undiscovered opportunities, ranging from the “value” approach where one is essentially a bargain hunter, through to the “growth” approach where one looks for companies with superior profit prospects. Whether value or growth, or a combination, or something else entirely, active managers justify their existence with the idea that a skilled investor can identify superior opportunities and can outperform the market.

I am often asked about where I sit in arguments about market efficiency and whether I feel stocks are correctly priced or not. This is, apparently, very important, why would one adopt a passive approach if there were all of those mispriced stocks out there, allowing skilled investors to outperform?

The answer is that I personally believe the market is highly inefficient and agree that skilled investors can outperform the market. However, that doesn’t mean everyone should invest actively. The key factor to note is the idea that trading and active investment is inherently a zero-sum game compared with the market.

WHY MANY LIKE PASSIVE INVESTING ?

In passive investing , the greatest plus point is the lowest fund expense. In India actively managed many funds “Expense Ratio” is maximum 2.25 % per year. At the same time several index funds & E.T.F’s “Expense Ratio” is maximum 1 %. The balance amount of expense ratio based on long term may produce high gains for investors. Buying an index may get diversification. Tension is reduced. If the market is either lowering or highering your investment also fluctuate similarly.

Moreover passive investors are long term investors. So that Capital gains tax is not required to pay. Short term investors have to pay 15 % as capital gains tax in profit. All are saved. Apart from this paying low brokerage. Being a passive investor there is no need to buy / sell routinely. No need to worry about Fund Managers performance.
 
WHAT ARE ALL THE NEGATIVE FACTORS AFFECTING PASSIVE INVESTING ?

In index participation, of some stocks / sectors would not be liked by us. But buying the total index which includes the disliked sectors also. Learning all those, Indian stock market has not still performed in maximum efficiency. Due to these reasons, active investors had gained much more gain. Even though the gains received does not equal but not even nears the index return is the unfold truth.

Some very big Mutual Fund schemes / E.T.F,s functioning in America are based in passive investing method. The size of those passive investing market is alone several 100 billion dollars. In world level, S&P based (SP – DR,s – Spiders) M.C.S.I. Index based ( I Shares ) Nasdaq 100 based QQQQ, hang Seng based TRAHK – Tracks are the popular passive investing methods.

The entire History / subject about passive investing are all O.K.

WHAT IS PASSIVE MANAGEMENT :-

Passive management (also called passive investing) is a financial strategy in which an investor (or a fund manager) invests in accordance with a pre-determined strategy that doesn't entail any forecasting (e.g., any use of market timing or stock picking would not qualify as passive management).

Passive investment management makes no attempt to distinguish attractive from unattractive securities, or forecast securities prices, or time markets and market sectors. Passive managers invest in broad sectors of the market, called asset classes or indexes, and, like active investors, want to make a profit, but accept the average returns various asset classes produce. Passive investors make little or no use of the information active investors seek out. Instead, they allocate assets based upon long-term historical data delineating probable asset class risks and returns, diversify widely within and across asset classes, and maintain allocations long-term through periodic rebalancing of asset classes.

The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future. The most popular method is to mimic the performance of an externally specified index. Retail investors typically do this by buying one or more 'index funds'.By tracking an index, an investment portfolio typically gets good diversification, low turnover (good for keeping down internal transaction costs), and extremely low management fees. With low management fees, an investor in such a fund would have higher returns than a similar fund with similar investments but higher management fees and/or turnover/transaction costs.

Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds. Today, there is a plethora of market indices in the world, and thousands of different index funds tracking many of them.

One of the largest equity mutual funds, the Vanguard 500, is a passive management fund. The two firms with the largest amounts of money under management, Barclays Global Investors and State Street Corp., primarily engage in passive management strategies.

Which would be suitable for me either passive or active is the million dollar question ?

Passive investing based on which index ( For example Nifty50 stocks based E.T.F ) those index levels highering, the gains depending upon the price hike , the same gains if possible, insufficient time sharing persons, complete zero about stock market, zero risk persons, able to enter immediately in compulsion, for all the above persons, passive investing is the best method.

Able to manage more time, knowing all the facts about stock market, able to earn money beating the index , risk taking persons are all active investing types.
Passive Investing Is the Solution

If you can’t pay someone to beat the market for you, and you can’t do it yourself, what options do you have? That’s where passive investing comes in.

Passive investing is investing with the knowledge that beating the market for a long period of time is nearly impossible. Instead, passive investors simply attempt to match market returns as closely as possible while keeping fees, taxes, market timing and fund selection mistakes to a minimum.

The most common way to invest passively is through an index fund. An index fund is a type of mutual fund that invests with the goal of matching the performance of an index, which tracks the performance of a market. Index funds accomplish this by investing in all the stocks of a particular index based on market capitalization.

For example, if you invest in an S&P 500 index fund, that fund will take your money and invest it in 500 of the largest companies in the United States based on their market capitalization. The largest portion of your money would go towards buying stock in the largest U.S. companies, such as Exxon, Apple, IBM, and on down the list, all the way to the smallest company (in which very little of your money would be invested). The beauty of this structure is that it allows the index fund to almost perfectly match the index (or market) while making very few trades.

Because very few trades have to be made after the initial purchase, transaction fees for the fund are almost zero. In addition, taxes are much lower because there is almost no turnover. Most importantly, passive managers don’t have to be paid large salaries to run the fund because it follows a set of simple trading rules. Therefore, the expense ratios of these funds can be extremely low, even as low as one tenth of a percent.

Passive investors also don’t lose any investment return to market timing mistakes because they know that attempting to beat the market by jumping in and out will only hurt them. And they certainly don’t attempt to switch between funds, because they already own the entire market in their single index fund!

Basically, once an investor knows that it is impossible to beat the market in the long run, there is no reason for them to be anything other than a purely passive investor. 

Customizing Passive Investing to Suit Your Needs !

Passive investing works for everyone, from young professionals with high-risk appetites to retirees simply looking to draw a steady income from their retirement savings.

The key to making passive investing work for any individual is to determine the correct asset allocation for his or her situation. Asset allocation is simply the mix of investment types that make up your portfolio. For example, a high risk, high return passive portfolio may be made up of mostly a U.S. stock index fund and a foreign stock index fund, with very little in a U.S. bond index fund. On the other hand, a low risk passive portfolio would be made up of mostly a bond index fund with much less in stock index funds.

By adjusting the asset allocation of their portfolio, investors can create a passive strategy that gives them the perfect balance of risk and return, no matter what their situation is.
So, Why Isn’t Everyone a Passive Investor?

Passive investing is not a new idea. The first index fund was created in 1975, and it still exists today as one of the largest funds in the world. The principles of passive investing are supported by hundreds of academic studies, and multiple Nobel Prizes in Economics have been awarded for research findings that detail the superiority of passive investing. You can even read what some of these Nobel Prize recipients have to say about passive investing here on a website. So, why do more than 90% of individual investors in the United States still attempt to beat the market by investing actively?

The fact is, most of the public’s investing knowledge comes from the mainstream financial media and investment professionals (such as brokers) because they have the financial means to get their messages out to the public. However, those financial means can also create very large conflicts of interest.

It is much easier for Wall Street to make money by selling the more expensive investment vehicles used by active investors than to make a living educating people about the advantages of passive investing. A broker’s business would quickly fail if he told every person that walked into his office that they would be better off as a passive investor. And the financial media would run out of well-paying advertisers, not to mention interested viewers, if they only ran story after story about the simple superiority of passive investing.

CONTRA INVESTING

Have you ever swimmed in a river or Sea facing, against the water flow ?  Not studied like all, and being successful in that field ? Not like everyone doing a job or business, choosing some different field and made a success ? If yes for all those, then for you “ CONTRA INVESTMENT ” may be best suited.     

WHAT IS CONTRA INVESTMENT METHOD ?  

Anyone, acting opposite to majority of the people’s  thinking and gaining through those actions. For example, when everyone telling to buy, we sell, when everyone selling, we buy includes in this method. Similarly while everyone selling a stock / sector the specified stocks value will be seemed very low. At that moment buying the stocks with smaller quantity, considerable growth can be obtained in future.    

HEAD WEIGHT AND FEAR ! 

The two important feelings controlling the stock market are Head weight and Fear. While stock market rises someone’s head weight rises. While head weight rising we chase and buy the stocks . This type may be gain for short term investors, but not for Long term investors. For some reason the entire stock Exchange, may have gone down or a sector may have gone down. Or else a specific stock alone may have gone down. Those situations will be cautiously utilized by Contra investors.   

Some big investors, keep an eye upon a sector or stock and may sell all the stocks entirely. A part of stocks value is decided by Supply and Demand. While the supply increases, and the demand decreases, the value of stock reduces. If happening continuously at a certain stage nobody would be seen for a particular stock or sector. During those moments, our God father , L.I.C, or some big Bulls like Warren Bufett take good of that Opportunity and purchase at Bulk Quantity.  

When equity markets are on the move, investors are quite happy to join the bandwagon. In fact, in boom times, we seldom discuss the strategy being used by our fund manager because all that matters is that he is giving great returns. It's only in a downturn that reality checks are done and one looks at strategies to minimize the pain. 

One such strategy is a 'contrarian' investing. As the name suggests, one would expect the fund manager have a completely different strategy to the existing market conditions. 

This basic idea is to protect the downside when markets are falling. But the reverse is also true. Returns in an upside might be lower.   

Understanding the term 'contrarian' is important because it can be defined in different ways. In most cases, contra investing involves selection of stocks that are not popular at the moment but has the potential to deliver over time because of factors like strong fundamentals, future turnaround in the cycle and so on.

For contra investing, there are couple of strategies that are used. The first one involves direct investment in stocks, whereby a particular theme is identified. The stocks are bought, in accordance with the theme and held for a particular time period. The simpler option is to select a contra fund that is offered by mutual funds. 

SO WHAT IS THE BASIC TENET OF CONTRA INVESTING ?

Uncertainties emerge in global events, economic growth, government policy etc. All such events converging today, creating huge opportunity for generating future returns. Thus current environment is apt for contrarian investment.

The reasons why a Contra strategy is apt at the current point of time are Most funds / investors are betting on the safest stocks. Top holdings of mutual funds are all among the top 10 market capitalized companies in India and constitute over 30% of total equity holdings .When these stock don’t move, several MFs don’t perform in the short run and this kind of Risk Aversion prevents more creative stock selection.

THE POSITIVES OF CONTRA INVESTMENT !

Like all people, like a massive goat shrub, traveling in one direction, we travel in opposite direction to purchase the stocks in a cheaper value. Since already gone down stocks further more decline is impossible. While the massive goat shrub taking a U turn a huge gain can be expected. After gaining we can leave the shrub, and for persons , developing the wealth, can be said as a Wonderful situation.  

HOW ARE SUCH STOCKS IDENTIFIED?

There’re no short-cuts involved here. It requires a lot of research and out of the box thinking. Accumulating information about prospects of the sector to which the stock belongs, its management, etc. are key to successful investing. Doing a comparison of PE ratios between stocks of different companies in the same sector as well as checking the balance sheets and annual reports are some ways to identify non-popular and good stocks.

THE NEGATIVES OF CONTRA INVESTMENT !

While all are walking in one direction , we changing our direction in opposite direction with 
no partnership, in the midst of the forest lonely with Fear mixed feeling possible. It may 
check the Individuals Patience. If a new comer while purchasing after entering , it may 
continuously go down. While the entire stock market rising, our portfolio alone remain 
standstill. So excessive patience persons can alone bravely handle this type of investment.  

DISADVANTAGES ! 

Factors to Investing in equities Health. The first law may take more scientific knowledge’s 
you. Each time you collect from pharmaceutical or medical supplies, will be the impact of a deep understanding of the factors underlying medical. Consider whether thiIt works as a 
valid reason to prevent them from doing so.

The last second reason is to avoid investing in shares is to have health permits market watch events near the most important steps as the FDA. I advise people to take seriously this time, it could to lead to a net decrease of the share price if a major event such as a FDA decision is contrary to the company, whether it is yet determined.

So this is. We have seen and assessed the advantages and disadvantages of investing in shares of health care. It is not truly universal, not all, but it is certainly a lot of work for many people. You must occur on more thinking in order to make your personal decision for or against. You can order a optimal decision based on information provided in this article.

HOW TO MANAGE THE UN-COMFORT ABILITY ? 

Any new methodology will be hard at the start. With patience, after investing one or two times, earning more gain may gain self confidence, automatically. Any stock suitable for investing , due to some reason the price lowers. You desire to buy that stock. 

A small quantity of stock can be purchased initially. Afterwards the stock may be dancing in sideways like a see-saw. In another incident a small downfall may happen. 

At that moment, a second small can be purchased. Like this two / three opportunities may knock your door. You have to utilize the situation favorably. In these methods the average price of the stock will definitely be larger than the finally purchased price. Don’t worry. 

Any stock the limit of High / Low cannot be defined even by the concerned company promoter itself. So, you and the promoter both are traveling in the same Boat, need not be forgotten.      

CAUTIOUS MOMENTS ! 

Stock prices after you purchased, lowered average value upto the bottom and making U turn we must be careful. Having claimed moderate gain, immediately sold, getting at not be executed. After good handsome profits we can quit. If you were a Long term investor, like your own house you can hold it for years lifetime. If a new comer then within Sensex and Nifty the stocks can be choosed. 

RISK ! 

Like in any investment method, this method also contains risk. The stock you ought to buy going on lowering and at a stage may disappear from the stock market. Like India, the growing Economy, for large companies nil possibilities are found, we must act cautiously. To safeguard from these problems any stocks weightage can be maintained not more than 5 %. Moreover, not waiting until the least bottom we can enter . Sometimes Contra Investor may loose the entire gains also like the Investment stocks during the Boom at about 2000. Now they were almost papers. 

TOOLS USED BY CONTRA INVESTORS !

Like value investors, they also select stocks of Low P.E., Low book value, further more seeing market sentiment ( While all purchasing, they sell, while others selling, they act Opposite ) they invest. To the Utmost to calculate the Ups and Downs fluctuation of the Market vicks Index ( India VIX – India Volatility Index ) will be seen , and used for Investment. Since the VIX Index, denotes the Ups and Downs of the market suddenly or rapidly rise / low the index value rises. To buy / sell they can use the Index Favorably.   

For Example :- 
By the end of year 2008, the VIX Index had gone to 85. It is a favorable period to buy stocks. Only considering vix , alone investment cannot be decided. It can also be used as a tool.              

GROWTH INVESTING

Let us see the second type of Investment method called as “Growth Investing”. Is there any person disliking growth ? But at the same time, like expecting growth, risk is also found. 

In practice, we could have seen, some young couples, marrying with flimsy family 
background, either Arranged or Love marriage. Being frugal and planned  i.e. in Rs.100/- income , saving of up to 30 to 50 % with 1 or 2 times a day alone taking moderate food. 
In years course, they may be able to buy a Residential plot, later building their own home 
with all comforts. Similar stories can be heard everywhere.  

A strategy whereby an investor seeks out stocks with what they deem good growth 
potential. In most cases a growth stock is defined as a company whose earnings are 
expected to grow at an above average rate compared to its industry or the overall market. 

Growth investors often call growth investing a capital growth strategy, since investors 
seek to maximize their capital gains.

Although it is often said that growth investing and value investing are diametrically 
opposed, a better way to view these two strategies is to consider a quote by Warren 
Buffett: "growth and value investing are joined at the hip". Another very famous investor, 
Peter Lynch, pioneered a hybrid of growth and value investing with what is now commonly referred to as a "growth at a reasonable price (GARP)" strategy.

In the past 15 – 20 years the examples of growth stocks are Reliance Industries, Infosys, 
Wipro, Cipla, B.H.E.L., L&T,O.N.G.C.,HCL Technologies, TCS, etc…can be said. 
Even today in India’s rapidly growing Economy , smaller organizations of today, expected 
to grow large in future years, as larger organizations are called as Growth stocks. 

A new investor while watching each small company, may think as growing as INFOSYS tomorrow. But all companies may not grow as INFOSYS. So while selecting these type of stocks, the investors must be cautious. 

Rapidly growing companies may face sudden problems. While happening they have to overcome the situation with strong Administrative capacity. When compared to value companies, in growth companies, risk will be more, and rewards, may also be more.   

How to select the growth company Stocks ? 

A stock is considered a growth stock when it’s growing faster and higher than stocks of 
other companies with similar sales and earnings figures. Usually, you compare the growth 
of a company with growth from other companies in the same industry or compare it with 
the stock market in general.

If a company has earnings growth of 15 percent per year over three years or more and 
the industry’s average growth rate over the same time frame is 10 percent, then this stock 
qualifies as a growth stock. A growth stock is called that not only because the company 
is growing but also because the company is performing well with some consistency.

Here are some other important things to look at when considering growth stocks:

Fundamentals :-
This refers to the company’s financial condition and related data. When investors do fundamental analysis, they look at the company’s fundamentals: its balance sheet, income statement, cash flow, and other operational data, along with external factors, such as the company’s market position, industry, and economic prospects. The company should have consistently solid earnings, low debt, and a commanding position in the marketplace.

Leaders and mega-trends :- 
A mega-trend is a major development that has huge implications for most (if not all) of 
society and for a long time to come. A good example of a mega-trend is the aging of 
America. Federal government studies tell us that senior citizens will be the fastest-growing segment of our population during the next 20 years. How does the stock investor take advantage of a mega-trend  By identifying a company that’s poised to address the opportunities that such trends reveal. A strong company in a growing industry is a common recipe for success.

Strong niche :- 
Companies that have established a strong niche are consistently profitable. Look for a company with one or more of the following characteristics:

A strong brand :-
Companies that have a positive, familiar identity — such as Coca-Cola and Microsoft — occupy a niche that keeps customers loyal.

High barriers to entry :-
United Parcel Service and Federal Express have set up tremendous distribution and delivery networks that competitors can’t easily duplicate.

Research & development (R&D) :-
Companies such as Pfizer and Merck spend a lot of money researching and developing new pharmaceutical products. This investment becomes a new product with millions of consumers who become loyal purchasers, so the company’s going to grow.

Given below based regulations clearly identifies which are the growth stocks !  

1)  In the past 5 / 10 / 15 years turnover, Net profit, E.P.S similar factors must have attained     better growth.( For example more than 20 % )The stocks other than that sector growth must be large ( Minimum more than 10 % ) 

2)  Not only in previous years, but also in forthcoming 5 / 10 / 15 years the companies, Turnover, Net profit, E.P.S the said growth is possible in forthcoming years. The company connected with the sector, Opponents, and Honest Management particulars whether present must also be Analyzed.

3) Expenses within the Marginal limit / In the coming years is it possible must be go through. 

4) Excellent Management sustainable, Promoters not in an intention to go short cut to increase their wealth.

5) Whether Possibilities found in the next 3 or 4 years, for the stock prices to be Doubled, could be Analyzed.

6) Whether R.O.E ( Return on Equity ) is upgrading ? R.O.E = Net Profit / Investors Capital.

Alright what are the characteristics of Growth stocks ?   

Six Characteristics Of Great Growth Stocks
The market’s upside action this week, in the wake of the Fed’s interest rate cut, has been unusually bullish by many technical measures. But I’m not going to write about that today. I’ll leave that to ace technical analyst Mike Cintolo, who weighs in on Monday. Until then, suffice it to say that you should be heavily invested now. But invested in what? Great growth stocks. We focus on six fundamental characteristics of great growth stocks.

These aren’t just any six characteristics. These are the six fundamental characteristics that correlated most highly with profits in a ten-year study of stocks bought for the Model Portfolio 
of the Cabot Market Letter.

In other words, after ten years of investing (1997 - 2006) these are the factors that were best at bringing us profits. Might another ten years bring a different result? I’ll let you know in ten years. Until then, however, I feel pretty good about these. So here they are, with the very best criteria - in the time-honored tradition of lists - coming last.

Huge mass markets ;-
This one is well known to many investors. The more potential customers there are for a product or service, the greater the possibility that the business will be a success and the greater the possibility the investment will be a success. But how big is a mass market? Sometimes it’s hard to know where to draw the line; there is no right answer. Choosing between a manufacturer of curling equipment (that sport where they slide the rock down the ice) and a manufacturer of shoes, I’d go with the shoe manufacturer. Its mass market was just one reason we added Crocs (CROX), the maker of “funny-looking plastic shoes” to Cabot Market Letter’s Model Portfolio nearly a year ago.

Market dominance / barriers to entry :-
Patents often provide a great barrier to entry. And if there’s no one else providing competition, you can be sure those patents are strong. Intuitive Surgical (ISRG), for example, has been a great winner, partly because it has no competitors. As for market dominance, this can be harder to measure. Game Stop (GME), for example, is by far the biggest retailer of video games in the U.S. But with just 23% of the market, is it dominant? Intelligent minds can disagree.

Accelerating earnings growth :-
There’s no ambiguity here. If a company’s earnings growth rate (measured by comparing the earnings of one quarter to the earnings of the same quarter in the prior year) increases for two quarters in a row, growth is accelerating. In general, faster growth is better growth, and a company whose earnings growth rate is accelerating (whether it’s due to increased revenues or more efficient operations) is becoming an increasingly attractive investment. My perception is that acceleration tends to be under-appreciated by investors (some just don’t see it), so buying when you first recognize it usually works out very well.

Triple-digit revenue growth :-  
In my experience, companies growing revenues at triple-digit rates (100% or better) tend to be small and less well known; thus they’re ripe for buying by institutions as they grow. Almost all solar power companies were enjoying triple-digit revenue growth (100% of better) earlier this year when their stocks were hot … and most still are. When Google came public it was growing at a rate of 125%, now it’s slowed to 58%, while Chinese Baidu (BIDU), which is hitting new highs, is growing at 120%. Crocs (CROX) is growing at 162%. Wynn Resorts (WYNN) is growing at 152%. And little China Security & Surveillance Technology (CSCT), which I’ve mentioned here before and which had a nice jump last week, is growing at a rate 
of 550%!

High profit margins :- 
Software companies tend to have very high margins because they deal in code that costs nothing to ship or store, while iron ore companies tend to have very low margins. In recent decades, high-margin stocks have trounced low-margin stocks. But with the recent strength of companies dealing in steel, potash, coal and other bulk commodities, the times may be changing. Jim Rogers, who for years has been trumpeting the new global bull market in commodities, certainly thinks so.

Excellent, innovative management :- 
Henry Ford, Thomas Watson, Ray Kroc, Jack Welch, Walt Disney, Akio Morita, 
Sam Walton, Bill Gates, Larry Ellison, Steve Jobs, Meg Whitman, Jeff Bezos, Martha Stewart, Craig Venter and Dennis Kozlowski (for a while) were (and are) all great managers who led their companies to success by thinking differently. Admittedly, there is no hard and fast measurement of management talent, but because this is the most important characteristic of 
all - and I think it always will be - it’s worth thinking about very hard. Most managers are nowhere near as good as those legends. But when you find a top manager - especially one 
with a record of prior successes - you should give him or her a little extra leeway. Top managers have a way of overcoming obstacles through a combination of vision, enthusiasm and leadership.

These would be straight opposite to Value stocks. Being with High P/E, P/BV, the profits yielded will again be reinvested. Dividend will be very low. These companies be I.T or Bio Technology related now Economical based companies would be (or ) in Highly growing countries / regions / sectors will be taking place. Due to these companies excellent growth net profit may be going on increasing. So that the stock prices may also be hiking. Investors investing in these companies probably consider for Capital Appreciation.    

Thomas Rowe Price Junior can be called as the Growth investing Technic Priest. In 1937, in the name of Rowe Price Associates, started his company. The stocks he purchased was called as “ Rowe Price stocks” by the market. Efficient Management, Better sectors, High Dividend and Profit, beating the Inflation, countries Economy, More growth stocks he invested. 

Moreover, while selecting for growth stocks, he has to come through some characteristics. They are Excellent analyzing facility, less opposition, very low Government restrictions, very low total salary( Good Salary) Minimum 10 % returns, Higher profit ratio, more E.P.S growth etc….. 

Personalities like Warren Buffett, distinguished that growth investing Vs Value investing contains no great difference. According to him value is one Leg, and Growth is another Leg, both are joining in Hip.  

Peter Lynch, is another popular American investor. He has worked in “Fidelity Investment” as Fund Manager for long time. He has written many books ( One up on Wall Street, Beating the Street, and Learn to Earn )are most popular. He united those value and growth investing and termed as GARP ( Growth at Reasonable price ) a new Technic popularly.  

These type of investors choose the stocks based other than the market growth at the same time, Low value stocks. While searching, not reaching the End of both types, instead growth as well as Low P/E stocks. 

While selecting those type of investment method being various scalar factors present 
“PEG” ( Price / Earnings to (EPS) growth) ratio is used more. If it is lower than one then it 
is a better investment. For example the stocks you have selected P/E is 5. That Organizations past 5 years E.P.S growth yearly 10 % then PEG is ( 5/10=0.5 ) In this example PEG Ratio being lower than 1, this can be considered as a better investment.