Employees Stock Option Plan

ESOP means Employee Stock Options. As the term signifies, ESOP is about ‘options’. Employee Stock Options or ESOP are generally given by most of the big companies in India, especially IT companies which are listed outside India to their employees

ESOP’s are Employee Stock Option Plans under which employees receive the right to purchase a certain number of shares in the company at a predetermined price, as a reward for their performance and also as motivation for employees to keep increasing their performance. Employees typically have to wait for a certain duration known as vesting period before they can exercise the right to purchase the shares. The main aim of giving such a plan to its employees is to give shares of the company to its employees at a discounted price to the market price at the time of exercise. Many companies (especially in the startup phase) have now started giving Employee Stock Options as this is beneficial to both the employer as well as the employee. ... read more on yourstory.com

If the market price of the stock is above the procurement price, the employee stands to gain by selling it off immediately. If however the price is below the agreed price level, the employee has the option to set aside his option and not exercise it.

ESOPs are nothing but “OPTIONS”, which are also in stock market in India (remember Future & Options?)

Let me tell you what Stock Options are in general. If a person has a Stock Option, he actually has a right to BUY a stock in future at a pre-decided price agreed at the time of giving those stock options. So in future whatever is the market price does not matter, you always have an option to buy it at the price which was agreed upon. In this case if market price of the stock is above the pre-decided price, then you can just exercise your options of buying the stock and instantly you will be in profit. If however, the current market price is less than the pre-decided price, then you choose not to exercise the stock option at all and nothing happens.

Let me give you an example. Let’s say that an employee joins a company on 1st Jan 2013. His company gives him 500 ESOPs with vesting period of 3 yrs and at the vesting price of Rs 200. What this means is that his vesting date is 1st Jan 2016 (after 3 yrs) , On that date, he has a OPTION to buy 500 stocks of the company at Rs 200 if he wishes. Now lets say on 1st Jan 2016 …

Case 1 – The stock price is Rs 800

In this case, the employee can exercise his option and he can get 500 stocks at only Rs 200 . At this moment, the employee will make a clean profit of Rs 600 each shares and a cool Rs 3,00,000 . Note that he does not have to pay anything here, when he exercises his option, he will automatically get his profit without putting anything from his pocket. It makes sense to exercise his option in this case, because vesting price is less than market price.

Case 2 – The stock price is Rs 130

In this case, it does not make any sense to exercise, because you will be in loss, because the price you have to pay is less than market price, so you let this option go.

Note : In case of stock options, you can never make any loss, it will always be some profit only.

Red Herring prospectus

The term red herring originates from the tradition whereby young hunting dogs in Britain were trained to follow a scent with the use of a "red" (salted and smoked) herring (see kipper). This pungent fish would be dragged across a trail until the puppy learned to follow the scent.

The reason it is called a red herring is due to a disclosure statement printed in red ink on the cover which explicitly states that the issuing company is not attempting to sell its shares. e.g. "A Registration Statement relating to these securities has been filed with the Securities and Exchange Commission but has not yet become effective. Information contained herein is subject to completion or amendment. These securities may not be sold nor may offers to buy be accepted prior to the time the Registration Statement becomes effective."

When a company decides to go public the company appoints underwriters and registrars of issue, it first involve one or more investment banks known as underwriters. The company and the investment bank first discuss some aspects like the amount of money a company will raise, the type of securities to be issued and all the details in the underwriting agreement. After the company secures an underwriter, it files a draft offer prospectus SEBI for review. 

This document contains information about the offering and company’s information like financial statements, management background, legal issues (if any), use of proceeds and risk factors. Once the draft document cleared by SEBI, it becomes offer document. Offer document is then submitted to registrar of the issue and stock exchange. Once offer document gets clearance from stock exchange, Issuer company makes it available to the public. The issue prospectus is now called as ‘Red Herring Prospectus’.

It means a prospectus which does not have complete details as regards the price at which the securities are being offered and the quantity of securities. When the offer of securities gets closed, then the company has to file a final prospectus stating therein the total capital or quantity of securities raised and the price of the securities or any other details which were not given in the red-herring prospectus. This final prospectus, in case of a listed public company, is necessary to be filed with the Securities and Exchange Board of India (SEBI) and the Registrar of Companies but if the company is not a listed one then the company has to file the final prospectus only with the Registrar of companies.

Red Herring Prospectus is a prospectus which does not have details of either price or number of shares being offered or the amount of issue. This means that in case price is not disclosed, the number of shares and the upper and lower price bands are disclosed.

On the other hand, an issuer can state the issue size and the number of shares are determined later. An RHP for and FPO can be filed with the RoC without the price band and the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot be determined until the bidding process is completed.

Hence, such details are not shown in the Red Herring prospectus filed with ROC. Only on completion of the bidding process, the details of the final price are included in the offer document. The offer document filed thereafter with ROC is called a prospectus.

Moat of an Indian Stock

The moat was used as a defence mechanism for castles. Usually, they were filled with water to reduce the risk of fires and create a barrier for horses and their riders. The moats were created very deep, which made them harder to cross.

Most are familiar with the sight of a moat, traditionally dug around castles, and frequently filled with water. When the moat was first employed, it was meant to provide an additional defense of castles, towns, or large installments of people. A water filled moat made extremely difficult to storm a castle and or gain access to the walls of a fortress. Attacking armies could not simply climb the walls, and attempt to bring them down, because the moat proved a formidable obstruction. Further, attempts to fill in the moat or provide a crossing was often met with a volley of arrows, to discourage such attempts.

During the early Middle Ages, a moat might not be filled with water. It was still a trench deep enough to render it difficult for attackers to breach the walls of a building. A moat not filled with water is a dry moat. Later, most moats were filled with water. However, they were not, as some suppose, filled with alligators or sharks. It would have been virtually impossible to keep sharks alive in moat conditions; it’s very hard to keep them living even in today’s aquariums. Keeping alligators would also have proven impractical.

Most early versions of the moat did not have drawbridges, as one most often thinks. They did have bridges that could be removed easily at the approach of an enemy. In most cases, drawbridges were not employed until the late Middle Ages.

Though we commonly think of the moat in association with European Castles, Medieval Japan and China had impressive moat systems guarding cities and castles. Some Japanese cities would have not one but several moats. Some buildings might be built between some of the moats, but the vital parts of the city could be protected by as many as three moats. Sometimes these moats were the dry moat variety. Today, a few moats remain, like the one surrounding the Japanese Imperial Palace.

Some Native American tribes also built moats around central living areas, at least as far back as the 16th century. These provided some protection against raiding tribes or raiding Europeans. However, the introduction of the rifle to American Indians did render some moats useless, unless they were very wide.

Trenches dug during many wars work on the principal of the moat, though these are dry moats. Even today, a military force may dig large trenches to slow down an enemy, make motor transport impossible, or to keep tanks from crossing. A moat or trench can also be a useful place to hide during long battles.

Moats also frequently are used in zoos to keep animals in. These normally span a large, unjumpable distance, and are fairly deep. Fans of the computer game Zoo Tycoon, know digging a moat around dinosaur installments is an excellent way to keep large predators from escaping and eating the scientists.

ITC's low-tax cigarette launch has helped boost margins.
 
Investment Thesis

ITC, India’s largest cigarette manufacturer by revenue, has garnered leading market share through its popular brands. It's not without its share of challenges, which include competitive pressures from cheaper substitutes such as chewing tobacco and leaf-rolled tobacco, and the potential for further government intervention (like the passage of higher taxes). Even so, ITC has defended its turf for several years by investing in product innovation, and in marketing its core brands. In addition, ITC has also recently expanded its product set to include lower-priced products (which are subject to a lower tax rate) to expand its customer reach. This has allowed it to post solid sales growth and expand operating margins in its cigarette business, despite rising taxes. We believe ITC will continue to hold a dominant position in the Indian cigarette market for over a decade, and we think Indian smokers will trade up to more premium brands as the prevalence of smoking increases (unlike in developed economies, where smoking is declining).

We believe ITC Limited enjoys a narrow economic moat, owing to its brand strength, pricing power, and the addictive nature of its core product. Large competitors, including Godfrey Philips and VST Industries, combined, hold approximately 20% share of the Indian cigarette market. Less than 5% of the total market by value, but 48% by volume, is served by over 300 unorganized cigarette and leaf-rolled tobacco manufacturers, which pose a low-price substitute to branded cigarettes. By launching branded products at lower price points, ITC has been able to effectively compete with these unbranded tobacco producers, and improve its market share over time.

ITC holds a greater-than-majority share of India's organized cigarette market, and has been able to raise prices while maintaining volume growth. Given that most smokers remain brand loyal for a long time, and are addicted not only to smoking but also to the taste of their particular brand, we believe that ITC has a narrow economic moat and will sustain its leadership in the Indian cigarette market, despite competitive and regulatory pressures.
 
Risk

The major risks facing ITC stem from potential changes in government regulations related to taxation, manufacturing licenses, and advertising or distribution bans. More specifically, if the government drastically increases the excise tax rate on cigarettes (similar to past actions), the company's production volumes and profitability could suffer. Apart from regulatory risks, we also believe there is a risk that ITC management may expand further into less profitable businesses--and away from its core competencies in cigarettes--which would not be in the best interest of its shareholders. Overall, we rate ITC as having medium uncertainty, reflecting that the firm derives more than half of its sales from the cigarette business, which in itself is a non-cyclical business that operates with minimal financial leverage.
 
Company Profile

ITC Limited is the largest cigarette manufacturer by revenue in India, with more than INR 300 billion in annual revenues and only 10% of its sales coming from outside India. ITC’s major business segments include cigarettes (56.2% of net sales), consumer products (14.6%), agricultural produce (14.9%), paper-related products (9.3%), hotels (2.4%) and other (2.6%). The company started as a subsidiary of Imperial Tobacco IMT in 1910, but today is 31% owned by the global cigarette giant, British American Tobacco BTI.

Beta

Beta is a numeric value that measures the fluctuations of a stock to changes in the overall stock market. A measure of a security's or portfolio's volatility. It also measures the responsiveness of a stock's price to changes in the overall stock market.

The degree to which different portfolios are affected by these systematic risks as compared to the effect on the market as a whole, is different and is measured by Beta. To put it differently, the systematic risks of various securities differ due to their relationships with the market. The Beta factor describes the movement in a stock's or a portfolio's returns in relation to that of the market returns. For all practical purposes, the market returns are measured by the returns on the index (Nifty, Mid-cap etc.), since the index is a good reflector of the market.

Beta is a measure of an investment's relative volatility. The higher the beta, the more sharply the value of the investment can be expected to fluctuate in relation to a market index. Beta is calculated by using regression analysis; one should think of beta as the tendency of a security's returns to respond to swings in the market.

A beta of 1 indicates that the price of a security or portfolio will move in tandem with the market, or further can be termed as neither more nor less volatile or risky than the wider market. A beta of more than 1 indicates greater volatility and a beta of less than 1 indicates less volatile than the market.

Beta is an important component of the Capital Asset Pricing Model, which attempts to use volatility and risk to estimate expected returns.

Risk is an important consideration in holding any portfolio. The risk in holding securities is generally associated with the possibility that realised returns will be less than the returns expected.

Risks can be classified as Systematic risks and Unsystematic risks.

• Unsystematic risks:
  These are risks that are unique to a firm or industry. Factors such as management capability, consumer preferences, labour, etc. contribute to unsystematic risks. Unsystematic risks are controllable by nature and can be considerably reduced by sufficiently diversifying one's portfolio. 
• Systematic risks:
  These are risks associated with the economic, political, sociological and other macro-level changes. They affect the entire market as a whole and cannot be controlled or eliminated merely by diversifying one's portfolio.

For example, if a stock's beta is 1.2, theoretically, it's 20% more volatile than the market. Many utilities stocks have a beta less than 1. Conversely, most high-flying tech stocks have a beta greater than 1, offering a chance for higher returns but with far greater risk.

On comparison of the benchmark index for e.g. NSE Nifty to a particular stock returns, a pattern develops that shows the stock's openness to the market risk. This helps the investor to decide whether he wants to go for the riskier stock that is highly correlated with the market (beta above 1), or with a less volatile one (beta below 1).

Boston Matrix of Stocks

BCG Matrix (Boston Consulting Group Matrix)

Within the world of product management and strategic planning, few strategies are as well recognized and appreciated as that of the Boston Matrix, which comes from the world-renowned Boston Consulting Group. 

A BCG matrix, also known as a Boston matrix or growth-share matrix, helps organizations figure out which areas of their business deserve more resources and investment. 

The “BCG matrix” or Portfolio Analysis is a portfolio planning model which had been created by Bruce Henderson for the Boston Consulting Group in 1968 to help corporations with analyzing their business units or product lines. 

The matrix framework categorizes products within a company's portfolio according to each product's growth rate, market share, and positive or negative cash flow. This helps the company allocate resources and is used as an analytical tool in marketing, product, strategic management, and portfolio analysis. By using positive cash flows, a company can capitalize on growth opportunities.

The matrix is recognized as the preeminent tool for classifying individual product lines within a company’s entire product portfolio, and for outlining the marketing strategies these companies must use to maximize their products’ returns.

"The payoff for leadership [in market share] is very high indeed, if it is achieved early and maintained until growth slows," Boston Consulting Group's Bruce Henderson told clients. "Investment in market share during the growth phase can be very attractive, if you have the cash. Growth in market is compounded by growth in share. Increases in share increase the profit margin...The return on investment is enormous." 

Often referred to as simply the BCG Matrix, its purpose isn’t merely to identify a company’s strongest product lines, but also to provide guidance as to 1) which product line the company should prioritize, 2) which product line the company should retain, 3) which product line it should kill, and finally, 4) which product line needs further definition and analysis. So, how does the BCG Matrix help define these four product classes? More importantly, how can your company use the BCG Matrix? 

A high-growth product is for example a new one that we are trying to get to some market. It takes some effort and resources to market it, to build distribution channels, and to build sales infrastructure, but it is a product that is expected to bring the gold in the future.

A low-growth product is for example an established product known by the market. Characteristics of this product do not change much, customers know what they are getting, and the price does not change much either. This product has only limited budget for marketing. There is the milking cow that brings in the constant flow of cash. An example of this product would be regular Colgate toothpaste.

But the question is, how do we exactly find out what phase our product is in, and how do we classify what we sell? Furthermore, we also ask, where does each of our products fit into our product mix ? Should we promote one product more than the other one? The BCG matrix can help with this.

The BCG matrix reaches further behind product mix. Knowing what we are selling helps managers to make decisions about what priorities to assign to not only products but also company departments and business units.

The growth-share matrix helps organizations assess its companies and business units on two levels. The first is its level of growth within the market, while the second measures its market share relative to the competition within its industry.

It is based on the observation that the company’s business and to further analyze its assets, the matrix divides the business units in four different categories on the basis of their Market growth Rate (MGR) & Relative Market Shares (RMS).

Stars

The business units or products that have the best market shares and generate the most cash are considered stars. However, because of their high growth rate, stars also consume large amounts cash. This generally results in the same amount of money coming in that is going out.

Stars are units with a high market share in a fast-growing industry. Stars can eventually become cash cows if they sustain their success until a time that the market growth rate declines.

The hope is that stars become the next cash cows. Sustaining the business unit's market leadership may require extra cash, but this is worthwhile if that's what it takes for the unit to remain a leader. When growth slows, stars become cash cows if they have been able to maintain their category leadership, or they move from brief stardom to dogdom.

Strategic options for stars include:

• Integration – forward, backward and horizontal
• Market penetration
• Market development
• Product development
• Joint ventures

As a particular industry matures and its growth slows, all business units become either cash cows or dogs. The natural cycle for most business units is that they start as question marks, and then turn into stars. Eventually the market stops growing thus the business unit becomes a cash cow. At the end of the cycle the cash cow turns into a dog.

The overall goal of this ranking was to help corporate analysts decide which of their business units to fund, and how much; and which units to sell. Managers were supposed to gain perspective from this analysis that allowed them to plan with confidence to use money generated by the cash cows to fund the stars and, possibly, the question marks. As the BCG stated in 1970:

Only a diversified company with a balanced portfolio can use its strengths to truly capitalize on its growth opportunities. The balanced portfolio has:

• Stars whose high share and high growth assure the future;
• Cash cows that supply funds for that future growth; and
• Question marks to be converted into stars with the added funds.

Cash cows

Cash cows are the leader in the marketplace and generate more cash than they consume. As leaders in a mature market, cash cows exhibit a return on assets that is greater than the market growth rate – so they generate more cash than they consume. These units should be ‘milked’ extracting the profits and investing as little as possible.

They generate the abundant cash required to turn question marks into market leaders. These are business units or products that have a high market share, but a low growth prospects. 

Cash cows are units with high market share in a slow-growing industry. These units typically generate cash in excess of the amount of cash needed to maintain the business. They consume minimum of company resources They are regarded as staid and boring, in a "mature" market, and every corporation would be thrilled to own as many as possible.

According to NetMBA, cash cows provide the cash required to turn question marks into market leaders, to cover the administrative costs of the company, to fund research and development, to service the corporate debt, and to pay dividends to shareholders.

It is desirable to maintain the strong position as long as possible and strategic options include:

• Product development
• Concentric diversification
• If the position weakens as a result of loss of market share or

Market contraction then options would include:

• Retrenchment (or even divestment)

Dogs

Business units or products that are dogs are those have both a low market share and a low growth rate and neither generates nor consumes a large amount of cash.

They don't earn a lot of cash, nor do they consume a lot. Most likely these aspects of a business are making little, if any money. Dogs are generally considered cash traps because businesses have money tied up in them, even though they are bringing back basically nothing in return. These business units are prime candidates for divestiture.

Dogs are more charitably called pets, are units with low market share in a mature, slow-growing industry. These units typically "break even", generating barely enough cash to maintain the business's market share. Though owning a break-even unit provides the social benefit of providing jobs and possible synergies that assist other business units, from an accounting point of view such a unit is worthless, not generating cash for the company. A company must avoid the business than can be categorized as dogs.

Strategic options would include:

• Retrenchment (if it is believed that it could be revitalised)
• Liquidation
• Divestment (if you can find someone to buy!

Question marks

Question mark, are characterised by rapid growth and thus consumes large amounts of cash, but because they have low market shares they do not generate much cash. The result is large net cash consumption but bringing little back in return They are also known as problem child or losing money.

A question mark has the potential to gain high market share and become a star, and eventually a cash cow when the market growth slows.

However, if the question mark does not succeed in becoming the market leader, then after perhaps years of cash consumption it will degenerate into a dog when the market growth declines.

According to NetMBA, question marks must be analyzed carefully in order to determine whether they are worth the investment required to grow their market share.

Strategic options for question marks include:

• Market penetration
• Market development
• Product development
• Which are all intensive strategies or divestment.