BOOK VALUE VALUATION

What is Book Value Valuation ?

The accounting net worth of a business – total assets minus total liabilities is called book value valuation. Assets are valued at their adjusted cost basis minus depreciation. The book value does not take into consideration certain unrecorded assets and liabilities such as the current value of goodwill, customer lists or lease obligations.

In Valuation method we have seen a customer ready to give money only for Machineries with all Accessories including Building and Land. His prediction is nearest Book Value. In Book Value, he tried to buy that Industry. But the Owner refused. Companies or Stocks Book Value exactly calculating and with that Company / stocks value discovering is called Book Value Valuation Method.

                  

Calculating all Business with Book Value is not suitable. For Example, you are owning a Departmental store. You have started that store , nearly 10 years back. Your stores present Machineries with Accessories value can be taken as Rs.10 Lakhs. Your stores Annual Net Profit can be taken as roughly Rs10 Lakhs. If you will be ready to sell that share in Book     Value ? Just think!

                  

So, we can conclude that each valuation method is suitable for some sort of Business only. For service oriented Industries book value method doesn’t suit. Capital Intensive told as Large Capitalization Business can be calculated with the book value valuation method. ( Shipping, Electricity Production, Banking, and Finance sectors )   

                            

Likewise several Old Economic Business can be valued through Book Value Method. Which stocks can be bought lesser than the Book Value? Which Company stocks can be bought?

                            

Absence of more growth sectors / stocks , more debts present companies, can be available in less than book value. In our country

1)      During Economic problems felt (or)

2)      In, Good companies ,problems raised (or)

3)      The, Good companies when not familiar to the World.  

                            

During those times the companies / company stocks can be available less than book value. Even in those times, better Track record present, Quality Organizational stocks can be bought , which may be better. 

                            

Even several times companies portray their purchased asset value in book. In those stocks the value may be hidden. While Analyzing those stocks and purchasing we can yield attractive gains.

                  

In the past 10 to15 years in our country Real estate sector has raised well. Several organization even today predicting their real estate in the purchased rate as in older years in the book. Recently in north India some textile sectors based stocks are found  suddenly rising due to their vacant places. Residential blocks and trading buildings were built and sold (or) rented by way of creating income to the company

                  

Using book value valuation method must be handled carefully. After creating “PEER GROUP”, P/BV (stock market price/ book value) founded and compared with, which stock is suitable for investment can be worked out. Separately using a stocks book value or using P/BV alone don’t invest. Because some companies available very lower than the Book Value may be in a Horrible situation. So, using “PEER GROUP” comparing with some other stocks / Business execute the Investment.

Tangible book value.

Book value minus intangible assets (goodwill, covenant not to compete, etc.). This method only records the assets that can be collateralized. It is most often used  by financial institutions.

Adjusted tangible book value. 

Adjusts the tangible assets up or down to their fair market value. It tells what the liquidation value of a business is most likely to be.  It is sometimes used in place

of book value for buy/sell agreements.

                              

MARKET PRICE VALUATION METHOD ;-

Advantages :-

In Economy (or) specified sector / companies while occurring problems the demand of those stocks / companies will be low. So, in those times, from its real value the prices will be available in very low cost. 

For Example :-

1)      S.K.F. Bearings a Multinational Company, Rs.125 /- reduced in Year 2008. Now its value           is Rs.  

2)      Likewise 2008- 09, VOLTAS stocks reduced to Rs.33/-.( During 2007-2008, a maximum          of Rs.250/- )Now it cost is Rs.    

                             

So, even Market value is most Transparent value method, we have to know how Effectively use for our own.  

Disadvantages :-  

In valuation we have seen a person comparing the market price for buying a Residential House. In the market, persons buying / selling being ready cost is the calculation used for this method. In this method the positives and also the negatives (like any other method) are also present. First we can see the Negatives,

                  

Market price is derived with various factors. Among those the important one is Demand and Supply. Market rising to the Top and Touching the Bottom line are casual incidences. But many amateur people within us , buy in the Top of the Sensex and with scolding in the Bottom of the market position is found common. 

                  

While Market being in the Top several stocks / companies value, deand being more, the values will be at the Top. Similar instances are not alone common for small investing but even for Giant Companies like TATA.

                  

In 2007, TATA Steel Company purchased, Britain’s “CHORES” for 12.2 Billion Dollars while market was at its Top. Similarly TATA MOTORS Company purchased Britain’s “JAHUAR” in 2008 for 2.3 Billion Dollars. After the stock market crash both companies stocks crashed largely. Rattan Tata in an interview said that the companies can be bought in considerable low prices. So, the market price is Either True must be investigated before Acquiring.   

  

Market Price Method

Estimates economic values for ecosystem products or services that are bought and sold in commercial markets.

1.    Overview

2.    Why Use the Market Price Method?

3.    Application of the Market Price Method

4.    Summary of the Market Price Method

5.    Applying the Market Price Method

6.    Advantages of the Market Price Method

7.    Issues and Limitations of the Market Price Method

Overview

The market price method estimates the economic value of ecosystem products or services that are bought and sold in commercial markets. The market price method can be used to value changes in either the quantity or quality of a good or service.  It uses standard economic techniques for measuring the economic benefits from marketed goods, based on the quantity people purchase at different prices, and the quantity supplied at different prices. 

The standard method for measuring the use value of resources traded in the marketplace is the estimation of consumer surplus and producer surplus using market price and quantity data. The total net economic benefit, or economic surplus, is the sum of consumer surplus and producer surplus.

This section continues with an example application of the market price method, followed by a more complete technical description of the method and its advantages and limitations.

Hypothetical Situation: 

Water pollution has caused the closure of a commercial fishing area, and agency staff want to evaluate the benefits of cleanup.

Why Use the Market Price Method? 

The market price method was selected in this case, because the primary resource affected is fish that are commercially harvested, and thus market data are available. 
 

Application of the Market Price Method: 
  
The objective is to measure total economic surplus for the increased fish harvest that would occur if the pollution is cleaned up.  This is the sum of consumer surplus plus producer surplus.  Remember that consumer surplus is measured by the maximum amount that people are willing to pay for a good, minus what they actually pay.  Similarly, producer surplus is measured by the difference between the total revenues earned from a good, and the total variable costs of producing it.  Thus, the researcher must estimate the difference between economic surplus before the closure and economic surplus after the closure. 

Step 1: 
The first step is to use market data to estimate the market demand function and consumer surplus for the fish before the closure.  To simplify the example, assume a linear demand function, where the initial market price is $5 per pound, and the maximum willingness to pay is $10 per pound.  The figure shows the area that the researcher wants to estimate ? the consumer surplus, or economic benefit to consumers, before the area was closed. 

At $5 per pound, consumers purchased 10,000 pounds of fish per year.  Thus, consumers spent a total of $50,000 on fish per year.  However, some consumers were willing to pay more than $5.00 per pound and thus received a net economic benefit from purchasing the fish.  This is shown by the shaded area on the graph, the consumer surplus.  This area is calculated as ($10-$5)*10,000/2 = $25,000.  This is the total consumer surplus received from the fish before the closure.

Step 2: 
The second step is to estimate the market demand function and consumer surplus for the fish after the closure.  After the closure, the market price of fish rose from $5 to $7 per pound, and the total quantity demanded decreased to 6,000 pounds per year.

Thus, the economic benefit has decreased, as shown in the figure.  The new consumer surplus is calculated as ($10-$7)*6,000/2 = $9,000.

Step 3: 
The third step is to estimate the loss in economic benefits to consumers, by subtracting benefits after the closure, $9,000, from benefits before the closure, $25,000.  Thus, the loss in benefits to consumers is $16,000.

Step 4: 
Because this is a marketed good, the researcher must also consider the losses to producers, in this case the commercial fishermen.  This is measured by the loss in producer surplus.  As with consumer surplus, the researcher must measure the producer surplus before and after the closure and calculate the difference.  Thus, the next step is to estimate the producer surplus before the closure. 

Producer surplus is measured by the difference between the total revenues earned from a good, and the total expense of producing it.  Before the closure, 10,000 pounds of fish were caught per year.  Fishermen were paid $1 per pound, so their total revenues were $10,000 per year.  The variable cost to harvest the fish was $.50 per pound, so total variable cost was $5,000 per year.  Thus, the producer surplus before the closure was $10,000 - $5,000 = $5,000.

Step 5: 
Next, the researcher would measure the producer surplus after the closure.  After the closure, 6,000 pounds were harvested per year.  If the wholesale price remained at $1, the total revenues after the closure would be $6,000 per year.  If the variable cost increased to $.60, because boats had to travel farther to fish, the total variable cost after the closure was $3,600.  Thus, the producer surplus after the closure is $6,000 - $3,600 = $2,400.

Step 6:  
The next step is to calculate the loss in producer surplus due to the closure.  This is equal to $5,000 - $2,400 = $2,600.  Note that this example is based on assumptions that greatly simplify the analysis, for the sake of clarity.  Certain factors might make the analysis more complicated.  For example, some fishermen might switch to another fishery after the closure, and thus losses would be lower.

Step 7: 
The final step is to calculate the total economic losses due to the closure—the sum of  
lost consumer surplus and lost producer surplus.  The total loss is $16,000 + $2,600 = $18,600.  Thus, the benefits of cleaning up pollution in order to reopen the area are equal to $18,600.

How Can the Results be Used? 

The results of the analysis can be used to compare the benefits of actions that would allow the area to be reopened, to the costs of such actions.  

Summary of the Market Price Method

The market price method estimates the economic value of ecosystem products or services that are bought and sold in markets. The market price method can be used to value changes in either the quantity or quality of a good or service.  It uses standard economic techniques for measuring the economic benefits from marketed goods, based on the quantity people purchase at different prices, and the quantity supplied at different prices. 

For those resources for which markets exist, economists determine individuals’ values by observing their preferences and willingness to pay for the goods and services at the prices offered in the market.  The standard method for measuring the use value of resources traded in the marketplace is the estimation of consumer surplus  and producer surplus  using market price and quantity data.  The total net economic benefit, or economic surplus, is the sum of consumer surplus and producer surplus. 

Applying the Market Price Method

The market price method uses prevailing prices for goods and services traded in markets, such as timber or fish sold commercially.  Market price represents the value of an additional unit of that good or service, assuming the good is sold through a perfectly competitive market (that is, a market where there is full information, identical products being sold and no taxes or subsidies).

Application of the market price method requires data to estimate consumer surplus and producer surplus.  To estimate consumer surplus, the demand function must be estimated.  This requires time series data on the quantity demanded at different prices, plus data on other factors that might affect demand, such as income or other demographic data.  To estimate producer surplus, data on variable costs of production and revenues received from the good are required. 

Advantages of the Market Price Method

• The market price method reflects an individual's willingness to pay for costs and benefits of goods that are bought and sold in markets, such as fish, timber, or fuel wood.  Thus, people’s values are likely to be well-defined.
• Price, quantity and cost data are relatively easy to obtain for established markets.
• The method uses observed data of actual consumer preferences.
• The method uses standard, accepted economic techniques.

Issues and Limitations of the Market Price Method

• Market data may only be available for a limited number of goods and services provided by an ecological resource and may not reflect the value of all productive uses of a resource.
• The true economic value of goods or services may not be fully reflected in market transactions, due to market imperfections and/or policy failures. 
• Seasonal variations and other effects on price must be considered.
• The method cannot be easily used to measure the value of larger scale changes that are likely to affect the supply of or demand for a good or service.
• Usually, the market price method does not deduct the market value of other resources used to bring ecosystem products to market, and thus may overstate benefits.

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.