Month: October 2022

1. Competitors:

The intensity of competition from existing competitors will depend on several factors including:

1. The number of competitors
2. Their relative size
3. Whether their product offering and strategies are similar
4. The existence of high fixed costs
5. The commitment of competitors and
6. The size and nature of exist barriers

2. Potential competitors:

Potential competitors who might have an interest in entering an industry. Whether potential competitors, identified or not, actually do enter, however, depends in large part upon the size and nature of barriers to entry. Thus, an analysis of barriers to entry is important in projecting the likely competitive intensity and profitability levels in the future.

Entry barriers include:

1. Capital investment required.
2. Industries like mining, refinery or automobiles require huge investments and larger gestation periods that increase the risk.

3. Economies of scale:

If scale economies exist in production, advertising, distribution, or other areas, it becomes necessary to obtain a large volume quickly. Such an effort not only increases the investment but it also increase the risk of retaliation from existing competitors. Reliance Fresh opted this strategy for reducing the price of fruits and vegetables in its retail outlets.

4. Distribution channels:

Gaining distribution in some industries can be extremely difficult and costly. Even large established firms that sell products with substantial marketing budgets have trouble obtaining space on the supermarket shelf Competition between Pepsi and Coke limit the customers’ choice on cola as most of the retail outlets have a policy of eliminating one cola product (either Coke or Pepsi brands) from their shelves.

5. Product differentiation:

Established firms may have high levels of customer loyalty caused and maintained by protected product features, a brand name and image, advertising, and customer service. Industries in which product differentiation barriers are particularly high include soft drinks, beer, cosmetics, over-the-counter drugs, and banking.

Unfortunately Transport Department of Govt. of India banned this advertisement by citing the reason such as youth tend to follow the ad, violate traffic rules and risk their life.

6. Substitute products:

Substitute products are represented by those sets of competitors that are identified as competing with less intensity than the primary competitors.

7. Customer power:

When customers have relatively more power than sellers do, they can force prices down or demand more services, thereby affecting profitability. A customer’s power will be greater when its purchase size is a large proportion of the seller’s business, when alternative suppliers are available, and when the customer can integrate backward and make all or part of the product.

8. Supplier power:

When the supplier industry is concentrated and sells to a variety of customers in diverse industries, it will have relative power that can be used to influence prices. Power will also tend to be enhanced when the costs of customers to switch suppliers is high.

ROI

Return on investment (ROI) is a financial ratio used to calculate the benefit an investor will receive in relation to their investment cost. It is most commonly measured as net income divided by the original capital cost of the investment. The higher the ratio, the greater the benefit earned.

ROI Formula

There are several versions of the ROI formula. The two most commonly used are shown below:

ROI = Net Income / Cost of Investment

or

ROI = Investment Gain / Investment Base

Benefits of the ROI Formula

There are many benefits to using the return on investment ratio that every analyst should be aware of.

Simple and Easy to Calculate

The return on investment metric is frequently used because it’s so easy to calculate. Only two figures are required the benefit and the cost. Because a “return” can mean different things to different people, the ROI formula is easy to use, as there is not a strict definition of “return”.

Universally Understood

Return on investment is a universally understood concept so it’s almost guaranteed that if you use the metric in conversation, then people will know what you’re talking about.

Limitations of the ROI Formula

While the ratio is often very useful, there are also some limitations to the ROI formula that are important to know.  Below are two key points that are worthy of note.

The ROI Formula Disregards the Factor of Time

A higher ROI number does not always mean a better investment option. For example, two investments have the same ROI of 50%. However, the first investment is completed in three years, while the second investment needs five years to produce the same yield. The same ROI for both investments blurred the bigger picture, but when the factor of time was added, the investor easily sees the better option.

The investor needs to compare two instruments under the same time period and same circumstances.

The ROI Formula is Susceptible to Manipulation

An ROI calculation will differ between two people depending on what ROI formula is used in the calculation. A marketing manager can use the property calculation explained in the example section without accounting for additional costs such as maintenance costs, property taxes, sales fees, stamp duties, and legal costs.

Absolute returns

The absolute return or simply return is a measure of the gain or loss on an investment portfolio expressed as a percentage of invested capital. The adjective “absolute” is used to stress the distinction with the relative return measures often used by long-only stock funds that are not allowed to take part in short selling.

The hedge fund business is defined by absolute returns. Unlike traditional asset managers, who try to track and outperform a benchmark (a reference index such as the Dow Jones and S&P 500), hedge fund managers employ different strategies in order to produce a positive return regardless of the direction and the fluctuations of capital markets. This is one reason why hedge funds are referred to as alternative investment vehicles.

Absolute return managers tend to be characterised by their use of short selling, leverage and high turnover in their portfolios.

The formula for absolute return is:

Absolute returns = 100* (Selling Price – Cost Price)/ (Cost Price)

Advantages

It offers multiple advantages. A few of the noteworthy are enumerated below:

• First, it is straightforward to calculate and understand for all users.
• Second, it is unaffected by period and benchmark comparison and provides returns generated in actual terms.
• Third, it helps in reducing overall volatility as it doesn’t consider intermittent changes.

Disadvantages

• It isn’t easy to compare across other asset classes.
• It is a fault measure when comparing different time frames.
• It doesn’t compare against any benchmark, which results in determining the relative performance. Also, absolute return lacks adjusting returns for inflation, leading to negative returns despite absolute returns showing a positive value.
• These measures don’t allow investors to assess the efficacy of the Fund manager and whether they can generate positive alpha. Also, this measure completely avoids assessing risk-adjusted returns.
• It is not comparable, which makes it an adequate measure of performance.
• It can lead to the selection of those investments where risk is higher as it doesn’t consider risk measures such as Standard Deviation and other performance ratios such as Sharpe Ratio, Treynor Ratio, etc.

Annualized return

The annual return is the return on an investment generated over a year and calculated as a percentage of the initial amount of investment. If the return is positive (negative), it is considered a gain (loss) on the initial investment. The rate of return will vary depending on the level of risk involved.

Annual Return Formula

The return earned over any 12-month period for an investment is given by the following formula:

Annual Return = [(Final value of Investment – Initial value of Investment) / Initial value of Investment] * 100

Advantages:

• It is very easy to calculate and simple to understand like payback period. It considers the total profits or savings over the entire period of economic life of the project.
• This method recognizes the concept of net earnings i.e. earnings after tax and depreciation. This is a vital factor in the appraisal of a investment proposal.
• This method facilitates the comparison of new product project with that of cost reducing project or other projects of competitive nature.
• This method gives a clear picture of the profitability of a project.
• This method alone considers the accounting concept of profit for calculating rate of return. Moreover, the accounting profit can be readily calculated from the accounting records.
• This method satisfies the interest of the owners since they are much interested in return on investment.
• This method is useful to measure current performance of the firm.

Disadvantages:

• The results are different if one calculates ROI and others calculate ARR. It creates problem in making decisions.
• This method ignores time factor. The primary weakness of the average return method of selecting alternative uses of funds is that the time value of funds is ignored.
• A fair rate of return cannot be determined on the basis of ARR. It is the discretion of the management.
• This method does not consider the external factors which are also affecting the profitability of the project.
• It does not take into the consideration of cash inflows which are more important than the accounting profits.
• It ignores the period in which the profits are earned as a 20% rate of return in 10 years may be considered to be better than 18% rate of return for 6 years. This is not proper because longer the term of the project, greater is the risk involved.
• This method cannot be applied in a situation when investment in a project to be made in parts.
• This method does not consider the life period of the various investments. But average earnings are calculated by taking life period of the investment. As a result, average investment or initial investment may remain the same whether investment has a life period of 4 years or 6 years.
• It is not useful to evaluate the projects where investment is made in two or more instalments at different times.

Systematic risk

Systematic risk is caused by the changes in government policy, the act of nature such as natural disaster, changes in the nation’s economy, international economic components, etc. The risk may result in the fall of the value of investments over a period. It is divided into three categories that are explained as under:

• Interest risk: Risk caused by the fluctuation in the rate or interest from time to time and affects interest-bearing securities like bonds and debentures.
• Inflation risk: Alternatively known as purchasing power risk as it adversely affects the purchasing power of an individual. Such risk arises due to a rise in the cost of production, the rise in wages, etc.
• Market risk: The risk influences the prices of a share, i.e. the prices will rise or fall consistently over a period along with other shares of the market.

Unsystematic risk

Unsystematic risk is the risk that is unique to a specific company or industry. It’s also known as nonsystematic risk, specific risk, diversifiable risk, or residual risk. In the context of an investment portfolio, unsystematic risk can be reduced through diversification while systematic risk is the risk that’s inherent in the market.

The risk can be avoided by the organization if necessary actions are taken in this regard. It has been divided into two category business risk and financial risk, explained as under:

• Business risk: Risk inherent to the securities, is the company may or may not perform well. The risk when a company performs below average is known as a business risk. There are some factors that cause business risks like changes in government policies, the rise in competition, change in consumer taste and preferences, development of substitute products, technological changes, etc.
• Financial risk: Alternatively known as leveraged risk. When there is a change in the capital structure of the company, it amounts to a financial risk. The debt–equity ratio is the expression of such risk.

The extended internal rate of return or the more commonly used, XIRR, is the rate which calculates the returns on the total investment made with increments, paid throughout the period under consideration.

XIRR is an annualized form of return. Annualized return indicates what investment would return over a time period if the annual return is compounded.

XIRR comes to an investor’s aid when investments are made into mutual funds at randomly spaced intervals. Moreover, redemptions are also processed at irregular time intervals. The time periods will differ for each cash flow. Each particular investment will offer a different rate of return at a given date of measurement.

XIRR= Weighted average CAGR of all instalments

IV= Investment Value (IV)

FV= Final Value (FV)

N= Investment intervals (n)

We understand it can be complicated to manually calculate XIRR for any investment. What’s more important is understanding its significance and need, especially when you are investing in mutual funds via SIP.

Therefore, XIRR can be used to calculate an investor’s mutual fund returns when investments and redemptions are spread over a period of time.

For example, Mr. A decided to invest Rs 50,000 in a thematic fund with the pharma sector as the theme on the news of the coronavirus pandemic. Mr. A redeems the invested amount on the news of economic recovery to look for better returns. Mr. A invests that Rs 50,000 in the consumer durables sector on the news of vaccine efficacy. On the release of auto sales data, Mr. A invested another Rs 50,000 in the auto sector with a short-term view to reap benefits of festive sales rally. Now, the investment and redemption time periods for each investment will be unevenly spaced. XIRR can be used to calculate the overall return on the invested corpus.

An investor may choose different options such as SIP, SWP, and lumpsum for different mutual funds. XIRR can be applied to such investment strategies.

XIRR, IRR, and CAGR can be quite confusing at times. CAGR and XIRR are both used to calculate returns on investment. XIRR can be referred to as an aggregate of multiple CAGRs. When there are multiple investments made in a fund, XIRR can be used to calculate the overall return.

There is a fine line of difference between CAGR and XIRR. CAGR is used to assess the performance of a mutual fund on a standalone basis. XIRR is computed to assess the performance of your investment in the mutual fund.

Let’s assume that one invests Rs 2000 per month for a year in a fund, which increases to Rs 48,000 in 4 years. How to calculate the overall return on this investment made over 12 months? If using CAGR, you will have to measure the CAGR for 48 months on the first installment, for 47 months on the second installment, for 46 months on the third installment, and so on. Instead of doing that, one can use the XIRR function of excel that takes into account all these CAGRs to give the overall CAGR.

XIRR and IRR functions of excel differ on the basis that the IRR function assumes that each period between a series of cash flows is of the same length. Rate of return on monthly, quarterly, or annual cash flows is generally measured using IRR. XIRR on the other hand offers to assign dates to the cash flows and doesn’t require each cash flow to be made after the same interval.

To summarise, if cash flows are made at regular intervals, IRR is preferred and if cash flows are not made at regular intervals then XIRR is preferred to measure the overall return.

Investing your money can be a fantastic way of building a better financial position for yourself and your family. It’s not possible to predict what the markets will do in the future, but these investing tips may help improve your investment success over the long term.

Leverage the power of compound interest

Over time, as your investments earn interest, if you reinvest those earnings, you earn interest on your interest. This is the core idea of compound interest. Without any extra effort on your part, compounding interest and time work together to potentially increase your investment returns.

If you start saving early, you take advantage of the effects of compounding interest on your investments over a long period of time. This has the potential to increase your total returns.

Embrace an Investing Strategy

It’s important to know what kind of investor you are and adhere to the principles of your investing strategies.

Use Rupee-cost averaging

Sticking to the discipline of Rupee-cost averaging can help you avoid making emotional decisions based on market turbulence. With Rupee-cost averaging, you invest a certain amount of money at regular intervals, regardless of what the market is doing. By always investing the same Rupee amount every month or other chosen period, you naturally buy fewer shares when the market is high and more shares when the market is low.

Asset Allocation

Your asset allocation, how you divide your portfolio among different asset categories, will be the biggest determinant of your investment returns. Many investors fail because they put little thought or effort into their asset allocation strategy.

If you place your money into overvalued asset categories you will experience poor long term returns. It’s important to overweight asset categories that are bargain priced and underweight or avoid asset categories that are expensive.

Know the risksInvesting your money can be a rewarding experience because of the risk involved in the process. Generally speaking, the greater the risk, the greater the reward. However, an acceptable risk for one person may not be an acceptable risk for the next. While investing your money may sound daunting, you don’t have to manage your portfolio yourself as long as you understand the risks behind investing your money, you can hire a portfolio manager to do the legwork for you. Are you comfortable losing money if the stock market performs poorly or does any sort of investment loss make you nervous? These are the types of questions to think about and discuss with an advisor to help gauge your tolerance for risk.

Investors with more time to recoup market losses may be more comfortable taking risks. However, as you near retirement or if you’re already retired, you may want to adjust your risk tolerance to make sure your investments are consistent with your goals.

Know your financial limitations: There is a very real risk to investing more than you can afford. If you want to make the most of your investments, your money shouldn’t be keeping you up at night. Instead, it is far better to invest an amount each month which is appropriate to your financial situation.

Keep Expenses Low

Most investors don’t realize how much difference high expenses make to their portfolio. Take a look at the what happens to your returns with a 1% higher expense ratio;

Review and rebalance your portfolio regularly

Over time, investments within your portfolio will grow at different paces. As a result, your diversification and asset allocation can become unbalanced. Add in any changes to your income, risk tolerance or family situation and your investments may no longer reflect your goals. An annual review of your portfolio with your advisor will give you an opportunity to fine-tune and rebalance your portfolio to help you stay on track toward meeting your financial goals.