December 27, 2021

CAGR meaning and calculation

CAGR or Compounded Annual Growth Rate refers to the mean annual growth over given period of time. To simply put, it shows the average annual return generated over a period of time thereby smoothing out any spikes or drops from the return over a period.

Let's take an example - you invested in a stock "A" at the beginning of year 2019 at Rs 1,000 and at end of year 2020 it's trading at Rs 500 and now at the end of 2021 its trading at Rs 3,000. How do you compute your average annual return? This is wherein CAGR comes to play, helping you smooth out the fluctuation to show your average return over 2019 to 2021.

How to calculate CAGR?

CAGR Formula
CAGR can be computed using above formula where in N refers to the number of years. Going back to our previous example, number of year would mean 2 years (2019 starting to 2021 end), Starting Value will be Rs 1,000 and Final Value will be Rs 3,000. Once calculated, you will get return of ~73.2%.

Calculating CAGR using EXCEL - 

You can use Excel's inbuilt formula of RRI. It has three arguments (number of years NPER, present value PV and final value FV).

So to calculate our example, your formula would be =RRI(2,1000,3000)

Always remember, while comparing CAGR between two stocks / investment / any item; numbers of years are equal. Else, you will be comparing apple to oranges.

October 13, 2021

Debentures explained

Definition: A debenture is defined as an instrument of debt executed by the company representing its obligation to repay the money at a specified rate and with an interest. It is one of the methods of raising the debt capital by company.

A debenture is like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.

Types: Debentures are primarily issued in two types - Convertible Debenture or Non-Convertible Debenture. Convertible debentures are a type of debentures that can be converted into equity shares of the company. Non-convertible debentures are defined as the type of debentures that cannot be converted into equity shares of the company

Important:
  • Convertible debenture carries lower interest rate, as they carry advantage of converting to equity at later stage
  • Maturity value of Convertible debenture is dependent on the share price

September 23, 2021

Dividend dates you must know

Here's quick guide for different dates you would read during Dividend announcement made by the Company and what does it signify -

Dividend Dates

Dividend Declaration Date : Date on which the dividend is announced by the company

This is the first trigger event, when company announces the dividend. This announcement includes details like dividend amount, total amount of dividend distribution and the record date (will explain this next).

Record Date (Cut-off date) : This is the date by when your name must be on the company's record books as a shareholder to be eligible to receive the dividend

On the dividend declaration day, together with quantum of dividend, the company also announces the Record Date. The record date is the date to simply put date on which final list of shareholder eligible for dividend would freeze. So if you want to be eligible for dividend, your name should be present on the company’s list of shareholders i.e. record book, by this date.

Shareholders whose name are not registered until this date on the company’s record book will not receive the dividend. 

Ex-Dividend Date : The date before which you must own the stock

The Ex-dividend date is usually two days before the record date. Reason for 2 days is due to the stock settlement time of 2 days followed in India. When you buy a stock, it takes two days (settlement time) before it gets reflected in your demat account. If you buy the stock on or after the Ex-dividend date, stock will not be reflected in your account within Record date and hence you won't get the dividend, instead, the previous owner of stock will get the dividend.

Dividend Payment Date : This is the date when dividend is disbursed to the shareholders

This is the date set by the company on which the dividends are disbursed to the shareholders.

Only those shareholders who bought the stock before the Ex-dividend date and got their name in record book of the company would be entitled to get this dividend. 

So if you are planning to get benefit of Dividend, Ex-dividend date is crucial and you need to make sure, that you buy the stock before stock starts trading as Ex-Dividend in secondary market.

Want to learn about how Dividend yield is calculated? Read here.

July 01, 2021

Free Cash Flow explained

In simple terms, Free Cash Flow (FCF) refers to the amount of cash generated by the entity after accounting for reinvestment in non-current assets. 

FCF = Cash from Operations [-] Capital Expenditure

Wherein, Cash from Operations = Net Income [+] Non-Cash expense [+] Changes in Net Working Capital. This number can readily be referenced from Cash Flow statement presented by the entity.

Non-Cash expense includes P&L expenses which have not been actually spent in Cash, like - Depreciation, Amortization, Stock based compensation, impairment charges etc.

Working Capital is calculated primarily difference between current asset and current liabilities, like -  Accounts Receivable, Inventory, Accounts Payable, etc.. Change in Net Working capital may be positive or negative number and will need to be added or deducted accordingly

Lot of Equity research report also calculates Levered and Unlevered Free Cash flow. So it's very important to understand the difference between them

Unlevered Free Cash Flow, also called Free Cash Flow to Firm (FCFF)

Levered Free Cash Flow, also called Free Cash Flow to Equity (FCFE)

Main difference between FCF, FCFF and FCFE is with respect to how the interest and debt is treated. Here's quick formula to give an idea on interest / debt treatment.

Free Cash Flow: Includes interest expense, but NOT debt issuances or repayments

Unlevered Free Cash Flow: Excludes interest expense and ALL debt issuances and repayments

Levered Free Cash Flow: Includes interest expense, and mandatory debt repayments

Formula to calculate each:

FCF: Cash Flow from Operations [–] Capital Expenditure

Unlevered Free Cash Flow (or FCFF): Earnings before Interest & Taxes (EBIT) [-] Taxes [+] Non-Cash Adjustments (like Depreciation, amortiztion, stock compensation) [+] Changes in Net Working Capital [–] Capital Expenditure

Levered Free Cash Flow (or FCFE): Net Income [+] Non-Cash Adjustments [+] Changes in Net Working Capital [–] Capital Expenditure [–] Debt Repayments

Note - as we started FCFE from Net Income, tax impact on debt repayment should be adjusted to arrive at more accurate number.

Unlevered free cash flow or FCFF is mostly used while doing discounted cash flow analysis


January 01, 2021

Exempt Income - Understanding & reporting in ITR

Income tax terminology can get very confusing at times and one of the most confused term is distinction of 'Tax deduction' and 'Exemption'. The lack of understanding leads to lot of people failing to report in the Exempt income in the Income Tax Return (ITR) filing. 

Understanding difference between 'Tax deduction' and 'Exempt income'

Tax deduction refers to the amount of money that is allowed as deduction from your total taxable income. The final amount after 'tax deduction' from total income is referred as ‘taxable income’. Concept of 'Tax deductions' is to motivate individuals to save and invest, also allowing some necessary expenses. Examples of 'Tax deduction' are amount deposited in PPF, NPS, donation made to charities (section 80G), Medical insurance, etc.

'Exempt income' on other hand means income that are excluded for arriving at taxable income. Exempt income are of two types - fully exempt (like Agricultural income, PPF interest, etc) and partially exempt (income subject to certain limit, like House Rent Allowance, Leave Travel Allowance, etc). Remember Exemptions are always from the specific income head and not from the gross total income. For e.g., Exemptions allowed under salary head cannot be claimed from any other income head.

To summarize, Exempt income is tax free from the point it is earned, while tax deduction are the part of income which is excluded basis certain tax provision and excluded from computing taxable income.

Tax Deduction vs Exempt Income


Why disclosure of Exempt Income is important?

Disclosure of Exempt Income is often ignored by individuals while filing income tax return, thinking it does not get taxed anyway - what assesse forgets is, this non-reporting can put them in risky situation when the future enquiry about the source of income is raised by Income Tax officer. In absence of disclosure under Exempt Income, you cannot pin-point source and open the assessment for further enquiry.

Section 10 of Income tax Act deals with all the incomes which are exempt from computing income taxes. Some examples of Exempt Income:
  • Interest credited to Provident Fund - Fully exempt (Statutory PF, PPF). In case of Recognized PF, only to the extent interest does not exceed 9.5% (Learn more about PPF here)
  • Dividend income from domestic company (amount not exceeding Rs. 10 lakh)
  • Gift or Voucher or Coupon on ceremonial occasions or otherwise provided to the employee - (a) Gifts in cash or convertible into money (like gift cheque) are fully taxable (b) Gift in kind up to Rs.5,000 in aggregate per annum would be exempt, beyond which it would be taxable.
  • Any income generated from agriculture and related activities including rent from land/farmhouse used for agricultural purpose, further processing of the agricultural product, income from seeds or saplings, etc. [Section 10(1)]
  • Share of income received from the family income, being a part of a Hindu Undivided Family [Section 10(2)]
  • Any amount received as a part of a life insurance plan including policy bonus [Section 10(10D)]
  • Any withdrawals from the provident fund (for salaried employees) [Section 10(11)(12)]
  • Amount received as compensation from the government, in case of disasters [Section 10(10BC)]
  • Income generated from tax-free securities [Section 10(15)]
  • National Pension System -  Any payment from the National Pension System Trust to an assesse on closure of his account or on his opting out of the pension scheme referred to in section 80CCD, to the extent it does not exceed 60% of the total amount payable to him at the time of such closure or his opting out of the scheme.
Disclosure Of Exempted Income For Salary Allowances in ITR

Disclosure of this type of exempted income is required to be made under "Schedule S - Details of Income from Salary" when filing tax returns
  • House Rent Allowance (HRA)
  • Leave Travel Allowance (LTA)
  • Encashment of Leave
  • Pension
  • Gratuity
  • Voluntary Retirement Scheme
  • Perquisites
Disclosure Of Exempted Income For Non-Salary Allowances in ITR

The Income Tax Act also specifies specific types of non-salary income that are also exempt from tax. These incomes include dividends, agricultural income, interest on funds, capital gains etc. Disclosure of these types of income is required to be made by the taxpayer under "Schedule EI - Details of Exempt Income" when filing tax returns

Screenshot of Exempt Income input required in ITR2:

ITR 2 - Exempt Income

Long-term Capital Gain tax exemption

It's important to note, Budget 2018 proposed to remove Section 10 (38) of the Income Tax Act, 1961. As per this section, the long-term capital gains (LTCG) arising on sale of equity shares or units of an equity-oriented mutual fund on which Securities Transaction Tax (STT) is paid was exempt from taxation. This section was initially introduced through the Finance Act, 2004, with effect from AY 2005-06, based on the Kelkar Committee report to attract investments from Foreign Institutional Investors (FII).

The Budget 2018 introduced Section 112A by withdrawing Section 10(38). It proposed to impose tax on the LTCG of the following: Shares, Equity-oriented funds or Business trusts. 

The LTCG tax is applicable at a rate of 10% on gains over and above Rs 1 lakh a year, and there is no benefit of indexation. The provisions of this section will apply from the financial year (FY) 2018-19, i.e. AY 2019-20.

Note: Article is meant for basic understanding and general guidance. Check with your tax consultant before filing taxes. Article is written on 1st Jan 2021 basis the then prevailing tax rules.

December 29, 2020

What is Exchange Traded Fund (ETF) and Index Fund?

For major participants in stock market - passive investing is the most preferred way. When it comes to passive investing - two of the most preferred way is investing via Mutual Fund SIPs or ETF. In Mutual Fund, easiest way to take the most balance approach is via Index Fund. It becomes imperative to understand this passive approach little more before embarking on long term wealth creation journey. Let's just dive into the basics -

What are Index Fund?

In most simplified definition - Index Funds are mutual fund schemes that track an underlying index like Nifty or Sensex. Objective is to invest in the same stocks that builds the underlying index in the same proportion, to replicate the performance of the underlying index.

What are Exchange Traded Fund (ETF)?

ETF is like a closed ended fund, where funds are raised in the beginning and then the ETF creates a portfolio of stocks representing underlying index (Sensex, Nifty, etc). Once portfolio is made, no further  fresh applications or redemption requests are taken. However, the ETF mandatorily gets listed on the stock exchange so you can always buy and sell it like equity shares in the market and also hold it in your demat account. 

What are the advantages of investing via Index Fund or ETF?

  • Both ETF vs Index Funds allow diversification of risk as they follow the particular index, and not any particular company or sector or industry.
  • Both being passively managed, operating costs are lower

Index Fund vs ETF

So, now question is - what is better? ETF or Index Fund?

ETFs have the advantage of comparatively lower cost over index funds. However, index funds have more advantages in ease of transacting, buying and selling at will and no need to have a demat account. Ideally, cost is the biggest factor when investing in a passive fund but in India due to low awareness there is lesser liquidity in ETFs. Therefore, personally I prefer Index Fund as opposed to ETFs.

You can check the list of Index Fund at StockXplain site here

November 09, 2020

Sovereign Gold Bond (SGB) Explained

Sovereign Gold Bond SGB

What is Sovereign Gold Bond (SGB)?

SGBs are government securities (issued by Reserve Bank of India on behalf of Government of India) denominated in grams of gold. They are substitutes for holding physical gold. Investors have to pay the issue price and the bonds will be redeemed at time of maturity.

What is the advantage of SGB over actual physical gold?

  • Purity of Gold
  • The quantity of gold for which the investor pays is protected
  • Government pays nominal interest rate each year
  • There is no additional cost impact of ‘making charges’ which is charged, if bought in physical form
  • It reduces risk and cost of storage associated with keeping physical gold
  • The bonds are held in the books of the RBI or in dematerialize form eliminating risk of loss of physical certificate

Benefits of Sovereign Gold Bonds

What about risks associated with SGBs?

Only risk is of price of gold at time of redemption / maturity. Capital loss will be there, if actual gold price falls below the purchase price.

Can I apply for SGBs?

Any person resident in India as defined under Foreign Exchange Management Act, 1999 are eligible to invest in SGB. Eligible investors includes  individuals, HUFs, trusts, universities and charitable institutions. Also you can invest in joint holding as well as on behalf of the minor his/her guardian.

I was resident, but now I am no longer resident. What happens to SGB I bought?

You can continue to hold SGB till early redemption/maturity, which you bought when you were eligible.

How can I apply for the bonds?

You can fill in the application form provided by the issuing banks/SHCIL offices/designated Post Offices/agents. You can also download application form from the RBI’s website. Banks may also provide online application facility. Lastly, you can also apply via your stock broking account (would be listed under Bonds at time of issuance).

How much can I invest? Is there any minimum or maximum limit?

The Bonds are issued in denominations of 1 gram and in multiples thereof. Hence, minimum investment needs to be 1gm. Maximum limit is 4 kg for individuals, 4 kg for Hindu Undivided Family (HUF) and 20 kg for trusts and similar entities notified by the government from time to time per fiscal year (April – March). 

In case of joint holding, the limit applies to the first applicant. 

For purpose of annual ceiling – it will include all SGB subscribed under different tranches during initial issuance by Government and those purchased from the secondary market.

What is the rate of interest and how will the interest be paid?

The Bonds bear interest at the rate of 2.50 per cent (fixed rate) p.a. on the amount of initial investment, i.e. issue price. 

Interest will be credited semi-annually to the bank account of the investor and the last interest will be payable on maturity along with the principal.

Is allotment guaranteed?

Yes, If you meet the eligibility criteria, produces a valid identification document and transfer the application money on time, allotment is guaranteed.

You can apply online (digital application) to be eligible for Rs 50 per gram discount as compared the issue price

How is the gold price arrived at?

The nominal value of SGB is in Indian Rupees fixed on the basis of simple average of closing price of gold of 999 purity, published by the India Bullion and Jewelers Association Limited, for the last 3 business days of the week preceding the subscription period.

What is the duration of bonds? Can I exit before the maturity?

Bonds are issued with tenor of 8 years. Early redemption of the bond is allowed after fifth year from the date of issue on interest payment dates. The bond will be tradable on Exchanges, if held in demat form. It can also be transferred to any other eligible investor.

How will maturity price of Gold arrived at?

Similar to issuance procedure, maturity amount would be based on simple average of closing price of gold of 999 purity of previous 3 business days from the date of maturity, published by the India Bullion and Jewelers Association Limited.

Is it possible to gift the bonds?

The bond can be gifted/transferable to a relative/friend/anybody who fulfills the eligibility criteria. Transfer can be done by execution of an instrument of transfer which is available with the issuing agents.

Can I use bonds as collateral for loans?

Yes, bonds are eligible to be used as collateral for loans from banks, financial Institutions and Non-Banking Financial Companies (NBFC).

What are the tax implications on i) interest received and ii) capital gain?

Interest on the Bonds will be taxable

Long term capital gain is tax free, if redeemed at time of maturity. Redemption prior to maturity will make the long term capital gain taxable

Indexation benefit is available, for computation of Long term capital gain tax, if transferred before maturity

Note, no TDS is applicable on the bond. However, it is the responsibility of the respective bond holder to comply the taxation requirements.

Can I trade these bonds?

The bonds are tradable from a date to be notified by RBI. (It may be noted that only bonds held in de-mat form with depositories can be traded in stock exchanges) The bonds can also be sold and transferred as per provisions of Government Securities Act, 2006. Partial transfer of bonds is also possible.

How does It compare to Gold ETF and Physical Gold?

SGB, Gold ETF, Physical Gold comparison
I consider, it has better edge compared to Gold ETF, if held till maturity, as long term capital gain is tax free. 

Drop in your comment for any additional questions / views.