To understand if Redington’s Stock is undervalued or not, we must first look into its business. On the face of it, the company looks like a typical IT company, but it is not. Looking at its business model will tell us why a strong-looking company like Redington trades at a PE multiple of below ten (10).

Do you know what the revenue of Infosys is? about Rs.150,000 crore. What is the revenue of Redington? about Rs.79,000 which is about 52% of Infosys.

Now let’s look at their Market Cap. Infosys has a market cap of about Rs.608,000 crore. If Redington follows the same 52% rule, its market cap should be about Rs.316,000 crores. But do you know what is the actual market cap of Redington? It is only about Rs.13,000 crores.

Persistent Systems has revenue of only about Rs.8,400 crores (23% of Redington) but its market cap is close to Rs.44,500 crore (3.4 times that of Redington).

This is why I’m referring to Redington as not a typical IT company. Considering Redington’s current income streams, it can best be described as a special trading company.

So in a way, we can say that, we cannot expect Redington to trade at the P/E levels of our IT stocks. We’ll also do the intrinsic value calculation for the company. It will actually decide, if at current PE levels, the stock is actually undervalued.

Business Model

Redington India is involved in the IT and technology industry. They have a diverse business model that includes the distribution and sale of various products, including laptops, desktops, printers, smartphones (referred to as Mobility), and cloud services.

Redington India is one of the authorized distributors and service providers for Apple products in India. They are responsible for distributing Apple products, including iPhones, iPads, Macs, and accessories, to various retailers and resellers in the Indian market. Additionally, they provided after-sales support and services for Apple products through their authorized service centers.

Like Apple, Redington also works as a distributor of hardware and software products of Microsoft, HP, Lenovo, Google Pixel, Samsung, Dell, IBM, Acer, Toshiba, etc.

Redington had partnerships with various technology companies to offer cloud services to its clients. Some of the major cloud service providers that Redington India could have partnered with for offering cloud solutions include:

• Microsoft Azure.
• Amazon AWS.
• Google Cloud Platform.
• IBM Cloud, etc.

Revenue Streams

The three main revenue streams of Redington are these:

1. Volume I.T: This segment includes the distribution of products such as tablets, laptops, desktops, and printers. This business is approximately one-third (about 35%) of the total revenue of Redington.
2. Mobility Business: It includes the distribution of smartphones which is another revenue stream. About 20% of the total revenue of Redington comes from this segment. It has been one of the fastest-growing business segments for Redington. However, it is also worth noting that Apple is one of the key suppliers to Redington who opened their own retail stores in Mumbai and New Delhi in April this year (2023).
3. Enterprise I.T (Information Devices): This is another segment of their business, and it typically includes higher-end IT products and services tailored for enterprises and businesses. This business segment operates at a margin that is approximately 2% points higher than the volume I.T and Mobility business.

To support the above three main business verticals, Redington offers the following services as well:

• Value-added services: Redington provides value-added services, such as installation, configuration, and maintenance of IT products.
• Logistics and supply chain management: Redington provides logistics and supply chain management services to its customers and suppliers. Redington has their own warehouse services. This helps suppliers and customers manage their inventory and ensure that they have the right products at the right time.

Margin

Redington’s EBITDA margins were reported at 2.5% in the Q4 of FY 2022-23.

EBITDA margins were 2.7% in Q3 and 2.8% from the same period in the previous year (FY 2021-22)

The company has indicated that by Q4 of FY 2023-24, the margins will improve and guide that they will likely be between 2.6% to 2.9%.

This is the reason why the P/E Ratio of Redington trades at a low PE ratio. The EBITDA margin for typical companies in the Indian IT sector (TCS, Infosys, Wipro, etc.) is typically around 20%. But Redington does business at an EBITDA margin of below 3%.

That is why, though it works in the IT space, it is not our typical IT company. So expecting that, someday, its PE will also become 25-30X is farfetched and looks unrealistic today.

Other Aspects of Business

1. Redington India faced margin pressure due to market contraction and pressure on inventory and stock liquidation. This is one reason why in FY 2022-23, its debt-to-equity ratio (D/E)swelled.
2. The company experienced strong revenue growth of 26% on a year-on-year basis, even though there were challenges in the market.
3. The drop in demand for home devices (such as laptops and tablets) due to reduced work-from-home and learn-from-home trends contributed to inventory build-up in FY 2022-23 (its effect on cash flow report).
4. There is an expectation that the pressure on inventory will ease in the upcoming fiscal year in the coming quarters as the demand for volume IT products will increase.
5. Redington India operates in multiple geographies, including India, Singapore, the Middle East, South Asia, Africa, Turkey, etc. with an expectation of continued growth in these markets.
6. The company’s focus on cloud services appears to be paying off with robust growth in this segment .

Latest Price Trend

In the last 90 days, the stock price has corrected by almost 11%. In July’23, its stock price was at Rs.190 levels. But today it is trading at Rs.165 levels. Hence, I thought to present to you a fundamental analysis of the company. I’ll present to you a quick intrinsic value estimation of the company.

Overall, my Stock Engine gives it an overall score of 79 out of 100. This is another motivation for me to do a self-check of its intrinsic value.

Intrinsic Value

Intrinsic value, in the context of finance and investing, refers to the true, inherent worth of an asset, such as a stock, bond, or company. It is often used in fundamental analysis to assess whether an investment is overvalued or undervalued based on a set of fundamental factors and calculations. The concept of intrinsic value is most commonly associated with stocks, where it is used to determine whether a stock’s current market price is justified by its underlying fundamentals.

Here are some key points about intrinsic value:

1. Fundamental Analysis: Calculating intrinsic value involves analyzing a range of fundamental factors, such as earnings, cash flows, dividends, growth prospects, and risk. The goal is to estimate the future cash flows that an investment is expected to generate.
2. Discounted Cash Flow (DCF) Analysis: The most widely used method for estimating the intrinsic value of a stock is the discounted cash flow (DCF) analysis. This approach involves forecasting the future cash flows the investment will generate and then discounting them back to their present value using a discount rate that reflects the investment’s risk.
3. Relative Valuation: In addition to DCF analysis, investors may also use relative valuation methods, such as comparing the stock’s price-to-earnings (PE) ratio or price-to-book (PB) ratio to industry averages or peer companies. These methods provide a relative perspective on whether the stock is undervalued or overvalued.
4. Margin of Safety: Intrinsic value is often used to determine a “margin of safety.” This means that an investor would consider buying a stock when its market price is significantly below its estimated intrinsic value. The larger the margin of safety, the lower the risk of overpaying for the investment.
5. Subjective Factors: Estimating intrinsic value is not an exact science, and it involves making assumptions about future variables like growth rates and discount rates. These assumptions can be subjective and vary between analysts, which is why different analysts may arrive at different intrinsic value estimates for the same asset.
6. Long-Term Perspective: Intrinsic value analysis is typically associated with long-term investing. It assumes that over time, market prices tend to converge toward intrinsic value as market participants become more rational and informed.

It’s important to note that intrinsic value is just one tool in an investor’s toolkit. It does not guarantee that a stock’s market price will align with it in the short term, as market prices can be influenced by various factors, including investor sentiment and market dynamics. However, over the long term, many investors believe that buying assets when they are undervalued relative to their intrinsic value can lead to successful investment outcomes.

I tried calculating the free cash flow of Redington taking numbers from its cash flow report. But it came negative for the current year. But if we look at the last 10 years’ cash flow data, it looks like, on average the company’s operation stayed cash flow positive. Hence, I’m trying a new approach to estimate the intrinsic value of this company.

Redington can collect about 40% of its PBT in the same year.

Redington being in a trading business, I’m assuming that it will not invest more than 15% of its PBT into CAPEX.

I’ll also assume a one-year forward PBT of Redington as Rs.2000 crores (FY 2024-25). Out of this PBT, it will convert about 40% of it (Rs.800 crore) as net cash flow from operations. If we take 15% of PBT as Capex (Rs.300 crores), the free cash flow to the firm (FCFF) will be Rs.500 crores.

Free Cash Flows To Equity (FCFE)

In the last 10 years, the company generally carried a debt of about Rs.1500 crores. But last year it had more than double the average debt on its balance sheet. It was an unprecedented situation as explained in SL.3 here.

For free cash flow to equity (FCFE) calculation, we take only 20% of debt into consideration (as a factor of safety). Hence, FCFE will look like this:

FCFE = FCFF + Debt = 500 + 300 = 800 Crores.

This way, the FCFE of the company comes out to be Rs.800 crores.

The free cash flow to equity (FCFE) of the company is Rs.800 crores.

Normal Period Growth Rate (Gnp)

In the last five years, the company’s ROE has increased from 13% to 20%. I’m assuming that it will remain at 20% levels in the coming years.

The company pays about 36% of its net profit (PAT) as dividends to its shareholders.

So this way, the sustainable growth rate (SGR = Gnp) of the company will be about 12.6% per annum.

Future Free Cash Flows

We’ve estimated that the present free cash flow to equity (FCFE) of the company is Rs.800 crores. In the next five years, the FCFE of the company will grow at about 12.6% per annum.

I have also assumed the following to calculate the terminal value (TV):

• Perpetual Growth Rate (after 5th year) = 3.5%
• Discount Rate = 10% per annum.

Taking these numbers as our basis future free cash flows for the next five years come out to be as follows:

Present Value of Future Cash Flows

At the discount rate of 10% per annum, the sum of present values (PV) of the above free cash flows comes out to be Rs.18,658 crores.

The company has issued about 78.16 crore number shares in the market.

This way, its intrinsic value per share will be as below:

• The sum of PV = Rs.18,658 crores.
• Nos. of Shares = 78.16 crores.
• Intrinsic Value / Share = Rs.238 per share.

This being a trading company with its own set of challenges, I’ll apply a standard two-thirds margin of safety to my estimated intrinsic value.

Applying this margin of safety, I’m assuming that a fair buy price for this stock will be about Rs.160 per share.

Conclusion

I know that Redington is not a typical IT stock and this is why it is trading at an EBITDA Margin of 2.5%.

I also know that in coming years, the company will have to diversify its business, as (maybe), its revenue from Apple’s products may fall. But it can be made up through value-added services (Cloud computing etc.). But it will take time (like 10 years).

It is a company in which the promoter’s holding is zero percent. But there are some top Indian companies like L&T and ITC where we can see the same behavior. Generally, I like companies, where the promoter’s holdings are high. But it is not a deal-breaker for me.

But I like the management of this company. The way they present their annual reports looks transparent, professional, and ethical.

I’ve tried to factor in all the negatives of the company while estimating its intrinsic value. My estimation is (it is for myself, not to be treated as an investment advice) as Rs.160 per share.

Its current stock price (Rs.166 per share) is already very close to my estimates.

I’m adding this stock to my watchlist.

Redington Is Trading at A PE of 9.45 | Is This An Undervalued Stock?

A Price-to-Earnings (PE) ratio of 9.45 is just one factor to consider when evaluating whether a stock is undervalued or not. While a low PE ratio may suggest that a stock is undervalued, it should not be the sole determinant in your analysis. Here are a few points to consider when evaluating whether Redington is undervalued:

1. Industry Comparison: It’s essential to compare Redington’s PE ratio to the average PE ratio of other companies in the same industry. A lower PE ratio compared to its industry peers could indicate relative undervaluation.
2. Growth Prospects: Evaluate Redington’s growth prospects. If the company is expected to have strong future earnings growth, a lower PE ratio may be justified. Conversely, if growth prospects are limited, a low PE ratio might not necessarily indicate undervaluation.
3. Earnings Stability: Consider the stability of Redington’s earnings. If earnings are consistent and predictable, a low PE ratio may be more reliable in indicating undervaluation. However, if earnings are volatile or uncertain, the PE ratio may not be as informative.
4. Financial Health: Assess the company’s financial health, including its balance sheet, debt levels, and cash flow. A company with a strong financial position may justify a higher PE ratio.
5. Market Conditions: Economic and market conditions can also influence whether a PE ratio is considered undervalued or not. In a bear market or during economic downturns, PE ratios across the board may be lower due to increased investor caution.
6. Qualitative Factors: Don’t rely solely on quantitative metrics like PE ratios. Consider qualitative factors such as the company’s competitive position, management quality, and industry trends.

It’s important to perform a comprehensive analysis, considering these factors and more, to determine whether Redington is undervalued or not. Additionally, it’s a good practice to consult with financial professionals or conduct thorough research before making any investment decisions, as the stock market can be influenced by various factors that may not be immediately apparent from a single metric like the PE ratio.

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My father has a VW Polo petrol since 2016. Being a retired man, he does not drive much. But he wants to get rid of the hassle of going to fuel stations to get the car refueled. Moreover, he also wants to contribute (carbon Footprint) by switching to an EV. Hence, he proposed to change the car from Petrol to an EV. Being an Ex Tata, the Tata Nexon EV Max (2023) is his pick. So I thought to check the economics of driving electric vehicles (EVs).

People who are looking to change cars now are definitely considering the option of an Electric Vehicle (EV). This is more relevant to those buyers whose preference is a hatchback or a compact SUV. Currently, there are budget EVs on offer by Tata and Mahindra. These cars are available at an on-road price ranging between Rs.12 to Rs.20 Lakhs.

Comparing the cost of purchase of EVs with their Petrol and Diesel Automatic variants, petrol and diesel cars are 30% cheaper. However, the cost of charging and maintenance of EVs is very low.

So, on one side we have EVs whose one-time purchase cost is about 30% higher. Then there are petrol and diesel cars whose cost of refueling is about 4 times higher than that of EVs.

So the question is, which is more cost-effective, EVs or traditional cars? Let’s answer it.

The economics of driving electric vehicles (EVs) are influenced by various factors, and they can offer several financial advantages compared to traditional gasoline or diesel-powered vehicles. Here are some key economic considerations when it comes to EVs:

1. Fuel and Operating Costs:
   • Lower Fuel Costs: EVs are generally cheaper to fuel compared to internal combustion engine (ICE) vehicles. Electricity is often less expensive than gasoline or diesel on a per-mile basis.
   • Maintenance Savings: EVs have fewer moving parts than ICE vehicles, resulting in lower maintenance costs. There is no need for oil changes, and brake wear is reduced due to regenerative braking systems.
2. Purchase Price and Incentives:
   • Initial Cost: While the purchase price of some EVs can be higher than their ICE counterparts, this gap is narrowing as technology advances and economies of scale come into play.
   • Government Incentives: Many governments offer financial incentives to encourage EV adoption, such as tax credits, rebates, or reduced registration fees. These incentives can significantly reduce the upfront cost of an EV.
3. Resale Value:
   • Depreciation: EVs often experience faster initial depreciation compared to ICE vehicles. However, their resale value can stabilize and even improve over time as the market matures and demand for used EVs increases.
4. Charging Infrastructure:
   • Charging Costs: Home charging is convenient and cost-effective, but the availability and cost of public charging stations can vary by location. Understanding the charging infrastructure in your area is essential for cost management.
5. Range and Battery Life:
   • Battery Degradation: Over time, EV batteries can experience degradation, which reduces their capacity and range. Manufacturers typically provide warranties that cover battery performance for a certain number of years or miles.
6. Environmental Benefits:
   • Emissions and Sustainability: EVs produce zero tailpipe emissions, which can lead to environmental benefits and may result in long-term cost savings related to environmental regulations and carbon pricing.
7. Total Cost of Ownership (TCO):
   • Consider the TCO of an EV over its lifespan, factoring in purchase price, fuel or electricity costs, maintenance, incentives, and resale value. TCO analysis can help determine whether an EV is cost-effective for your specific circumstances.
8. Driving Patterns:
   • Assess your daily driving habits, including commuting distances and travel frequency. EVs are well-suited for daily commuting and short to moderate-distance travel. Longer trips may require more planning due to charging infrastructure limitations.
9. Financial Considerations:
   • Evaluate your budget, financing options, and the availability of loans or leases for EVs. Consider how an EV purchase fits into your overall financial plan.
10. Insurance Costs:
    • Insurance rates for EVs can vary depending on factors like the make and model of the vehicle, your driving history, and location. Compare insurance quotes to find the best rates.

In summary, the economics of driving electric vehicles can be favorable due to lower operating costs, potential government incentives, and environmental benefits. However, the decision to switch to an EV should be based on your individual circumstances, including your budget, driving patterns, and access to charging infrastructure. Conducting a thorough cost analysis and considering the long-term benefits can help you make an informed decision about whether an EV is right for you.

Requirement

There are two use cases of cars for us. The first is for office commuting and the second for long trips. I’m not considering the use case of cars as a taxi.

• Office Commute: The car is mainly used for office commuting within the city. To travel longer distances, there is another car available. For such a use case, I’m assuming a budget EV with a range of 200 KM will be sufficient.
• Long Trips: Here the car is also used for longer trips, say on weekends. For this type of use, I’m assuming a budget EV with a range of 350 KM will be necessary.

Our next step will be to select a budget EV that matches the above two requirements.

Car Selection

Primarily, we’ll consider only the budget EVs available in the market. We’ll pick only that EV whose Petrol/Diesel variants are also available. This way, we can make an apple-to-apple comparison.

• Office Commute: For this type of commute, we can pick Tata Nexon EV Prime. This car can offer a range of about 250 km on a full charge. If the person wants to avail a more economical car, then the Tata Tiago EV is a more budget-friendly car with a range of 210 Km.
• Long Trips: For this type of commute, we will pick the Tata Nexon EV Max. Its range on full charge is 350 km. Here I’m assuming that a long trip is about 150 km on one side.

These EVs will be compared with two similar cars running on traditional fuels, Tata Nexon Petrol AMT and Diesel AMT.

Please note that EVs inherently have an automatic transmission. Hence to have an even match of cars from the Petrol and Diesel segments, I’ve referred only to the automatic variants (AMT) for comparison purposes.

Cost of Driving A Car

To calculate the cost of driving a car, we’ll use four parameters:

1. On-road cost of the brand new car (purchase cost).
2. Refueling cost the car (for 5 years).
3. Servicing cost of the car (for 5 years).
4. Comprehensive insurance cost (for 5 years).

Using these costs as our basis, we will calculate the cost of owning the car for a five-year period. In these five years, only the cost of purchasing a new car is a one-time expense. All the other three costs are of recurring in nature.

I’ve assumed only a five-year period as ownership because I’m assuming that the battery health will be best during this period only. After five years, the charging speed and charge retention quality will substantially go down. Hence, the end of the fifth year is the time to change the car.

Petrol and Diesel Car [With Online Calculator]

In this section, we’ll calculate the cost of driving a petrol and a diesel car. In this calculation, I’ve assumed the following:

• Car Make and Model: Tata Nexon
• Years for this the car is used for commuting: 5 Years
• Kilometer run each year: 6,000 KM
• Fuel Efficiency (Km/Ltr): 12 (petrol) and 13.5 (diesel)
• Fuel Rate (Rs./Ltr): 110 (petrol) and 95 (diesel)
• Service cost (Rs./year): 8000 (petrol) and 9500 (diesel)
• Insurance (IDV): Average for 4 years 55% of the on-road cost
• Insurance (Premium): 1.91% of IDV

With these as our assumption, the total cost of driving petrol and diesel cars is as below:

• Tata Nexon Petrol (AMT): The on-road cost of this car is about 15,58,000. Taking into consideration the kilometers run, fuel consumption, annual maintenance, and insurance cost, the total cost to run this vehicle for five (5) years, is about Rs.19,38,467.
• Tata Nexon Diesel (AMT): The on-road cost of this car is about 17,53,000. It is 12.5% more expensive than the Petrol variant. Though the total cost of refueling the diesel car variant, in a 5-year period, is 23% less than petrol. But the car is also expensive in terms of servicing cost and insurance. Hence, the total cost to run this vehicle for five (5) years, is about Rs.20,85,272 (7.5% higher than its petrol variant).

EV – Electric Vehicle [With Online Calculator]

In this section, we’ll calculate the cost of driving an electric vehicle (EV). In this calculation, I’ve assumed the following:

• Car Make and Model: Tata Nexon EV (Prime & Max)
• Years for this the car is used for commuting: 5 Years
• Car’s ability to run on full charge (KM): 250 (Prime), 350 (Max)
• Battery Capacity (KWH): 30.2 (Prime), 40.5 (Max)
• Charging Efficiency of Battery: 88%
• Electricity Rate (Rs./unit): 10
• Service cost (Rs./year): 8000
• Insurance (IDV): Average for 4 years 55% of the on-road cost
• Insurance (Premium): 1.91% of IDV

With these as our assumption, the total cost of driving an electric vehicle (EV) looks like below:

Conclusion #1 (Short Trips)

Let’s look at the economics of driving electric vehicles (EVs). For that, we’ll compare the cost of running EVs over petrol and diesel cars.

• Tata Nexon EV (Price): The on-road cost of this car is about 18,20,000 (16.8% higher than the Petrol variant). However, the total cost of charging the batteries, in a 5-year period, is 85% less than the cost of refueling its petrol variant (Rs.41,182 vs. Rs.2,75,000). The car is also cheap in terms of servicing cost and insurance. Hence, the total cost to run this vehicle for five (5) years, is about Rs.19,91,563 (only 2.7% higher than petrol).
• Tata Nexon Diesel (AMT): The on-road cost of this car is about 20,10,000 (29% higher than the Petrol variant). However, the total cost of charging the batteries, in a 5-year period, is 85.6% less than the cost of refueling its petrol variant (Rs.39,448 vs. Rs.2,75,000). The car is also cheap to service and get insured. But still, the total cost to run this vehicle for five (5) years, is about Rs.21,89,265 (13% higher than petrol).

So we can conclude that if the average run of the car is about 6000 Kilometers in a year, a petrol car is still more cost-effective. Though the Nexon EV (Prime) is proving only 2.7% costlier than Petrol.

So for people who want to use their cars only for office commuting, where the average commute per year is close to 6000 km a day, a Tata Nexon Petrol is best. But if you are okay with spending that 2.7 % extra in a 5-year period, Tata Nexon EV (Prime) is also a suitable option.

A better car for office commuting is Tata Tiago EV. The cost of running this car is a 5-year period, is 27.4% less than even Tata Nexon Petrol (AMT). What makes this car moe cost effective for everyday office commuting is its lower on-road cost. Though it must be kept in mind that Tata Tiago will only go about 210 Km on a full battery. Hence, it is only suitable for shorter rides withing the city.

Conclusion #2 (Long Trips)

For people who cannot compromise on long hauls with their Electric Cars (EVs), a more suitable option is the Tata Nexon EV (Max). Though the total cost of purchasing, running, maintaining, and insuring this car is higher (10% more) than the EV-Prime, still it is a better buy. The EV-Prime has only a 250 Km range compared to the 350 Km range of the EV-Max. For long trips on expressway types of roads, the range of 350 Km is more apt.

Conclusion #3 (Higher Kilometers Per Year)

What happens if a person covers more than 6000 kilometers in a year? Will the situation remain the same? Petrol cars will still dominate the EVs and Diesel cars?

For people who use their cars for more than 7,000 km in a year, the Tata Nexon EV-Prime becomes a more economical car than its Petrol variant. Above 13,000 Km in a year, the Tata Nexon EV-Max has become the second most affordable car.

But if someone is not bent on using their EV car for long drives, the most economical car in this case becomes the Tata Tiago EV.

Have a happy investing

 ds is a popular choice. People seek to invest in them to grow wealth faster. Their benefit is that they offer diversification, professional management, and attractive returns. However, what many of us may not realize is that mutual funds are also not immune to market volatility. They also have to book losses. Knowing about how mutual fund loss booking is managed can teach us how to deal with bad stocks in our portfolio.

How do mutual funds handle losses? How do these factors influence the calculation of their overall portfolio’s returns? I’ll try to demystify how mutual fund loss bookings are accounted for. We’ll discover how they calculate the portfolio’s returns (CAGR) after they have booked losses.

We will try to look into the mind of a fund manager and see how he/she deals with bad stocks and the associated loss bookings. We, as savvy retail investors, can learn from these managers to deal with bad stocks in our stock portfolio. Our yardstick of whether our stock portfolio is good or not is the annualized returns (CAGR), right? How to calculate the CAGR of our portfolio after booking losses?

It is not a topic on which you would’ve read much before. But upon reading this piece you will definitely get a new perspective on how one can calculate annualized returns on our stock portfolio. You’ll also learn why loss booking in our stock portfolio is ok, even expert mutual fund managers do it.

Let’s know more about this topic.

A Mutual Fund Portfolio and Loss Booking

Suppose there is a mutual fund scheme that has collected a total sum of Rs.100 Crores from various investors. Out of these Rs.100 crore, the following are the distribution of the funds:

• Rs.50 Crore is invested in various stocks.
• Rs.38 Crores is available as cash in the bank.
• Rs.12 Crores were lost as and when losses were booked upon selling stocks.

Suppose, the current market value of the invested amount (Rs.50 Crores) is Rs.165 crores. The average period for which the invested money has stayed invested is about 4.5 years.

How this mutual fund scheme will calculate the annualized return generated by its investment portfolio?

• Please Note: The mutual fund has collected Rs.100 crores. Now, they have about Rs.165 crores as the market value of the invested corpus and Rs.38 crores in cash. Even if everyone decides to withdraw the money today, the mutual fund can give them back Rs.203 Crores (=165+38) on the collected Rs.100 Crores. The period for which the money has stayed invested is 4.5 years.

Portfolio Return Calculation After Loss Booking [Steps]

An experienced mutual fund manager understands the importance of reporting annual returns accurately. It should be in compliance with SEBI regulations.

In our case, the mutual fund has collected Rs.100 crore from investors, and the current value of the invested corpus is Rs.165 crore. Cash worth Rs.38 Lakhs is also available in the bank.

To calculate and report the annual return for the 4.5-year period, the mutual fund scheme will use the following steps:

Step #1: Calculate the Total Value of the Scheme

The Total Value of the scheme will have two components. The first will be the current market value of the invested Corpus. In our example, how much is the invested corpus? The invested corpus is represented by a portfolio of stocks bought at a total sum of Rs.50 crores.

The current value of the invested corpus is valued at about Rs.165 crores. This is calculated as the total number of shares of each stock multiplied by their current prices.

The second component will be the cash holding. In our example, the cash holding lying in the bank account is about Rs.38 crores.

This way, the total value of the scheme is Rs.203 crore. (Rs.165 + Rs.38).

Step #2: Calculate the Absolute Return

The mutual fund schemes also report absolute returns. The absolute return of a mutual fund portfolio is the net gain or loss expressed as a percentage. It measures the performance irrespective of external benchmarks, reflecting the fund’s standalone profitability.

The formula to calculate the absolute Return is this,

= Total Value of Scheme – Collected Funds) / Collected Funds.

Absolute Return = (Rs.203 Crores – Rs.100 Crores) / Rs.100 Crores

Absolute Return = Rs.103 Crores / Rs.100 Crores = Absolute Return ≈ 1.03 or 103%

Step #3: Calculate the Annualized Return

The annualized return of a mutual fund portfolio calculates the average annual gain or loss. It enables the investors to assess the compound growth rate over a specified period. This type of reporting of returns facilitates performance comparisons between two mutual fund schemes.

Annualized returns also account for investment duration. Hence, it allows the investors to evaluate the long-term growth potential of a scheme more accurately.

For investors, annualized returns are more useful than absolute returns. Why? Because It considers the time value of money and investment duration. Hence, it provides a more accurate picture of long-term growth potential.

Suppose there are two mutual funds. One reports an absolute return of 100%, but it took 8 years for the fund to yield these returns. The second mutual fund scheme reports an absolute return of only 55%, but it took only 3.5 years to reach the stage. What do you think, which mutual fund has yielded better returns?

To answer this question, one must calculate their annualized returns. For the first scheme, the annualized return is 9.1% and for the second scheme, it is 13.3%. Hence, the second scheme has yielded better returns.

The Formula:

Annualized Return = [(1 + Absolute Return) ^ (1 / Investment Period) – 1]

Now, let’s calculate the annualized return:

In our example, the mutual fund has yielded an absolute return of 103%.

Hence, Annualized Return = [(1 + 1.03) ^ (1 / 4.5) – 1]

Annualized Return ≈ (2.03)^(0.222) – 1

Annualized Return ≈ [1.1703 – 1] ≈ 0.1703 or 17.03%

So, our example scheme should report an annualized return of approximately 17.2% for the 4.5-year period.

This calculation takes into account the initially collected funds, the current value of the invested corpus, and the cash holdings. The calculation also considers the time period for which the money has been invested.

Why Mutual Funds May Sometime Book Losses

Mutual fund schemes do encounter situations where they may need to sell their stock holdings at a loss.

Let’s get some insights into this practice:

#1. Risk Management

Example: Suppose there is a mutual fund that holds shares of a technology company. Due to unexpected industry-specific challenges or a poor quarterly earnings report, the stock price of that company begins to decline rapidly. To limit further losses and protect investors, the fund’s portfolio manager can decide to sell the stock at a loss. He will then reallocate the redeemed capital to other stocks or keep them as cash for some time.

#2. Portfolio Rebalancing

Example: Suppose, a balanced mutual fund has a target allocation of 60% in stocks and 40% in bonds. After a prolonged bull market, the equity portion of the portfolio has grown to 70% of the total assets. To bring the allocation back in line with the fund’s objectives, the portfolio manager will have to sell some stocks, even if it means realizing losses. The redeemed capital will be allocated to debt instruments like bonds or deposits. Sometimes, a portion can also be left idle as cash.

#3. Tax Considerations:

Example: Suppose, towards the end of the calendar year, a mutual fund, internally by themselves, not at the behest of unit holders, has booked significant gains in certain stocks (sold stocks at profit). In this scenario, where a mutual fund scheme has redeemed a few units for profits (or received dividends), they are responsible for paying capital gains tax on the booked profits.

To offset these gains and reduce the fund’s tax liability, the portfolio manager strategically sells other non-performing stocks in the portfolio at a loss. This loss harvesting helps minimize the tax impact on the fund’s investors.

#4. Changing Market Conditions:

Example: Suppose, a mutual fund holds shares in a company operating in a cyclical industry. The portfolio manager initially invested in the company during a period of economic growth. But economic conditions have changed, and a recession is looming. Recognizing that the company’s stock may suffer further losses in a recession, the manager can decide to sell the position to protect the fund’s performance. The proceeds from the same will be further reinvested or kept as cash till the next opportunity.

#5. Fund Redemption and Liquidity Needs:

Example: Suppose, in response to a sudden market downturn, many investors in a mutual fund decide to redeem their shares. To meet these redemption requests, the fund manager must raise cash quickly. In this case, if the cash balance is not enough, the manager will have to sell a portion of the fund’s holdings, even if it results in losses. This is done to honor the redemption requests without disrupting the remaining investors.

Conclusion

Here’s a quote from Warren Buffett, one of the most successful investors of all time, that emphasizes the advantage of informed individual investors over professional fund managers:

Mutual Fund Loss Booking: Our Guide to Portfolio Return Calculation

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Let’s unlock the wealth for ourselves. There exists a universal dream among people of building wealth and securing a brighter financial future. But we often hear the cry of those who say they lack the savings required to venture into the world of investments. Hence, they procrastinate, being convinced that the doors to financial prosperity are not open to them. These people do not realize the power of systematic investment plans (SIPs). .

This article aims to give such people financial hope and empowerment. The write-up is for those who dream of building wealth even with their limited savings. There exists a financial pathway perfectly designed for this journey – Systematic Investment Plans (SIPs).

Let’s unravel the mystique surrounding SIPs. Systematic investment plans are an ally for people who can afford only small savings. Here we’ll not only grasp the essence of SIPs but also feel empowered to take our first steps.

Finance can be a daunting realm, especially for those who are new to it. Whether you’re a novice or an experienced hand, the concept of SIPs holds the promise of unlocking the doors to financial well-being for all.

So, let’s embark on this enlightening journey together, where limited savings are no longer a roadblock. We are going to make our small savings a stepping stone toward our financial freedom.

Use This Investment Planner [A Calculator]

Suppose, you are somebody, who can save only Rs.1,500 per month from your savings. But you wish that you had Rs.10 Lakhs as your wealth. Does this dream look farfetched? The way to build such wealth is to first save some money and then invest it wisely.

Use the below calculator to know how you can reach your goal. To build today’s equivalent of Rs.10 Lakhs in the next 20 years, it will need a lumpsum investment of Rs.1.17 Lakhs at a rate of return of 18% per annum.

But very few of us will have a lump-sum amount of Rs.1.17 lakhs available for investing, right? But this calculator will also tell you that a monthly SIP of just Rs.1,389 at 18% per annum for the next 20 years will build you Rs.32 Lakhs (which is today’s equivalent of Rs.10 Lakhs).

So you can see, how SIP has made it possible for a person who could only afford a savings of Rs.1,500 per month to become a Lakhpati (a millionaire).

Suggested Reading: What happens if someone gradually increases their SIP contributions each month? It further creates a snowballing effect (higher power of compounding. Check this Step-Up SIP calculator.

Section 1: The SIP Advantage for Small Savers

Imagine a financial plan that doesn’t demand lump sum money. It is a plan where you can begin your wealth-building journey with as little as you’re comfortable with. Systematic Investment Plans, or SIPs, are precisely that. It is a strategy designed to make investing accessible to everyone, regardless of their savings potential.

At its core, SIP is about consistency and discipline. It’s like setting up a savings routine where you invest a fixed amount regularly, often monthly. The money is routed into selected mutual funds or stocks. The beauty of SIP lies in its ability to transform small, consistent contributions into a substantial corpus over time.

Distinct advantage of SIP

1. Accessibility: Unlike traditional investments that require a lump sum upfront, SIPs can have a modest starting point. With an affordable minimum investment threshold, SIPs are the gateway to financial growth for individuals who thought they needed more money to start.
2. Discipline: SIP instills financial discipline. When we commit to investing a fixed amount regularly, it becomes a financial habit. This disciplined approach ensures that our money is being put to work automatically month after month.
3. Risk Mitigation: We worry about market volatility. SIPs address this concern through a concept known as “rupee cost averaging.” This means you buy more units when prices are low and fewer when prices are high. Over time, this strategy lowers our average cost per unit, helping you navigate market ups and downs. In fact, the greater will be fluctuations, the better it is for the SIP.
4. Long-Term Growth: SIP is not a get-rich-quick scheme. It’s designed for those with a long-term investment horizon. The longer you stay invested, the more your wealth can grow. Compound interest, often referred to as the “eighth wonder of the world,” works its magic best over time, and SIP allows it to tap into its potential.

In essence, SIPs are a financial ally for small savers. Whether you’re saving for your child’s education, a dream vacation, or a comfortable retirement, SIPs provide the tools to turn your aspirations into financial reality.

Section 2: Overcoming the Lump Sum Myth

The belief that substantial savings are a prerequisite for entering the world of investments is a myth. It can discourage many aspiring investors. However, Systematic Investment Plans (SIPs) are tailor-made to beat this myth.

Imagine yourself as an athlete who does marathons. SIP investing is like running a marathon, steadily pacing yourself over time. While lump-sum investing is like sprinting. It requires a burst of funds upfront.

SIP overcoming the myth of lumpsum investing

1. Compounding Magic: SIPs can be as effective money compounders as lump-sum money. Compounding is the process by which your investments earn returns, and those returns, in turn, generate more returns. Over time, this snowball effect can lead to significant wealth accumulation. The longer you stay invested, the more powerful compounding becomes. Compounding equally applies to all forms of investing.
2. Smoothing Market Volatility: Market timing is a challenge for small investors. When one invests in a lump sum, bad timing can lead to losses or below-average gains. SIPs spread our investments over time, in highs and lows. Hence, in SIP investing the need to time the market becomes irrelevant. Why? Because one is investing at all times.
3. Affordability: SIPs make investing affordable. You don’t need a vast amount of money upfront. Instead, you start with an amount that fits your budget, as small as you’re comfortable with (Rs.500 per month).

Practical Tip: Keeping an SIP in an equity scheme running at all times is the first step. In parallel, let a recurring deposit (RD) run and accumulate some cash in your bank account. Whenever there is a big correction or a crash in the market, use the funds in the RD to buy units of your SIP mutual fund in bulk. This way you are able to take the benefits of both, regular and lump-sum investing.

To illustrate the power of SIP and compounding, consider this simple example. Suppose you are a 25-year-old individual who just got into a job. Your target is to accumulate today’s equivalent of Rs.1 Crores as your retirement fund. To reach the goal, you will need to invest Rs.2,34,000 in lump-sum (at 18% per annum) for 35 years.

Now, how many 25-year-olds will have a spare Rs.2.34 lakhs for investing? A tiny minority, right? But a SIP of only Rs.2,250 at 18% per annum will build a today equivalent of Rs.1.Crore in 35 years (check the calculation in the above calculator).

Section 3: Key Benefits of SIP

Systematic Investment Plans (SIPs) are a tailored strategy designed to empower small savers. Let’s delve into the multitude of benefits of the SIP, in addition to what we’ve already seen.

1. Accessibility: SIPs are remarkably inclusive. They break down the entry barriers to investing by allowing us to start with a minimal amount, as low as ₹500 or ₹1,000 per month. This accessibility means anybody can start investing regularly.
2. Professional Management: Through SIPs, we invest in mutual funds. These funds are managed by experienced professional fund managers. Their expertise can be invaluable, especially for those who may not have the time or knowledge to manage their investments actively. A SIP investor just dumps his money to the fund manager who in turn applies his skill and knowledge to invest the collected money.
3. Transparency: As SIPs are done in mutual funds, there is full transparency about where the money is invested. People can check the details of their mutual fund scheme online, anytime. The details of our contributions, the units purchased, and the current value of investments are all available online. This transparency ensures that we stay informed about our progress.

Section 4: Getting Started with SIP

Now that we’ve discovered the power of Systematic Investment Plans (SIPs) and their benefits, it’s time to take the next step. Don’t worry; it’s a straightforward process.

1. Set Clear Financial Goals: Before diving into SIPs, it’s crucial to define the financial objectives. There are two things that must be defined, the corpus size and the time available to build that corpus.
2. Assess Where To Invest: Experts also call it assessing one’s risk tolerance. This step is also straightforward and it is linked to our investment horizon. If the time is less than 3 years, one must invest in debt mutual funds. If the time is less than 5 years, hybrid funds are suitable. For a time horizon above 5 years, pure equity funds (or even direct stocks) are best.
3. Choose the Right SIP: Choosing a mutual fund scheme that aligns with our goals is essential. One of the better ways to do it is to use a mutual fund screener. The Stock Engine has a mutual fund screener, it comes bundled up as free with it. Once you have picked a suitable scheme, you will know approximately what returns you can expect in the future.
4. Determine the Investment Amount: Use the investment calculator provided in this article to determine how much you should invest each month (SIPs) to reach the goal.

Starting A SIP

All mutual funds have two plans, regular and direct. A direct plan always yields higher returns than a regular plan. Why? Because the total expense ratio of a direct plan is lower than a regular plan. Generally speaking, a direct plan will yield a 1% higher return than its regular sibling. Over a long SIP period, like 10 years, this 1% extra return can make a big difference.

For example, investing Rs.2,250 each month at 17% per annum for 35 years will build a corpus of Rs.5.91 Crore (equivalent to today’s Rs.76 Lakhs). Similarly, investing Rs.2,250 each month at 18% per annum for 35 years will build a corpus of Rs.7.89 Crore (equivalent to today’s Rs.1.0 Crore). So you can see, that a minor 1% differential in return substantially affects the final corpus.

Now the question is, how to invest in direct plans? The best way is to open the website of the mutual fund company (like ICICI Pru, HDFC Securities, Axis Mutual Funs, etc.) and apply there. You can also use apps like Kuvera to easily invest in direct plans.

Section 5: Real-Life Success Stories

Real-life stories have the power to inspire and demonstrate that wealth creation through Systematic Investment Plans (SIPs) is not only blah-blah but an achievable reality.

Let’s meet a few individuals who started with limited savings and witnessed their financial dreams come true through the magic of SIPs:

Rajesh’s Dream Vacation

Rajesh, a young professional, had always dreamt of taking his family on an exotic vacation. He decided to start a SIP for the next 3-year period in a debt mutual fund. Over the years, his SIP investments have grown consistently. As SIPs are executed on autopilot, at the end of the period Rajesh was astonished to see the accumulated corpus. Rajesh’s story is a testament to how SIPs can turn aspirations into reality, one step at a time.

Mita’s Education Fund

Mita was worried about her child’s future education expenses. With limited savings, she felt overwhelmed by the thought of covering the cost of higher education. Mita began a SIP specifically for her child’s education. As she diligently contributed for 12 years, a sum of Rs.5000 each month in a multi-cap mutual fund (16% p.a.). When the time came for her child to pursue higher studies, Mita was relieved that she had more than Rs.20 Lakhs in her SIP account.

Ankit’s Early Retirement

Ankit, in his early 30s, had always dreamt of retiring early to pursue his passions. However, he believed he needed a massive lump sum to achieve this dream. Ankit started a SIP with a portion of his monthly income (Rs.25,000) and stayed committed to his long-term goal (20 years). As his time horizon was long, he decided to risk investing in a quality small-cap mutual fund (17% p.a.). To his surprise, by the time he was in his early 50s, Ankit had amassed Rs.5.5 Crores (equivalent to today’s Rs1.7 crore). This was just enough for his early retirement.

Section 6: Overcoming Common Excuses

Excuses often stand as formidable roadblocks on the path to financial prosperity. However, understanding and addressing these common excuses can help us overcome them. For all of us who feel that investing is not easy, SIP is the answer to most of our excuses.

Excuse 1: “I’ll Start When I Earn More”

Delaying your investment journey until you earn more is a missed opportunity. By starting early, we can take advantage of the magic of compounding in the later years. Waiting until you earn more may cost you valuable years of potential wealth accumulation. So, even if one’s income is less, it is wiser to at least start a SIP of Rs.500 per month and let it compound for decades.

Excuse 2: “I Don’t Understand Investing”

Investing can seem complex, but SIPs in mutual funds can simplify the process. When we invest in SIPs, we are essentially delegating the investment decisions to the fund managers of the mutual funds. All you need to do is select a suitable mutual fund scheme that aligns with your goals and risk tolerance. It’s an excellent way for beginners to participate especially in the stock market.

Excuse 3: “I’m Afraid of Market Volatility”

Market volatility can be intimidating, but SIPs are designed to mitigate this risk. Suppose you are in your early 20s and have little idea of equity. Should you avoid equity and start your investments with insurance or bank deposits? I think a better start would be to start a SIP in index funds. To know more about index investing; read this article.

Excuse 4: “I’ll Build Emergency Savings, Then Invest”

Building emergency savings is essential. While saving is essential, delaying the start of a SIP in a suitable equity-linked plan is also a necessity. Even a 2-3 years delay can substantially hinder the possibility of us reaching our financial goals. I think, when the convenience of SIP is there, we shall not delay our equity exposure even by one month. Start today.

Conclusion

In the journey towards financial empowerment, small savers often find themselves wrestling with doubts, hesitations, and perceived limitations. However, we stand at the cusp of transformation, where small savers are no longer bound by the confines of their initial savings. Systematic Investment Plans (SIPs) emerge as the torchbearers of financial hope and empowerment.

SIPs shatter the misconception that substantial savings are a prerequisite for investing. They offer a disciplined, strategic, and long-term approach that not only mitigates risk but also leverages the power of time and compounding.

Remember that it’s not the size of your initial savings that matters but the commitment to your financial goals. SIPs are the vehicle that transforms determination into prosperity.

The power to unlock wealth and secure a brighter financial future is within your grasp.

Have a happy investing.

The Power of Systematic Investment Plans (SIP) for Small Savers [A Calculator]

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