#Fincabulary 22 – Takeout Value

MeaningThe estimated value of a company if it were to be taken private or acquired.

A firm’s takeout value considers various metrics, such as cash flows, assets, earnings and multiples used in similar takeovers. The mergers and acquisitions environment can also affect the takeout value of a company. There is no exact formula for takeout valuation, since a variety of metrics, such as EBIDTA multiple, P/E ratio and even firm-specific information can be taken into account. The value is used by both financial analysts and shareholders. The analysts will use the valuation to determine a range of possible price levels for takeover bids, while shareholders can estimate how much return they might receive if their shares are acquired.

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WHAT MAKES AN INVESTOR TICK?

-By Shruti Dhumal & Ryan Rego (SIES College of Management Studies, Mumbai)

INTRODUCTION

Conventionally under traditional finance, it is assumed that people are rational and make logical decisions while investing and that they are unbiased when it comes to determining the price of a security.  However, that is not usually the case. There are certain psychological and emotional factors that influence investors. Many times, investors derive their own set of rules that supposedly govern the movement of a particular stock which is also known as heuristics.

Behavioural finance is a field that combines psychology with economics and finance to try to provide explanations as to why a person takes an irrational decision

ROLE OF BEHAVIOURAL FINANCE IN STOCK MARKET

It can always be seen in the stock market that emotions and not the fundamental or technical changes are the reasons for the sudden short-term changes. It might be observed in such cases that whenever an analyst is questioned as to why the market was up/down, he/she doesn’t have a specific reason. It’s actually the euphoria or fear amongst the people that drive the market. Investors think irrationally and tend to make cognitive errors. Due to this tendency, it can be concluded that markets cannot be efficient when it comes to information.

Investor’s emotions and their behaviour play an important role in every step of their investment portfolios. At the time of portfolio building, it is important that investors discard their traditional heuristics of their wealth building processes. For long-term investments, it is necessary that the investors have long term perspective rather than short term emotion driven decisions. Sometimes people tend to react collectively because the others are behaving in a particular manner. It could be due to the occurrence of sudden events such as the Brexit. All such reactions are short term and people should not be carried away by the collective emotional decisions of the crowd.

Hence, wisdom is accepting the reality rather than thinking how it should have been.

Shruti

Figure 1: Sensex growth May-June 2017

The above graph shows the Sensex graph for the month of May 2017. One can clearly see a drastic rise in the Sensex since 25th May 2017 and 2nd June 2017. The stock market has been attaining new heights every day. And every moment we tend to see more euphoria driven results.

One can notice a similar phenomenon in the Bitcoin market; one of the main reasons for the Bitcoin boom is that it has been hyped up to a great extent.

An increasing number of investors are also hopping on the Bitcoin wagon and investing due to the fear of missing out on opportunities. This drive creates more momentum thus creating a snowball effect. Bitcoin prices shot up by more than 120 percent in 2017, after gaining 125 percent growth in 2016. Recently Bitcoin has been increasing in the 4000 and 5000 level which is a whopping growth rate.

Shruti dhumal

Figure 2: Bitcoin prices’ variations

On 29th August, 2017 Mumbai faced a heavy downpour followed by floods and the citizens were panic-struck. This incident instilled fear in the minds of Mumbaikars, because of which they opted to stay home the next day despite there being no rains. This is a typical behaviour observed even in the case of investors during market cycles-sell when there is panic in the market, but don’t buy when share prices have reached an all-time low because of fear.

Another example would be the recent missile firing by North Korea towards Japan. Japanese markets were down by only 0.45%, India’s Sensex on the other hand, fell down by 1.2%.Behavioural finance also explains the occurrence of asset bubbles, one of the most famous bubbles that occurred was the American housing bubble in 2006.

CONCLUSION

Behavioural finance tries to identify and study the irrational behaviour of the masses with the hope of correcting such irrational behaviour.It also seeks to provide measures to identify and possibly prevent asset bubbles from occurring and curb the unwanted speculations which ultimately lead to losses.

Enigma of Twin Deficits!

By – Ishan Kekre

The problem of twin deficits has pestered past Indian governments and was a problem of grave concern for the UPA-2 government. Without further ado, I would like to talk about what twin deficits really are? The twin deficit comprises of fiscal and current account deficit. The fiscal deficit is the total debt generated by the government to finance its expenses. It shows that the government has no other option other than borrowing. PIIGS countries are an example of how high fiscal deficits can lead a country to bankruptcy.

When the fiscal deficit is high, it implies government has to borrow heavily, meaning demand for loans will rise in the market leading to higher interest rates and higher cost of borrowing. Private firms shy away from loans and even pull out from existing projects as loans are costly. This has an adverse impact on employment and income. This phenomenon refers to as ‘crowding out’ of private investments. The FRBM act (2003) mandates every central government to restrict its fiscal deficit to 3% of its GDP.

On the other hand, current account deficit or C.A.D is the situation where imports are significantly greater than exports leading to a negative balance of trade. It is therefore also known as trade deficit and has a substantial impact on G.D.P of a country.

The linkage between the two deficits is critical. Under heavy fiscal deficit, the government borrows from credit market and then from foreign sources. Due to high demand and opportunity to make a profit, institutions from abroad supply funds. This lead to currency exchange by foreign firms leading to an increase in demand for the Indian rupee. Hence, rupee appreciates making exports expensive and imports cheaper. Hence, imports start exceeding exports leading to a higher trade deficit for the country. Thus, a high fiscal deficit can lead to a very high trade deficit for the country and together they are called the ‘Twin Deficits’!

# Fincabulary21 – Impaired Insurer

MeaningAn insurance company that is potentially unable to fulfill its policy obligations, and has been placed under rehabilitation or conservation.

An impaired insurer is not insolvent, but does pose a potential threat to its policyholders. People consider impaired insurers a risk because they may be unable to fulfill obligations afforded to its citizens in the case of an emergency.  A court can place the insurer in conservation or rehabilitation until the health of the company improves enough that the risk of insolvency has ended. An impaired insurer that is unable to exit court ordered conservation or rehabilitation may be considered an insolvent insurer, and may be forced into liquidation.

# Fincabulary20 – Yield Pickup

MeaningThe additional interest rate an investor receives when selling a lower-yielding bond in exchange for a higher-yielding bond.

The bond with the lower yield generally has a shorter maturity, while the bond with the higher yield will typically have a longer maturity. A certain amount of risk is involved since the bond with a higher yield is often of a lower credit quality. Additionally, the investor can be exposed to interest rate risk with the longer maturity bond. For example, an investor owns a bond issued by Company ABC that has a 4% yield. The investor can sell this bond in exchange for a bond issued by Company XYZ that has a yield of 6%. The investor’s yield pickup is 2% (6% – 4% = 2%). Ideally, a yield pickup would involve bonds that have the same rating or credit risk, though this is not always the case.

India’s Solar Dilemma –A story of “Economies of Scale”

By Aditya Prakash Pandey (BKFS 2016-18)

The World Energy Outlook Report of 2015 suggests that India has the potential of around 750 GW of power through the solar energy of which it has set itself a target of 100 GW of power by the year 2022 with a current installed capacity of 12 GW (Data till March ’17). Solar capacity of 750 GW is three times of the current energy demand and hence has huge potential for fulfilling future needs. With five years till the deadline and 88 GW to go, the target seems difficult but achievable. However, project funding, cost of land and equipment and low efficiency are hindrances that cannot be ignored.

Challenges:

1)    Low capacity utilization factor (efficiency)

2)    Transmission and distribution losses amount to 40% of the energy generated

3)    Unpredictable weather patterns and low strength of sun at times present challenges

4)    Land acquisition – Land scarcity, high cost of land acquisition and strict regulations

5)    Lower demand as –

  1. Coal sourced power is cost effective means of energy
  2. Unpredictability of power supply to grid by solar plants due to its reliance on sunlight

6)    High initial cost, large area required for installation, maintenance, skilled labour, high temperature in some areas and lack of environmental awareness are other issues that need to be addressed

7)    The auction price of solar projects has decreased drastically – Rs 15 per unit in 2012 to Rs 5 per unit in 2015 to Rs 3.3 per unit in Feb 2017. This requires cost effective solar solutions

Economies of scale – The elephant in the room

In a typical solar project, the solar module accounts for approximately 60% of the projects’ cost. The price of solar modules has declined by 35% in the past 2 years and is further expected to decline by 20% in 2017. This decline is due to the production of modules at ultra large scale by Chinese companies which enjoy economies of scale and technological and operational efficiency. The cost of these modules is around 30-35% less than the cost incurred by Indian manufacturers. Due to this, countries like China, US, Taiwan, and Germany are dumping their products in India making the sector highly competitive for Indian producers. Flexible pricing, better quality, predictable delivery and utilization of latest technologies have added to the competition. Indian manufacturers are now on the brink of shutting down their shops despite the huge domestic potential. The competition has eroded the financials and the banks are hence not willing to finance these companies. The willing FI’s are offering debts at unaffordable rates to the companies.

The other aspect is the scale at which power is being generated through solar sources. Due to variability in production (which depends on sunlight) and a limited number of plants and limited connectivity, power grids are facing challenges in anticipating the demand and supply mismatch which would vary by the hours of the day. Solar power generation of large scale will ensure sustainable growth of the solar power sector. Also, large scale projects will help in adding technological solutions (like automated maintenance) to the system to make the process effective and efficient.

Conclusion

In current scenario, solar power generation requires a capacity expansion, which depends on cost effective solar modules. Governments push to the solar manufacturing sector must be backed by financial support to these companies, therefore ensuring self-reliant sustainable growth of the sector. For Make In India to work along with cost effective green power, focus needs to be laid on financing this sector. This will also contribute to minimizing the trade deficit and contributing to the GDP.