Retired CEO of the Vanguard Group, John Bogle rightly stated-
His logic is simple, yet solid- investing is about owning businesses and reaping the rewards of their growth. Now, these rewards come in the form of business growth as well as dividends.
A DRP is a formal program that is offered by a publicly-traded company to its existing shareholders. As per the program, investors are provided with the opportunity to reinvest their cash dividends into additional shares of the underlying stock on the dividend payment date.
Breaking this down further- when dividends are paid, they are received by shareholders as a direct deposit in their bank accounts or as a check. DRPs give stock market enthusiasts the option of reinvesting the amount of a declared dividend into additional shares, bought directly from the same company.
In a nutshell, in a DRP, the dividend declared is not paid but re-invested to buy additional security units. Thus, an investor who has opted for the DRP is bound to see a higher number of units allocated to him, periodically.
ALSO READ: All About Smart Dividend Investing
There are three common types of DRPs-
There are numerous benefits of buying shares through a DRP. These can be reaped by the company issuing the shares as well as the shareholders.
Significance for Investors:
A DRP is a great way for shareholders to accumulate more shares. There are no commissions attached to a DRP, and there prevails the possibility of a price discount. Consequently, the cost basis for purchasing the shares through a DRP can be considerably lower, compared to buying them from the open market.
Further, investors can also buy fractional shares (a portion of an equity stock that is less than one full share).
In the long term, the effect of automatic reinvestment on the compounding of returns is an added advantage. The below flow chart clarifies this process-
Significance for the Company:
Companies that pay dividend benefit from DRPs in the following ways-
Like any other instrument and activity in the share market, DRPs have both an upside and a downside. Few disadvantages of DRP are-
Now, the main question that arises is- should DRP be chosen?
In today’s evolving times, there are numerous investment opportunities for an investor in the financial market- mutual funds, banks, shares, bonds, gold, real estate etc., depending upon the risk appetite and investment duration. Nonetheless, it is a well-accepted fact not all investment modes can be suitable for every investor.
DRPs can be opted if shareholders wish to save on transaction costs while purchasing shares. Besides, those with a long-term perspective can choose a DRP to receive compounding returns (explained in the figure above).
On the flip side, some market experts believe that DRPs are not always a feasible option, especially in the case of equity or a balance scheme. This is because as the value of investment under the growth option and the dividend reinvestment option remains the same at the end.
GUIDE CHECK: Guide to investing in Dividend Stocks
We will understand this comparison in the backdrop of mutual funds, which provide a choice of three plans- Growth Plans, Dividend Payout Plans and DRPs.
GOOD READ: Dividend Yield or Dividend Growth!
The consensus opines that for long term financial planning, growth plans are the best. The ones on a hunt for a source of regular income can prefer a dividend payout plan. DRPs, on the other hand, are an automatic reinvestment arrangement. They encourage long-term investment instead of active trading. Besides, they tend to have a stabilising influence on stock prices.
An investor can assess his/ her investing motive, style, and risk appetite to select the plan of his/ her choice.
What is Earnings Per Share? EPS is the per share profit by a business in a given period. While analysing a business financially, it serves as one of the basic tools. EPS is calculated by dividing profits by total shares outstanding for a given period. EPS is reported on the profit and loss statement of an enterprise and works as a denominator for beloved price-to-earnings ratio (P/E ratio), used not just by novice investors but also fund managers. A business is required to generate sustainable earnings in its life cycle, and earnings or profits are essentially among major intend of a promotor. To know more about P/E ratio read: Understanding Price-Earnings Ratio But reported earnings of a business will likely differ from actual cash earnings because devising profits mandate broader accounting standards and principles to provide a fair picture of an enterprise. EPS, therefore, becomes imperative for investors, market participants and other users of information. EPS estimates are circulated by sell-side analysts to market participants. Financial Modelling is applied to arrive at the EPS estimates of future financial years, semi-annual periods or quarterly, depending on the reporting adopted by the firm. Analyst estimates are then collected by market data providers like Reuters, Bloomberg, IRESS to provide a consensus view of analysts on the business and its financials, including revenue, operating expense, earnings before interest and tax, profit after tax, EPS. Market estimates enable participants to evaluate the expectations of sell-side analysts from a particular company, sector or even index. Analyst estimates also indicate the divergence between an individual’s expectations and collective expectations of analysts that are tracking the company. An individual can, therefore, determine whether the stock of the company is undervalued or overpriced by the market against hi one’s fair value estimates that are based on the expectations from the company. More on EPS read: What Do We Mean By Earnings Per Share (EPS)? How to calculate EPS? Although general formula considers total shares outstanding in the denominator, it is preferred to use weighted average shares outstanding over a period because companies issue new shares, buyback or cancel shares. Net Income is the profit reported by a business after incurring income tax. It is also called as Net Profit After Tax. Dividends on Preferred Shares are paid to preferential shareholders because they have first right over the income of a business, but preferred shares don’t have voting rights like common shareholders or ordinary shareholders. Weighted Average Shares Outstanding is calculated after incorporating changes in number of shares during a period, and using weighted average shares outstanding provides a fair financial position of a company. Basic V/S Diluted EPS Diluted EPS is calculated after adding the weighted average number of shares that would be issued after the conversion of dilutive shares to weighted average shares outstanding. Dilutions can include share rights, performance rights, convertible bonds etc. Whereas Basic EPS is calculated by taking weighted average shares outstanding that incorporate changes to number of shares outstanding such as buyback, new issues etc. What is Adjusted-EPS? In a financial period, firms may incur one-time expenses or transactions that are not usual in the normal course of business. The objective of adjusted EPS is to arrive at a fair picture of the business, especially for financial forecasting. Extraordinary items are excluding from EPS to arrive at adjusted EPS figure. These items can include gain on sale of assets, loss on sale of assets, merger costs, capital raising costs, integration expenses etc. What is Normalised EPS? Normalised EPS is calculated to arrive at an EPS figure, which embeds the fluctuations in income due to business cycles or industry cycles. It also includes adjustments made for calculation of adjusted EPS such as one-time gains or losses. Normalised EPS is a useful measure for companies that are sensitive to economic cycles or changes in the business environment. By smoothening out the fluctuations, it provides a fair picture of the business. If a company has reported high normalised earnings over periods, it is considered that the company is less sensitive to changes in business cycles because of its stable revenues and income during the periods. EPS and Price-to-earnings ratio Calculation of price-to-earnings ratio requires EPS as denominator and price of the stock as numerator. EPS therefore becomes a very important financial metric for investors. EPS and price data also allows participants to compare the historical trends of the P/E ratio with the current market scenario and P/E ratio of the stock. How can increase grow EPS? Businesses can increase EPS by focusing on increasing their revenue, by improving operational efficiencies either by deploying technology to reduce cost, or negotiate better prices with vendors, operate in tax efficient manner, etc. Businesses can also improve EPS by undertaking corporate action such as buying back of shares. Read: Pros and cons of buybacks – Story of 5 Popular Stocks including Aurizon Good read: Every Doubt You Have On Earnings Per Share- Explained Right Here!
What are ETFs? ETFs are similar to funds where pooled money of investors is managed by a fund manager, who runs the ETF. These funds invest in equity, debt, commodity or any other asset class, depending on its offering. Good read: Mastering the Basics of Investing in ETFs Price of the ETF is based on a value of net assets in the fund and is subject to change each trading day consistent with underlying changes in the value of net assets. Since ETFs are traded in markets just like shares, the quoted price of an ETF either reflects a discount to its NAV or a premium to its NAV. Investors have flocked to ETFs because of low-cost proposition and opportunity to take exposure in a specific pool of assets, which are professionally managed by an investment team with the investment manager. Some ETFs are also used as a proxy to define sentiment in an underlying sector, commodity or index since ETFs are actively traded in market hours, incorporating the latest information in prices. Fund management businesses have continued launching new and innovative ETFs, which have seen great demand over the past. Read: Gold ETFs register massive capital influx; while PDI, GPP, ERM, AME, RED Under Investors’ Lens Large and popular ETFs have also defied liquidity problems because of large scale investor participation. But it remains a problem with lesser-known ETFs with small market participation. ETFs also pay distributions to the holders that are either derived through interest income, dividend income or capital gain. Active and Passive ETFs With ETFs markets growing strongly as ever, there remains a divide between active fund managers and passive fund managers. Passive investment strategies have grown immensely popular among market participants over time. This strategy is cost effective. Many seasoned investors such as Warren Buffett, John C Bogle- founder of the Vanguard Group have endorsed passive ETFs. Active ETFs do not track a benchmark, and performance is not tracked to any given index. These funds are based on countries, sectors, market capitalisation, asset classes, etc., and active investment management allows a manager to beat the returns delivered by broader markets or indices. If you look at the great investors like Warren Buffet, Philip Fisher or Peter Lynch, they have set themselves as a preamble for active investors, and their record of delivering sustainable returns over the long term continues to attract investors to active alleys of markets. Since Passive ETFs are designed to match returns of respective benchmarks, there is no scope of delivering outperformance no guarantee that fund will not underperform the benchmark. However, the expenses charged to investors are relatively lower compared to Active ETFs. Passive ETFs are cheaper than Active ETFs because the use of resources is limited in the former. Since they are designed to match the benchmark and its underlying securities, trading in Passive ETFs is mostly automated running on algorithms, and stock picking is not required, thereby no research. Read: ETFs: Investors Up the Ante and ETFs Run the Show for Long-Term Returns ETFs based on asset classes and style Sector ETFs: These are the most common type of ETFs in market. Sector ETFs track specific sectors like Information Technology, Consumer Staples, Consumer Discretionary, Metal & Mining. These are similar to index funds but are actively traded in stock exchanges. Equity ETFs: Equity ETFs may include equity-focused Sector ETFs. As the name suggests equity, these funds invest in stocks independently or are benchmarked to a specific index. Perhaps, Equity ETFs are the most common ETFs. Fixed Income ETFs: These funds invest in fixed income instruments and pay distributions out of the interest earned on bonds. Further Fixed Income ETFs can be separated as investment-grade ETFs, high-yield ETFs, Government bond ETFs. Commodity ETFs: Commodity ETFs invest in physical commodities like precious metal, agricultural goods, natural resource. These funds include products like Gold ETFs, Oil ETFs, Grain ETFs, Silver ETFs. Good read: Investing in Commodity ETFs Short ETFs: Also known as inverse ETFs, these funds are designed to benefit when the benchmark is falling. Short ETFs hold short positions in the benchmark index futures or constituents of the index to benefit from fall in value or prices. To know more about short selling read: Minting Money While the Asset Price Tanks; Enter the World of Short Selling Leveraged ETFs: Leveraged ETFs use derivatives to amplify the returns and risks of a fund. These are also called geared ETFs. Leveraged ETFs may also hold equity or bonds along with the derivatives to amplify the net asset value movement of funds. Do read: All You Need to Know About Exchange Traded Funds Why investors prefer ETFs? Passive investment vehicles continue to appear compelling to a large investor base, and there are numerous reasons driving the demand for passive investment vehicles. Low-cost and no minimum investment: ETFs have lower expenses compared to traditional mutual funds, and most of the funds have no minimum investment criteria. As a result, the market for ETFs has grown strong, due to its reach to investors with limited capital. Must read: Mutual Funds vs. ETFs: Which Are Better? Exposure to specific asset classes: Investors with large portfolio also use ETFs to enter to into specific asset classes like Gold ETF or Commodity ETF, but not limited to sector ETFs, theme-based active ETFs like technology, mobility, e-commerce etc. Portfolio diversification: ETFs provide investors with an opportunity to diversify a portfolio of concentrated stocks by including exposure to specific sectors, indices, and commodities. More importantly, the diversification is available at a low-cost investment, which further drives the need for ETFs in a portfolio. Accessibility: It is perhaps the most compelling value ETFs provide to investors. Since ETFs are available on stock exchanges like shares, investor participation remains strong, and some popular ETFs boast high liquidity levels. Read: Confused on How to Invest in ETFs? We Have Some Tips! Further read: 6 Reasons to look at ETFs
Defining Macroeconomics Macroeconomics is a branch of Economics that evaluates the functioning of an economy as a whole. It studies the performance and behaviour of key economic indicators such as economy’s output of goods and service, exchange rates, the growth of output, the rate of unemployment and inflation, and balance of payments. Macroeconomics emphasises on the policies and economic behaviour that influence consumption and investment, exchange rates, trade balance, money flow, fiscal and monetary policy, interest rates, national debt, and factors influencing wages and prices. The scope of the subject goes beyond microeconomic topics like the behaviour of individuals, firms, markets, and households. History of Macroeconomics Macroeconomics originated with John Maynard Keynes post the great depression when the classical economist failed to explain the great economic fallout. Classical economics mostly comprised theories that studied pricing, distribution, and supply & demand. In 1936, John Maynard Keynes published – The General Theory of Employment, Interest and Money – effectively changing the perception of how macroeconomic problems should be addressed. The theories of Keynes shifted to focus on aggregate demand from the aggregate supply. Keynes said: ‘In the long run, we are all dead’. This statement was made to dismiss the notion that the economy would be in full employment in the long run. Later the theories developed by Keynes formed the basis for Keynesian economics, which gained popularity over other schools of thoughts including Neoclassical economics. Neoclassical economics emerged in the 1900s. It introduced imperfect competition models, which included marginal revenue curves, indifference curves. The theories in neoclassical economics argued about the efficient allocation of limited productive resource. Neoclassical economists explain consumption, production, pricing of goods and services through supply and demand. Some assumptions of this thought were an individual’s motive is to maximise utility as companies seek to maximise profits. Individuals make rational choices and act independently on perfect information. Over the years, many new schools of thought in Macroeconomics have found footing in the economics world. These include monetarist theories, new classical economics, new Keynesian economics, and supply-side macroeconomics. Difference between Macroeconomics and Microeconomics Major topics in Macroeconomics National income and output The estimation of national income includes the value of goods and services produced by a country in a financial year domestically and internationally. National income essentially means the value of total output generated by an economy in a year. National income can also be referred as national expenditure, national output or national dividend. Financial systems Understanding financial systems is an important concept in macroeconomics. A financial market is a market for financial securities and commodities, including bonds, shares, precious metal, agriculture goods. It is important for an economy to have markets where buyers and sellers can exchange goods. A financial market helps in the allocation of resources. Financial markets facilitate savings mobilisation, i.e. financial intermediaries channelise funds from savers to borrowers. Investment remains on the agenda for policymakers to promote growth, and financial markets facilitate funds by allowing individuals to invest in bonds and stocks, which are issued by institutions seeking funds for investments. Business cycles A Business cycle or an economic cycle refers to fluctuations in production, trade or economic activities. The upward and downward movement generally indicates the fluctuations in gross domestic product. A business cycle has four different phases: expansion, peak, contraction, and trough. An expansion in an economy is when economic growth, employment, prices are rising. The peak is achieved when the economy is producing maximum output, inflation is visible, and employment levels are running high. After a peak, the economy enters into contraction, which leads to a fall in employment, depleting economic activity, and stabilisation in prices. At trough, the economy is at the bottom of the cycle, and the next phase of expansion starts after the trough. Interest rates Macroeconomics also deals with interest rates in the economy. Interest rate policy of an economy is formulated and maintained by the central bank. A central bank manages the money supply in the economy. The intervention by the central bank to propel economic growth is called monetary policy. The monetary policy of an economy seeks to maintain employment and inflation in the economy. The motive of the monetary policy is to achieve full employment and maintain stable prices.
What is meant by Balance of Payments or BOP? Balance of Payments refers to the record of transactions maintained by a country with the rest of the world. It is a detailed list of international transactions that a country has with its trading partners. These transactions can be made by the residents, domestic businesses or by the government. In an ideal situation, the sum of all the elements of BOP should be zero. However, this is rarely witnessed as most countries do not have the exact same amount of inflow as that of outflow. The inflow and outflow from the rest of the world, can be with respect to goods, services, assets, investments, etc. Notably, a deflection from the ideal zero BOP state may not always be harmful. A surplus (positive BOP) might indicate a strong economy as it means exports are greater than imports. While, a deficit (negative BOP) might point to an increased debt on the home country. The Balance of Payments is highly reflective of the economic strength of a country. Most of the impacts of BOP are indirectly observed on various macroeconomic indicators. What are the Components of BOP? BOP comprises of two broad components, namely, Current Account and Capital Account. Sometimes the Capital Account is referred to as the Financial Account, along with a separate capital account. The Financial Account includes transactions in financial instruments and central bank reserves. While the capital account includes transactions in capital assets. A balance in inflow and outflow of all these accounts makes for a BOP equal to 0. CURRENT ACCOUNT: In technical terms, Current Account is the sum of Balance of Trade, Factor Income (net income from foreign investments) and unilateral transfers (net gifts and grants received). Put simply, current account records the transactions done in goods and services, investments and the net transfer payments or unilateral payments. Exports are maintained as credits, while imports are maintained as debits in the balance of payments. A positive current account balance means that the domestic country is a net lender, while a negative current account balance indicates that the home country is a net debtor. According to the double-entry accounting method, any entry on the export side would be adjusted with an appropriate entry on the import side. For example, for a good exported by the home country to a foreign country, the corresponding import transaction would be the inflow of foreign currency received in exchange for the good exported. CAPITAL ACCOUNT: The capital account involves all transactions relating to international asset It involves transactions made in the reserve account as well as loan payments and investment made across nations. These loans, however, do not include the future stream of interest or dividend payments as they are a part of current account. This is so because they form a part of nation’s spending or income, depending on the type of flow. A capital account is said to be in deficit when a country purchases more assets than the assets it sells to the rest of the world. An increase in assets is followed by a corresponding decrease in cash and vice versa. In some countries, the capital account is known as the financial account and has separate component called the capital account. This capital account records the transactions that do not affect the income, production or savings like international transfer of trademarks and rights, etc. What do BOP deficit and surplus mean for the home country? In layman’s language, BOP tells us whether the country is earning enough to meet its expenditure. If there is a deficit, then it can point towards the country’s growing expenses which are not sufficed by the income generated. Thus, there is a need to generate debt in order to fund the current requirements. Many a times the need to repay current debt gives rise to more debt. Therefore, an endless cycle of financing previous debt with current period loans takes place. The credit received from the rest of the world is generated either by taking a loan, which adds as a liability in the accounts or by selling off the assets currently possessed by the country. These assets can be natural resources, land, commodities, etc. A surplus on the other hand means that a country is exporting more than it is importing in all its existing BOP accounts. This can be a positive sign in most instances as it points towards stronger economic movements. A surplus can encourage the home country to invest in production of goods and services and in turn promote GDP growth. However, an export-driven growth in the long run could point to lack of sufficient demand in the home country. In such a case, the government should boost consumer spending in home country in order to become more self- reliant. What are the factors affecting BOP? BOP depends on various factors. These include: The domestic exchange rate: Exchange rate is a measure of foreign currency with respect to the domestic currency. Governments can revalue or devalue the exchange rate with the help of appropriate policies. This affects the BOP by making exports cheaper as the exchange rate falls and making imports cheaper when the exchange rate rises. The spending capacity of domestic consumers: As businesses and households are left with greater disposable income, they can spend more on imports and this can affect the BOP. Price competitiveness offered by domestic goods: For a country that is going through higher rates of inflation than its trading partner, the goods and services offered by it would be relatively more expensive. Thus, the country becomes less competitive in terms of price competitiveness. The country with lower inflation would thus have cheaper exports. In such a case, domestic consumers would prefer foreign goods and services causing increased imports and eventually a BOP deficit. Domestic policies: Trade based taxes and tariffs are a huge influencer on the BOP. Policies boosting exports are always beneficial to a country. It is important to pay attention to imports by imposing restrictions using tariffs or quotas. Apart from trade centric policies, domestic policies aimed at economic growth may cause changes in BOP. For instance, increased interest rates can promote FDI in the home country, which would affect the Current Account in BOP.