Month: November 2022

Introduction

Every business unit is supposed to make investment decisions rationally in order to make efficient investment choices. 

Making rational investment decisions can help a business unit experience higher profitability from an investment. While irrational decisions can result in heavy losses. 

But, how can a business unit make rational decisions?

A business unit can make rational decisions by using financial metrics and computation ratios like Net present value, Internal Rate of Return (IRR), Payback period, etc.

The Internal Rate of Return (IRR) is one of the most important financial metrics that facilitate rational decision-making for investors. 

Let us understand the detailed answer to the question ‘What is IRR?’.

What is the Internal Rate of Return (IRR)?

Companies use Internal Revenue Rate (Internal Rate of Return (IRR)) to evaluate profit centres and decide between major capital projects. 

But this financial metric can also help you to evaluate certain financial events in your life, such as loans and investments.

Internal Rate of Return (IRR) is also known as discount rate. It is the interest rate that is used to find the current total value (NPV) of zero of a bunch of cash flows (good and bad) . 

Discounted cash flow method is used for finding out the Internal Rate of Return (IRR) during financial analysis.  

Understanding the Internal Rate of Return (IRR)

Internal Rate of Return (IRR) as mentioned above is used by business units to make corporate finance decisions. 

For example, a company will choose an option to either buy a new machine for production or use the current machine by comparing the Internal Rate of Return (IRR) of each option. 

The first huddle an investment decision faces is that the Internal Rate of Return (IRR) of investment should be more than the cost of capital for the company to be profitable. 

When the first hurdle is passed, the next step is to compare the Internal Rate of Return (IRR)s of all the options. The project with the highest Internal Rate of Return (IRR) is then selected.

Calculation of Internal Rate of Return (IRR)

The Internal Rate of Return calculation takes the cash inflows and the timing of such inflows into consideration in the formula. 

Internal Rate of Return (IRR) can only be calculated using the trial-and-error method unless computer software is used.

Equation or IRR formula;

0 = CF0 + {CF1 / (1 + IRR)} + {CF2 / (1 + IRR)} ^2 = NPV = aggregate of cash flows from each period discounted at Internal Rate of Return (IRR).

Where:

CF0 = Initial investment or outlay

CF1, CF2…, CFn = Cash Flows

n = Each period

N = Holding period.

NPV = Net Present Value

IRR = Internal Rate of Return

Example for Internal Rate of Return (IRR) 

Let us understand the concept in crystal clear terms with the help of an IRR example:

Suppose, A loan was taken for Rs. 400000 with repayment of Rs.2100 Each month. The period of the loan is 30 years. 

Then, the Internal Rate of Return (IRR) (or initial rate of return) on this loan annually is 4.8%.

Because the payments are made equally and at equal intervals of your time, another approach is to discount these payments at a 4.8% discount rate, which can produce a net present value of Rs. 400,000.

Putting the suggestions within the Internal Rate of Return (IRR) computation Formula:

• The initial payment (CF1) is Rs. 400,000 (a positive inflow)
• Subsequent cash flows (CF2, CF3, CFN) are negative Rs. 2100 (negative because it is being paid out)
• Number of payments (N) is 360 monthly payments
• Initial Investment is Rs. 400,000
• Internal Rate of Return (IRR) is 4.8%. PA.

How should an entity interpret Internal Rate of Return (IRR)?

The Internal Rate of Return (IRR) is generally indicated the profitability of any prospective project or investment, it is based on future estimates and might differ from actual profitability. 

Still, decisions can be made on the basis of the Internal Rate of Return (IRR). 

Internal Rate of Return (IRR) can be used to draw some conclusions which are as follows;

Higher Internal Rate of Return (IRR) is better

Better profitability is indicated by a higher Internal Rate of Return (IRR); therefore, businesses use Internal Rate of Return (IRR) to compare the profitability of two or more projects or investment options. The project or investment option with a higher Internal Rate of Return (IRR) is selected to earn maximum profit.

Internal Rate of Return (IRR) about NPV

Businesses generally use Internal Rate of Return (IRR) for profitability analysis of the Net Present Value. Internal Rate of Return (IRR) provides a better understanding of net present value.

For example, a lower net present value but a higher Internal Rate of Return (IRR) indicates that the project might see substantial growth, but it will not add much value to a cost-bearing entity. 

It is mostly a short-term project or investment. 

On the other hand, a higher net present value but a lower Internal Rate of Return (IRR) indicates that the return might come slowly, but it would reward the entity with significant value. 

It is mostly a long-term project.

What is a good Internal Rate of Return (IRR)?

Whether the Internal Rate of Return (IRR) is good or bad will depend on the cost of capital and the cost of investment opportunities. 

For example, a real estate investor may pursue a project with an Internal Rate of Return (IRR) of 25% if the same investment in real estate offers a return, say, 20% or less.

However, this comparison assumes that the risk and effort involved in making these complex investments are almost the same. 

If an investor can get a slightly lower Internal Rate of Return (IRR) for a less risky or time-consuming project, then they may gladly accept that low Internal Rate of Return (IRR) project. 

In general, however, a higher Internal Rate of Return (IRR) is better than a low one, if everything else is equal.

Advantages of Internal Rate of Return (IRR)

There are several advantages of using the Internal Rate of Return as a measure to assess the financial factors. Some of these advantages are as follows:

Cost of capital not Required

Internal Rate of Return (IRR) is a subjective metric. The cost of capital is the rate at which the business agrees to fund the project. 

Computation of Internal Rate of Return (IRR) does not require the cost of capital, which removes the risk of computing the wrong rate. 

Once the Internal Rate of Return (IRR) is calculated, the projects can be compared on the basis of Internal Rate of Return (IRR), and one of them can be selected.

Considers time value of money

The Internal Rate of Return (IRR) is calculated by calculating the interest rate where the present value of future cash flows is equal to the investment required. 

The advantage is that the cash flow period for all future years is also considered and, therefore, each cash flow is given equal weight through the amount of cash flow time.

Simple to use

Internal Rate of Return (IRR) is a simple way to compare two or more investments or projects. 

Internal Rate of Return (IRR) provides a quick comparison measure for capital decision making. 

A business unit has to compare the rates of Internal Rate of Return (IRR) to make a capital budgeting decision based on Internal Rate of Return (IRR). 

The business has to choose an investment or project with the highest Internal Rate of Return (IRR).

Limitations of Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is a useful financial metric, still, it has some limitations. The drawbacks of using Internal rate of return are as follows:

Overly optimistic

The Internal Rate of Return (IRR) is overly optimistic. The Internal Rate of Return (IRR) does not take into account the inherent nature of the reinvestments. 

Typically, reinvestment is done at the cost of capital and not at a rate of return. It leads to the overestimation of future cash flows.

Ignores Size of Project

The disadvantage of using the Internal Rate of Return (IRR) method is that it does not take into consideration the project size compared to the projects. 

Cash flow is simply compared to the amount of money that is used to generate that cash flow. 

This can be difficult if two projects require a very different amount of money spent, but a smaller project returns a higher Internal Rate of Return (IRR).

For example, a project costing Rs. 1000000 with an expected cash flow of Rs. 250000 over the next five years has an Internal Rate of Return (IRR) of 7.94 percent, while Rs. 100000 projects with an expected cash flow of Rs. 30000 over the next five years has an Internal Rate of Return (IRR) of 15.2 percent. 

Using the Internal Rate of Return (IRR) method alone makes a small project even more attractive, and ignores the fact that a larger project can generate much higher and perhaps more profitable revenue.

Ignores Reinvestment Rates

Although the Internal Rate of Return (IRR) allows us to calculate upcoming cash flows, it assumes that such cash flows can be reinvested at the same rate as the Internal Rate of Return (IRR). 

That assumption does not happen as the Internal Rate of Return (IRR) is sometimes a very high number and the chances of such a return are often rare or very limited.

Ignores Future Costs

The Internal Rate of Return (IRR) approach is only concerned with the estimated cash flow generated by the injection and ignores future costs that may affect profits. 

Considering an investment in trucks, for example, the cost of fuel and future repairs may affect profits as fuel prices fluctuate and the requirements for repairs change. 

A dependent project may be necessary to purchase vacant land where a truck network is parked, and that cost will not result in an Internal Rate of Return (IRR) calculation of revenue generated by ship operations.

Multiple Internal Rate of Return (IRR)

A single project might have multiple Internal Rate of Return (IRR)s. This case may generally occur when any investment or project has both positive and negative cash flows over its life.

Internal Rate of Return (IRR) Vs. Return on Investment.

Businesses may look for a return on investment (ROI) when making large budget decisions. 

ROI tells the investor about the return any investment or project may earn in the entire life span; it is not an annual return rate. while the Internal Rate of Return (IRR) informs the business what annual growth rate it can achieve. 

These two numbers will usually be the same within one year but will not be the same for long.

ROI is a percentage increase or decrease in investment or project from the initiation to the end of the investment or project. 

It is calculated by taking the difference between the current or expected future value and the initial value, dividing it by the cash outlay, and multiplying by 100.

ROI calculations can be calculated in almost any activity by applying the above formula. 

However, ROI cannot be relied upon in long-term investments or projects.

Internal Rate of Return (IRR) Vs. Compound Annual Growth Rate.

The Compound Annual Growth Rate measures the annual return on investment throughout the investment or project. 

The Internal Rate of Return (IRR) is also the annual return rate. However, the Compound Annual Growth Rate usually uses only the starting and ending values to provide an average annual return.

The Internal Rate of Return (IRR) is unique as it involves recurring cash flows — indicating that inflows and outflows are frequent when it comes to investing.

Internal Rate of Return (IRR) Vs. Modified Internal Rate of Return (IRR).

The Modified Internal Rate of Return (IRR) takes into consideration that the reinvestment can be done at different rates, while Internal Rate of Return (IRR) considers that the cash flows are reinvested at the same rate. 

Further, it does not matter if the project is expected to generate positive or even negative cash flows, MInternal Rate of Return (IRR) shows a single value for it, while Internal Rate of Return (IRR) might have multiple values in such a case.

Since Modified Internal Rate of Return (IRR) solves the issues in the Internal Rate of Return (IRR), it is a better and more realistic approach than Internal Rate of Return (IRR). MInternal Rate of Return (IRR) is generally lower than the Internal Rate of Return (IRR).

Conclusion

Any investment decision should be made after taking into consideration the profitability of various investment options and comparing them, a decision should be made for the best benefit of the business. 

It is natural to do a cost-profit analysis. We understood the concept of the Internal Rate of Return (IRR) and how to interpret and use it in making investment decisions. 

You can use the concept of Internal Rate of Return (IRR) in making daily life financial decisions too. 

Internal Rate of Return (IRR) can be used in making decisions for Investments involving cost and cash inflows.

Introduction

Intraday trading is a way to trade in stocks where the trader buys and sells shares on the same day without any open positions left at the end of the day. Thus, intraday traders try to buy the stock at a lower price, sell it at a target price.

In stock markets, the price fluctuates every second. A trader must know when to buy and sell the stocks to earn positive returns. Tools like candlestick charts are of great help to traders. However, such requires a good understanding of the charts and relevant information that can help them make the right decisions.

So, we will talk about the fundamentals of Candlestick’s meaning and understand the steps to help you read them.

What is Technical Analysis?

Technical analysis is a technique of forecasting the future financial price movements of the stock based on an examination made of the past price movements of the stock price.

Technical analysis is not a technique of seeing the future but it helps an investor to forecast what is “Likely” to happen to the price of a share of a company. It uses the information captured by the price to interpret what the market is saying with the purpose of forming a view of the future.

What is Candlestick Chart?

Candlestick Chart originated in Japan over 100 years before the bar charts and point-and-figure charts. A Japanese man named Homma discovered that the price of rice was highly influenced by the emotions of the people along with the supply and demand of rice.

A candlestick chart shows that emotion by picturising the size of the price moves using different colours. By regularly analysing the candlestick chart, an investor can make a trading decision based on the regular occurring patterns of directions of the price.

Unlike a simple line chart, each series on a candlestick contains four data points. i.e., The opening price, The high price, the Low price, and the closing price.

Components of a candlestick chart

The components of a candlestick chart are as follows:

The body

The main body of a candle stick (The portion which is coloured) shows investors the closing and opening price of the share. 

If the body of a candlestick is long, it indicates that the share has been traded more often in the market, and there is strong selling or buying pressure created for the share in the market. 

When the body of a candlestick is small, it indicates that the share has been traded less in the market, and there is light selling or buying pressure for the share in the market.

The Wicks

The highest top of the highest wick shows an investor the highest price at which the stock was traded for the period for which the candlestick is prepared. 

If the open or close was the lowest, then there would be no lower wick. While the lowest bottom of the lowest wick shows an investor the lowest price at which the stock was traded for the period for which the candlestick was prepared. 

If the open or close were the lowest, then there would be no lower wick.

The Colour

Traditionally, the candlesticks were of two colours, i.e., white and black, which are now sometimes replaced with green and red, respectively.

The green colour or the white colour indicates that the stock price has closed higher than the open price of the stock, and the red colour or the black colour indicates that the price has closed lower than the open price of the stock. 

Example of a candlestick chart. 

As we can see, there is a red and green candlestick, and both of them represent different things. 

When a candle stick is green, it means that the closing price was higher than the opening price, and when a candlestick is red, it means that the closing price was lower than the opening price.

Types of Candlestick Patterns

A candle has four price components; The open, The close, The high, and the low. 

The combination of these four prizes forms different shapes known as candle or candle patterns. 

Candle patterns can be single, double, or triple, depending on the number of candles it consists of. Following are the types of candle patterns:

Single Candle Pattern

A single candle pattern contains only a single candle.

(Examples; Hammers, Doji, spinning top, spinning bottom)

Double Candle pattern

Double candle pattern has two candles.

(Examples; Bullish engulfing, Bearish engulfing, Bearish Harami, Bullish Harami)

Triple Candle Pattern

Triple Candle Pattern has three candles.

(Examples; Morning star, Evening star, 3 white soldiers, 3 black crows) 

Common Candlestick Patterns

The attitude of the market participants is reflected by a candlestick. Different types of candlestick patterns represent different types of market participants’ attitudes. The candlestick patterns can also reflect the trading patterns since investors are humans only and humans try to act similarly in the same situations. 

The following are some common candlestick patterns:

Doji Candlestick pattern: 

Doji candlestick pattern represents a situation where the stock price closes exactly where it opened. The Doji is a single candle pattern meaning it has a single candle because it shows a neutral situation where the market is neither bullish nor bearish. It is the only pattern that shows such a neutral situation. It looks like a dash only and has no body.

Example of a Doji Candlestick pattern

The price closes exactly where it opens because the Bullish and Bearish pressure in the market is at equilibrium. 

The Bullish and Bearish pressures are roughly equal, which may cause a previous trend to end. 

Such a situation may result in a market reversal, which means the price move is the opposite of the trend in previous periods.

Thus, a Doji Candle may indicate a price reversal in the coming future.

Hammer candlestick Family

This family consists of related single candlestick patterns. Hammer candlestick patterns have a long lower or upper wick and a small body on the opposite side. 

The hammer candlestick pattern indicates a price reversal, just like the Doji Candlestick pattern. The following are the members of the hammer candlestick family:

Hammer Pattern

A hammer candlestick chart will have a small body in the upper part of the candle and a long lower candlewick. 

Bearish trends are shown by the hammer candlestick pattern and suggest that the price of the stock may go down.

(The green arrow shows that the price moves higher while the red arrow shows the price decline).

Inverted Hammer Pattern

An inverted hammer candlestick chart will have a small body in the lower part of the candle and a long upper candlewick. Bearish trends are shown by the inverted Hammer Candlestick pattern just like the hammer candlestick pattern and suggest price reversal.

(The green arrow shows that the price moves higher while the red arrow shows the price decline). 

Hanging man Pattern

The hanging man pattern looks the same as the Hammer pattern, but bullish trends are shown by the Hanging man pattern. The hanging man pattern also shows that there might be a materialisation of the downside.

(The green arrow shows that the price moves higher while the red arrow shows the price decline).

Shooting star Pattern

The shooting star pattern looks the same as the inverted hammer pattern, but bullish trends are shown by the shooting star pattern. The shooting star pattern indicates that the recent rise could stop, and the market will start correcting lower.

(The green arrow shows that the price moves higher while the red arrow shows the price decline).

Engulfing Candlestick Pattern

Engulfing candlestick consists of a random candle and another bigger candle that fully encompasses or “Engulfs” the price action contained within the first thus, it’s a double pattern candle.

The Engulfing candlestick pattern that appears in a bullish market is called a Bullish Engulfing candlestick pattern, and the engulfing candlestick pattern that appears in a bearish market is called a Bearish Engulfing candlestick pattern:

Bullish Engulfing pattern

(The green arrow shows that the price moves higher while the red arrow shows the price decline).

Bearish Engulfing Pattern

(The green arrow shows that the price moves higher while the red arrow shows the price decline).

Morning and Evening Star Candlestick Patterns

These are triple candle patterns, and they forecast market reversals.

Morning Star Pattern

The morning star pattern indicates an upward reversal and occurs during a bearish trend. It starts with a bearish trend and goes to a small bearish or bullish trend that gaps down. 

Then the price goes up and forms a bigger bullish candle. The third candle should cover at least half the body size of the first candle.

Evening Star pattern

The evening star pattern is opposite of the morning star pattern and indicates a downward reversal and occurs during a bullish trend. 

It starts with a bullish trend and goes to a small bullish or bearish trend that gaps down. Then the price goes up and forms a bigger bullish candle. 

The third candle should cover at least half the body size of the first candle.

What are the pros and cons of executing analysis through candlestick charts?

There are several merits and demerits of making decisions based on candlestick chart analysis. Hence, we have listed the pros and cons of candlestick charts to facilitate a view of both sides of the coin.

Pros of candlestick charts

The merits of candlestick charts are as follows:

• Candlestick charts give a complete view of the four price levels in the chart, i.e. the open, the close, the high, and the low.
• Candlestick charts are the pictorial presentation of investors’ attitudes thus, making it easier to spot the market supply and demand.
• Candlestick charts help the investors to judge the future short-term direction of price.
• Candlestick charts consider the investors’ psychology and attitude in the determination of price direction. 

Cons of candlestick charts

The demerits of candlestick charts are as follows:

• Understanding and analysing the candlestick charts may become complicated for the investor as it requires an investor to memorise the rules and types of patterns.
• A beginner investor may find a candlestick chart overload of information and data.

How to read a candlestick chart? – Price trends

Candlestick charts have been used by investors for more than 100 years till now; this is because candlestick charts cover a wide range of information relating to the stock prices and have design patterns that make them easy to read and understand.

In the candlestick chart, each candlestick indicates the open, the close, the high, and the low for the time frame a trader has chosen. Candlestick charts also show the current prices as they are prepared. 

Following are the prices one needs to understand while reading a candlestick chart:

Open Price

The open price of a stock can be indicated by the top or bottom of the candlestick body, depending on whether the stock has moved up or down during the period. 

If the price is trending up and closing higher than its open, then the open is indicated by the bottom of the body, and the close is indicated by the top of the body of a candlestick chart. 

If the price is trending down and closing lower than its open, then the open is indicated by the top of the body, and the close is indicated by the bottom of the body of a candlestick chart. 

The candlesticks that close higher are often filled in as either a green or a white-coloured candle. The candlesticks that close lower are often filled in as either a red or a black-coloured candle.

High price

The top of the shadow or the tail indicates the high price. If the open or close was the highest price, then there would be no upper shadow.

Low Price

The bottom of the shadow or the tail indicates the low price. If the open or close was the lowest price, then there would be no lower shadow.

Close price

The close price is the last price traded during the candlestick period, indicated by either bottom (for red or black candlestick) or top (for green or white candlestick) of the body of a candlestick chart. 

Changes in the price of a stock change the candle patterns while it is forming; the open remains constant, but until the end of the candle, the high and low keeps on changing. 

The colour may also change as the candle is forming; it may go from green to red if the price drops from a higher level than the open to a lower level than the open.

The last price of a stock when the period of candlestick ends is the close price, the candle gets completed, and a new candle starts to form.

Price Direction

A trader can know the direction of price by the colour and positioning of the candle(s) in the candlestick chart. In case the price closes lower than the open, the candlestick will be red, and the candle will be located below and to the right of the previous one. 

When the price closes higher than the open, the candlestick will be green, and the candlestick will be located above and to the right of the previous one.

Price Range

The distance between the top of the upper shadow and the bottom of the lower shadow is the range the price moved through during the time frame of the candlestick chart. The price range is calculated by subtracting the lower price from the higher price. 

Now, as we know the basic components, let us dig into how to read candlestick charts.

A trend is when something is going in one direction constantly for a while. A stock market trend may last up to a second, a minute, an hour, or even decades. 

There are three steps to identify a trend on a candlestick chart; they are as follows:

First, just take a quick look at the chart. Check the direction the stock is going. (Up, down, or sideways)

Second, now zoom into the chart and try to analyse the intermediate terms highs and lows through the trend.

Third, try to make a rational guess about where we stand in the trend. Use the above two steps to guess where we stand, i.e., closer to a low or a high?

Highs and lows, peaks and valleys

After making a rational guess of what the trend direction is. You need to perform some trend analysis to get a better idea of how the trend is playing out. 

The peaks and valleys in the stock trends are the most important factors to be kept in mind while performing the trend analysis.

Having peaks and valleys that are higher than previous peaks and valleys is a sign of a strong trend.

Example of Candlestick charts

The above diagram shows that the stock rises and falls, but each time successive peaks and lows are higher than the last.

When a trend is not a higher high or a higher low, it should be considered to be a weak trend at the least and a trend reversal at worst. 

Now, to make a rational guess, you need to first measure the gap between peaks and lows. 

Whether it is increasing or decreasing over time, this will give a rough idea of how long it takes for a peak-to-low to occur and how considerable the price changes will be.

How are Candlestick charts different from Bar Charts?

In the candlestick, just below the main body, there are wicks. The wicks show the highest and lowest trading price for the day’s trading. If the upper shadow on a down candle is short, it indicates that the high was closer to the open for the day. 

A short upper wick indicates that the close was near the high. The shape, colour, and length of the day’s candlestick depend on the relationship between the day’s open, close, high, and low.

Bar charts consist of multiple price bars, with each bar representing how the price of a stock has moved over some time. Each bar chart shows open, high, low, and close prices. The vertical lines on the chart represent the low and high for the period.

Bar charts and candlesticks show the same information but in a different manner. 

Candlestick charts are more expressive in terms of picturing and visualising due to the colour coding set for the price bars and body, which is better at showing the difference between the high and low in the market for the period.

Conclusion 

Analysing the price movement of shares in the market often helps investors to earn profits on trading and even in investments. As we understood, a candlestick chart is a quick way to analyse the price trends of stock of the company in the stock market. 

Knowing how to read candlestick charts also helps the investor to know the attitude of the traders and the investors in the market; how the investors see the stock. A pictorial presentation of the ups and downs of the market is easy to read if one has a keen eye and an understanding of candlestick charts.

Introduction

The greater the risk, the greater the potential profit. This is a proverb associated with the stock market. Every investor who joins the stock market seeks the greatest possible return on their initial investment. However, equities with significant profit potential have a considerable risk of capital loss or value depreciation. In such circumstances, investors have little alternative but to assess their risk tolerance and invest in equities with limited risk exposure.

High-risk and growth investors may be interested in searching for high-growth, high-beta companies. High-beta stocks may be utilised to generate high profits, but they also carry substantial downside risk during market declines. 

Understanding beta and its applications might be crucial for investors attempting to find the best-performing equities in the market. Below, we will examine the details of high beta stocks and everything related to them in a comprehensive and detailed manner.

What Are High Beta Stocks?

Before diving into stocks with high beta, let’s look at the bigger picture and define beta. So, what are high beta stocks, and what does beta mean? 

Beta is a statistical term that indicates the volatility of a stock’s price compared to an index representing the market, such as the High beta stocks Nifty or S&P. Essentially, it seeks to quantify how much the stock’s price will fluctuate in reaction to the market movements. 

As the beta represents the stock’s volatility, it is used as an indication of risk.

In other words, it attempts to determine how much a stock can rise above the market when the market rises and how much it can fall below the market when markets correct. The greater a stock’s beta, the more it will climb during market rallies and decline during market corrections.

Thus the high beta stocks meaning is that the stocks which are much more unstable and carry greater risk. Beta is most often connected with capital asset pricing (CAPM), which is used to price stocks, where it serves as a measure of systematic risk. Thus various investments are valued based on the beta, the risk-free rate of return, and the risk premium.

High beta index corporations are more sensitive than the market as a whole. The beta of an individual stock quantifies its sensitivity. A beta of 1 shows that the asset follows the market. Less than 1 indicates a less unstable asset than the market, whereas larger than 1 indicates a more unstable asset.

A beta of 1.2, for instance, indicates that the asset is 20 per cent more unstable than the market. In contrast, a beta of 0.70 is 30 per cent more stable than the market. Beta is assessed relative to an index that is widely followed, such as the S&P 500 Index.

Beta Factor= Covariance ÷ Variamce

Beta is a factor of capital asset pricing (CAPM) used to determine the cost of equity investment. The CAPM formula employs the overall average rate of return and the beta profits of the business to calculate the rate of return that investors may anticipate depending on their perception of investment risk. In this manner, beta may affect a stock’s predicted return and share price.

Using regression analysis, beta is computed. It quantifies the propensity of a security or a portfolio to react to market fluctuations. The formula for determining beta is the covariance of an asset’s return with the baseline performance divided by the volatility of the benchmark’s return over a specific period.

You might be curious why investors invest in such stocks now that you know what high beta stocks are. It is because these stocks come with their own set of benefits that make them unique and more desirable than other stocks. You should be aware of what these benefits are.  

Benefits Of High Beta Stocks

High beta stocks, even though considerably risky compared to normal stocks, have many benefits that make them better than ordinary stocks.

Considering all the aspects, we can summarise the benefits of High beta stocks into a few points, which are as follows:

• Risk Analytics
• Greater Returns
• An excellent investment, if properly managed.

Now that we know the benefits, let us look at the advantages from a much broader perspective. For CAPM adherents, beta is helpful. When measuring risk, it is crucial to examine the price volatility of a stock. 

Beta makes intuitive sense as a measure of risk, as it represents the probability of a stock losing value. Consider an early-stage technology stock with more price volatility than the market. It is tough not to believe that this stock will be riskier than a utility company with a low beta.

In addition, beta provides a simple, quantitative, and straightforward measurement. There are differences in beta based on factors such as the market index used and the measurement period. In general, the concept of beta is easy, and it is a valuable metric for calculating the costs of equity used in a valuation process.

While high beta stocks may indicate possibilities to catch upswings and generate substantial returns, particularly in rising markets, this would demand an active and alert strategy and prompt entrance and profit booking. To those for whom market timing is immaterial, there is no alternative to selecting equities with solid fundamentals and holding them. 

In such a procedure, beta is also a crucial input as an indication of the stock’s potential contribution to the portfolio’s volatility. High beta equities in a portfolio may need to be balanced with low beta stocks that are more conservative. Beta, like all other indicators, cannot serve as the only foundation for investing choices.

A high beta stocks list improves a person’s wealth via considerable equity return rates. During an upswing in the stock market, this yield is possible when benchmark indices are increasing in value. Any slight change in such index values causes a substantial increase in the price of a high beta stock and, therefore, an increase in the portfolio’s value.

Stock price fluctuations are reliant on the index and not vice versa. Beta establishes the correlation between the stock price movement and the index movement. A stock with a beta of more than one is considered aggressive, whereas a stock with a beta of less than one is considered defensive. These bold and conservative categories are crucial to investment decisions when a portfolio manager seeks to control the portfolio’s beta.

They also act as a hedge when seen against inflation. 

High beta stocks provide much higher returns than the country’s current inflation rate. This suggests that the actual worth of total investment will increase, resulting in a substantial increase in the buying power of individual investors.

These are all the necessary details about the advantages of high beta stocks, which allow them to be a better investment option than ordinary stocks. While it might seem significant on the surface, high beta stocks also have drawbacks. 

Limitations Of High Beta Stocks

The beta has various drawbacks when investing based on a stock’s characteristics. To begin with, beta does not include new information. 

Think about a company, which we will call “Company A.” Company A is thought to be a defensive stock (A stock that produces reliable dividends and profits independent of the general stock market’s condition) with a low beta. When A started investing in stocks and took on more debt, its beta no longer showed the big risks it was taking.

Moreover, many technology companies are very new to the market and lack sufficient price history to develop a trustworthy beta. The inaccuracy of historical price movements as a prediction of the future is a further cause for concern. Betas are essentially rearview mirrors, reflecting only a little amount of what lies ahead. 

Additionally, the beta value of a single stock tends to fluctuate over time, rendering it untrustworthy. Granted, beta is a decent risk indicator for traders seeking to purchase and sell equities within short time frames. However, it is less effective for investors with long-term goals.

The conventional definition of risk is the potential for loss. When investors evaluate risk, they assess the possibility that the value of the stocks they purchase may decline. The issue is that beta, as a risk indicator, does not differentiate between upward and downward price fluctuations. For most investors, downward movements represent a danger, and upward moves represent an opportunity. Beta does not assist investors in distinguishing between the two. For most investors, this makes little sense.

Value investors despise the concept of beta because it indicates that a company with a significant price decline is riskier than before the drop. A professional investor would claim that a firm offers a lesser-risk investment when it declines in price since investors may purchase the same shares at a lower price despite the subsequent increase in the stock’s beta. There is no correlation between beta and fundamental variables such as changes in corporate management, new service breakthroughs, or net income.

The other limitations of High beta stocks can be summarised into two broad spectrums, which are as follows:

• High risk

Stocks with a beta value greater than one are particularly volatile since they are more sensitive to market movements. Consequently, any downturn in the stock market may result in significant losses for investors since a slight decline in benchmark points can result in a considerable reduction in the market value (price) of high-value securities.

• Considers only market risks

The beta coefficient measures the rate at which a stock’s price swings about an underlying benchmark index. Thus, individuals get an accurate estimate of how their stock will perform relative to the general performance of the stock market. In such computations, only unsystematic risk characteristics such as stock market circumstances and economic variables are included.

Therefore, investors often face the danger of slipping into a value trap if the beta coefficient is the only criterion evaluated before selecting the best shares for investment. Even when the value of the benchmark index increases over time, the value of related securities may decline owing to poor management or the inability to reach production goals.

That sums up all the limitations high beta stocks have, which is not a major red flag to not invest in such stocks but is considerable enough to be noted. Now that you know about the pluses and minuses of high beta stocks, let us take a look at examples of some high beta stocks along with their recent performances in the market.

Examples Of High Beta Stocks

Whatever concept it may be, it becomes much easier to understand when you look at examples. We can consider indexes such as high beta stocks nifty which contain high beta stocks such as CG Power and Industrial Solutions which has a beta of 2.62, Indiabulls RE with Beta of 2.32, Reliance Capital with Beta of 2.43 and so on.

As instances of equities with betas in the vicinity of 2.5 that were members of the S&P 500 index, we examine three stocks from the recent years. Note that these examples are for illustrative reasons and are not meant to serve as financial advice. Below are some of the most noticeable high beta stocks:

1. AMD

AMD is a semiconductor business that competes with Intel and Qualcomm by manufacturing chipsets and microchips. In 2019, the value of AMD’s shares increased by more than twofold; as of June 2020, its market capitalisation is $53 billion. With a beta of 2.12, the business remained riskier than other S&P 500 equities during its positive run.

2. SIVB

Silicon Valley Bank is owned and run by SVB Financial Group, which serves customers in this prosperous area of California. According to the company’s website, Silicon Valley Bank has helped finance over 30,000 startups, and SVB is included in the list of the nation’s central banks. Additionally, the bank is one of the leading suppliers of financial services to Napa Valley wine growers. Due to the company’s comparatively limited market and riskier customers, the stock had a beta of 2.25.

3. URI

United Rentals is the world’s most significant equipment rental firm, primarily serving North American clients. Since its founding in 1997, URI has amassed a rental fleet of almost 700,000 pieces of heavy equipment valued at close to $15 billion. However, the firm works in a highly cyclical and commoditised sector. Slight variations significantly influence demand, such as those caused by contractions in the construction or building industries. Thus, the stock’s beta was 2.28.

From the above instances, it can be easily understood that high beta stocks have a similar market performance proportional to their beta values. Hopefully, these examples gave you a better understanding of high beta stocks and their relative trends.

Concluding thoughts

High beta stocks need intensive active management. Frequently, they are mature small- to mid-cap companies with high instability around significant announcements.

Individuals may invest in shares with a high beta if wealth creation is their primary objective, regardless of the risks involved. If the company’s management is good, shares with a beta greater than 1 are likely to deliver higher returns on the profitability of benchmark indexes. Extra technical analysis may be conducted using other similar terminology to prevent such high-risk rates.

Remember that trading in solid growth and high beta equities entails significant risks. Thus it is essential to monitor these assets and aim to counterbalance them with reduced-risk investment portfolios and funds for liquidity.

The above information provided you with a thorough understanding of how high beta stocks work. Having an explicit knowledge of High beta stocks can help you understand whether it is a good investment for you or not and can further reduce the risk associated with such volatile investments. 

Introduction

EQUITY SHARES!! 

If you are even remotely related to the financial world, your ears would not have missed this term. 

The equity shares enjoy substantial glory among the cohorts of financial experts. Any investment management discussion is incomplete without using equity shares in it. 

It is the most common instrument used for investing in the stock market. 

Since the ‘swim and sink with the company‘ shares are so popular, let us understand what they mean and whether they are worth investing in or not?

What is Equity Share?

When an investor purchases an equity share, they contribute to the company’s total capital by becoming the shareholders of the company. 

Equity shareholders are the company owners who receive ownership to the extent of shares held by them. These shareholders are vested with voting rights and get a say in the company’s decision-making. 

Equity investments provide various benefits like capital appreciation and dividend payouts. The ultimate objective of a company behind issuing equity shares is to generate capital for business development. At first, the company gives equity shares through an Initial public offering (IPO). Later, when the company is listed, the general public can easily trade shares on the stock exchange.

The National stock exchange (NSE) and the Bombay stock exchange (BSE) are India’s two popular stock exchanges.

However, the equity share definition provided below will provide the main gist of the matter.

Equity share meaning

Equity shares are the certificates of ownership issued by a company to generate funds for expansion and growth in exchange for ownership.

Types of Equity Shares

There are various types of equity shares depending on ownership, dividend payments, preference, employment in the company, etc.

So, we have listed below all the types of equity shares, and they are as follows:

Ordinary shares

Ordinary shares are the shares that a company issues to raise funds for meeting its long-term expenses. An investor gets ownership of the firm in exchange for these shares. The portion of ownership received by an investor is equivalent to the number of shares they hold. The ownership allows shareholders to have a say in the company’s decision-making, thereby providing them with voting rights.

Preference equity shares

Preference equity shareholders lack voting rights or membership rights that ordinary shareholders avail. But, these shareholders are prioritised during dividend payments above ordinary shareholders, and they also receive the assurance of cumulative dividend payments.

Preference equity shares are further classified into two types:

• Participating Preference Equity Shares 
• Non-participating Preference Equity Shares. 

Participating preference equity shareholders receive a specific amount of profits and bonus returns in a specific financial year. However, these benefits largely depend on the company’s success.

Non-participating preference equity shareholders do not receive any such benefits.

If the company goes insolvent, preference equity shareholders will receive the repayment of capital before the ordinary shareholders during the winding-up phase. 

Bonus shares

When a company has access to retained earnings, it decides to distribute its profit in the form of a bonus issue. Hence, Bonus shares are the type of equity shares that the company issues to its existing shareholders from its earnings.

Since the issue is made to the existing shareholder, there is no increase in the company’s market capitalisation. However, market capitalisation does increase when other types of equity shares are issued.

Right shares

Right shares are exclusive shares reserved for only specific or premium investors, and these shares facilitate an increase in the equity stake of a particular shareholder. 

The main objective behind issuing right shares is to raise money from premium investors for a specific financial requirement. Hence, the issue of such shares happens at a discounted price.

Sweat equity shares

Sweat equity shares are those shares that are received only by the directors and employees of a company.

The shares are issued to the employees or directors as a token of appreciation for their excellent work.

It is issued to applaud the contribution of such employees and directors to the intellectual property rights, know-how, or value addition to the company; sweat equity shares are issued at a discount to such directors and employees.

Employee Stock Options (ESOPs)

Employee stock options (ESOPs) are a grant provided by the company to its employees and director for retention and incentive purposes. 

This grant states that an employee can purchase certain shares at a predetermined price on a future date under the terms specified in the Employee stock option plan (ESOP).

After this grant is offered, it is exercised only for those employees or directors who have accepted it.

Treasury stock

When a company decides to conduct a buyback of its shares, the shares repurchased are called Treasury Stock.

Hence, treasury stocks are those equity shares repurchased from the stock market by the company. 

Types of prices of Equity Share

For someone who is a beginner at investing, the different types of prices of equity shares can create confusion leading to investment disasters. Hence, it is essential to know about the different prices used to value a stock. 

The different types of prices of equity shares are as follows:

Face Value

The value of a share that a company records in its books of accounts are termed face value. 

Face value forms the legal capital of a company in its books of accounts.

Issue Price

The issue price is when a company offers its shares to the investors, and the face value and issue price are similar in cases of new companies. 

Security premium or Share premium issues

When a company decides to issue shares at a higher price than its face value, it is said to be given at a premium.

Share discount issue

When a company decides to issue shares at a lower price than their face value, it is said to be given at a discount.

Book Value

The book value of a share signifies the value that shareholders will receive if the company is liquidated. 

This value is most commonly used during mergers and acquisitions, and it is also valuable for estimating the company’s current valuation.

The formula for calculating the book value of a share is as follows:

Book value per share = Equity available to ordinary shareholders / Number of outstanding shares

Or,

Book value per share = Paid-up Capital + Reserves and Surplus – Any Loss / Number of outstanding equity shares of the company.

Market Value

The market value of a share is the price at which shares are sold in the stock market, and this value applies only to companies listed on the stock exchanges.

Stock market value is affected by various external factors, and hence they can be different from the Book value or other fundamental values.

Fundamental value

Fundamental value is the price of a share calculated by various methods to ascertain figures that will facilitate the merger and acquisition of a company or find out the current valuation of that particular company.

The various methods used to calculate fundamental value are as follows:

• Dividend Discount Model
• Chop Shop Method
• Price Earning Ratio Method
• Earning Capitalisation Method.

Attributes of Equity Shares

Some features of the equity shares are as follows:

Voting Rights

Most equity shares carry voting rights for their shareholders, allowing them to take an active part in the company’s management. It’s one of the key features that help in differentiating equity shares from preference shares. 

Yielding High returns

Investors who possess a high appetite for risk can derive extreme corpus returns from equity shares. Also, the price movement of these investment options is backed by numerous internal and external factors. Even though these shares are volatile and possess high-risk characteristics, they yield greater returns. 

Permanent in nature

Equity shares are non-redeemable and are issued to the public in general. These risky investment options are paid off at the time of winding up of the company after paying off debentures and preference shareholders.

Additional profits

Equity shareholders have the leverage to earn potential profits in a fiscal year, increasing their total wealth.

The liquid nature

Equity shares are traded both in primary and secondary markets and are therefore highly liquid investments. This, in turn, makes them highly liquid because one can sell them during trading hours and withdraw funds at their discretion, ensuring maximum wealth creation.

Dividend distribution

A company is under no obligation to pay dividends to its equity shareholders in the case when a particular company does not make enough profits or has incurred losses in any specific year.

Why should one invest in Equity Shares?

Equity shares are a popular name in the financial world. It is the go-to investment strategy for ambitious investors willing to take the risk to obtain high returns.

Some of the reasons stating as to why an investor should invest in equity shares are as follows:

Substantial income

Equity shares allow you to generate capital gains through appreciation in the market value of the company’s stock. Apart from building a colossal corpus with substantial returns through capital gains, the equity shares also assure steady income through dividend payouts. 

The capital gains, high returns, and steady dividend payouts from the equity investment add to your wealth generation.

Inflation shield

Inflation is the hidden devil that depreciates the time value of your money. Every year the value of your money deteriorates by a certain percentage due to inflation. So, when you invest money in the stock market, you can earn returns at a higher percentage than inflation. 

This strategy increases an investor’s purchasing power and helps them beat inflation while benefiting them with inflation-proof earnings.

Diversified Portfolio

Risk-averse investors prefer debt instruments over equity investments, given the risk involved. However, these high-security investments can underperform, leading to inflation troubles. 

Hence, one can smartly invest a safe amount in equity investments to maximise returns. 

Merits of investing in Equity Shares

If you have not already heard enough success stories about the benefits of equity investments, let us address the merits of investing in Equity shares.

The merits of investing in equity shares are as follows:

Substantial reward

Equity investments are high-risk investments, but they also offer great returns. When a company is profitable, the equity investors benefit through steady dividend payouts. An investor also enjoys capital gain when the market value of a company’s stock increases.

Efficient and user-friendly

Investors are usually investors in the equity market with the help of a stockbroker or financial planner, which makes it easy. However, an investor can also invest in equity investments of any company of choice using a Demat account.

A Demat account is suitable for facilitating efficient and user-friendly trading transactions.

Diversity in Investment 

Equity investment provides various options across different types of industries and sectors. 

This variety of options helps investors create a diverse investment portfolio by exposing it to two sectors, thereby creating a balanced lump of stocks that are bound to give stable returns in the future.

Demerits of investing in Equity Shares

Investors cannot always expect positive returns from their equity investments. History has witnessed many investors booking extraordinary profits by investing in undervalued equity shares. 

However, there are numerous cases where people have lost all their money by investing in stocks of companies that have failed later. To prevent the money from becoming a failed investment, an investor should know the following risks before investing in the equity market.

Hence, the demerit of investing in equity shares are as follows:

Loss of Capital

The market value of equity shares of a company is evaluated by the demand and supply of that particular share.

If the investors are proactive enough to ascertain a company’s expected future growth accurately, they increase their intensity while purchasing the shares of that particular company. The more the purchase, the better the market value. 

However, if a company ascertains that a company will not perform well in the future, it may decide to sell its shares. When the selling of shares is more than its purchase, the market price of that share decreases.

So, if you have invested in a share that experienced more selling than purchases, you might incur a capital loss due to the decrease in the market value of the share.

Volatile Nature 

The equity market fluctuates broadly, and hence it is considered volatile in nature.

The market value of a share can fluctuate beyond expectations. 

A share price can go from 100 to 200 in a day, and it can go from 200 to 100. Hence, it is crucial to ascertain the volatility of a share before investing in that particular share.

The fluctuations in the market depend on various factors like market sentiment, social, political, and other macroeconomic external factors. 

So, staying alert and careful is imperative to avoid severe loss. 

How to invest in Equity Shares

To invest in equity shares, an investor needs to have the following prerequisites in place.

The following accounts that an investor must have before they decide to invest in the stock market are as follows:

• Demat account

The Demat account facilitates the holding of shares and securities in electronic form.

• Trading account

The trading account is necessary for buying and selling shares. An investor must have a trading account registered with a stock brokerage firm if they want to place orders for the trading of shares. 

• Linked Bank account

A linked bank account is mandatory if an investor wants to invest in the equity market through Initial Public Offering (IPO) or from the secondary stock market.

Now, after an investor has ensured the formation of the accounts mentioned above, there are two ways investors can invest in the stock market. The two ways to invest in the equity market are as follows:

• IPO 

The first method of investing in the stock market is by placing a bid for an Initial Public Offering (IPO).

A company launches its IPO before it is listed on any stock exchange. The IPO is a method used by the company to provide its equity to public investors. 

The investors can bid for an IPO through the stock exchange or buy certain shares through a net banking account.

• Stock Market

If an investor was not allotted shares through IPO, they could always purchase them from the stock market after listing the company. So, to purchase the stocks from the stock market, an investor should follow some steps. The steps are as follows:

• The first step toward investing in the equity market is to open the mandatory accounts required for investing. These accounts include the Demat account, trading account, and linked bank account.
• The most crucial step toward investing in the equity market is researching the company in which one has decided to invest. 
• Once you are done with the background checking and have finalised your investment option, you can log in to your trading account and select the shares you have decided to buy.
• After this, you have to place an order for the selected shares. 
• Once you have placed the order, wait for the transaction to complete. After completing the transaction, the shares will be automatically credited to your Demat account.

These are the methods one can use to invest in the equity market.

Is there a substitute for risk-averse investors?

Risk-averse investors avoid equity investments because of the risk involved. Though equity shares yield the highest returns in the stock market, the risk involved can be disturbing. 

Hence, an alternative investment for such investors would be investing in instruments with a lower risk. One should remember that debt instruments with lower risk tend to generate lower returns, and this is why an investor cannot expect substantial capital gains from debt instruments. 

But, for someone with a low-risk appetite, debt instruments are a go-to choice. 

Final thoughts

Equity shares are efficient and easy instruments for facilitating better returns. However, investing in the equity market is time-consuming and requires tremendous effort. 

So, before one decides to invest in the equity market, one should better understand the fundamentals and workings behind the equity market and its operations. 

After gaining the required knowledge and experience, an investor can build a considerable corpus through equity investments.