New To Investments? Five Things To Know To Avoid Taking A Wrong Call

If you have just started investing money, you may be profoundly fidgety, and rightly so, about the financial prospects of your investments. However, blindly following the sales pitch of the agent, or that of the fund, can risk your money big time. Ideally, you should read the fine print, and then take a calculated call later on. There are several factors that need to be weighed before you loosen your purse strings.

Five Terms To Understand Before You Throw Your Hat Into The Ring

1. Debt-led or equity led: If you want to play ultra-safe, you should ideally zero in on a debt-led fund irrespective of the return you are likely to receive in the equity-led fund. No matter how much the agent assures you, there is a considerable risk that you undergo when the investment is equity-led.

2. The rule of 72: When you want to know the rate of interest paid by the fund or financial institution, just divide 72 by the number of years it takes to double the money. For instance, if the fund promises the doubling of money in 9 years, it simply means that it will offer 8 per cent per annum (72/9).

3. Income Tax factor: Invariably, your investments earnings will come down when it comes under the tax bracket at any level. For instance, the fixed deposits are taxable at the time of redemption. An 8% return will reduce to 6.4% if you fall in the 20% tax bracket. Those whose earnings are earning more than Rs 5 lakh but less than Rs 10 lakh fall in the 20% tax bracket.

4. Earnings per share (EPS): Don't get carried away by the big figures such as Rs 500 crore net profit earned by the company last year. To be able to put the figure in perspective, you must know the EPS ratio. If there are two companies, one earns Rs 500 crore and the other earns Rs 250 crore profit it doesn't mean at all that investing in the former is necessarily better than investing in the latter.

The former (with more net profit) has a total of (say) 5 crore outstanding shares, while the latter company (with half the profit of former company) has a total of 1 crore outstanding shares. The EPS formula says EPS equals total net profit divided by the total number of shares. We will get the EPS figure of the first company at Rs 100, while the other company at Rs 250. So, you will stand to receive the higher dividend in case of company with less income after becoming shareholder of the second company simply because there are fewer shareholders who will share the profits.

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5. Price Equity Ratio (P/E) ratio: It tells you about the valuation (whether it's high or low) of company's share price. If a company is earnings an EPS of Rs 100 and the price of a share trades at Rs 1,000. It implies that the company will take 10 years to justify the price of shares with current income. Similarly, if the company's share price jumps to Rs 2,000, it would mean the share price has become expensive, because at this rate, the company will have to take another 20 years to justify the earnings at this rate. So, don't buy the shares just because you can afford to buy, first ascertain whether the scrip is expensive or cheap, and the PE ratio will help you do so.

The P/E ratio of Hindustan Aeronautics is 16.99 at the price band of Rs 1,240, while Bandhan Bank's P/E ratio is 36.95 at the share price of Rs 375. So, when you look at the figures closely you will realise that even if Bandhan Bank's share is available for just Rs 375, the stock is over-priced because the P/E ratio is quite high. At the same time, the HAL share price seems quite high at Rs 1,240 but it actually is not because the P/E ratio is just 16.99.