Should Investors in Equity Markets Be Worried about the Timing of Their Investment - Essay Example

Equity Financing Introduction: Finance is the life blood of any business, because for undertaking any kind of activities, even major or minor, source of funds is playing a massive role. The proper utilization and allocation of funds should be under the control of finance manager or his associates. Finance is the life blood of every business that requires for carrying out the organizational operations from the beginning to the end. Financial management is a concept, which deals with the efficient and effective usage of economic resources, such as capital finds in a most appropriate manner. Investment in Equity Markets: The modern thinking in Financial Management today is that financial managers do not perform the role of goal keepers of financial data and information, and arranging funds, whenever directed to do so. Rather, financial managers occupy a key role in top management areas by solving complex management problems. Today, the financial managers are responsible for shaping the fortunes of the enterprise and are involved in the most vital management decision of allocation of capital. Finance managers are responsible for the procurement of funds and effective utilization of funds to achieve the business objectives. Finance manager is required to make decision on investment, financing and dividend keeping in view the objectives of the company. While making investment, it is necessary to give stress for the time value of money. It means that the worth of money received today is different from that it should be received in future. There are number of reasons related with the time value of money, such as- 1. Risk- An uncertainty about the receipt of money in future; 2. Preference for present consumption- Most of the companies may prefer for present consumption , rather than the future consumption either because of urgency need; 3. Investment opportunities- Majority of the investors and companies should prefer the present money, because of the availabilities of opportunities of investment for earning additional cash flows. "Investment Analysis generates equivalent current year values allowing comparisons between different investments and identifies investment performance spikes or dips providing a tool to maximize overall return" (Investment Analysis Software. 2007). In addition to this, time value of money is very important, because it helps in arriving the comparable value of the different amount arising at different points of time in to equivalent values of a particular point of time either in present or in future. The cash flows arising at different periods of time can be made comparable by using any of the two ways- i.e. by compounding the present money to a future date, (for finding out the value of the present money.); or by discounting the future money to present date, (for finding out the present value of future money.) Under techniques of compounding, future value of a single cash flow is- FV= PV (1+r) ; Where, FV= Future Value n years; PV= Present value of cash flow today; r = Rate of interest per year; n = Number of years for which the compounding is done; Similarly, under discounting techniques, the present value of a single cash flow is- PV = FVn (1/1+r) ; Where, FVn = Future value n years; r = Rate of interest per year; n = Number of years foe which the discounting is done; Both investment and financing of funds are two crucial functions of finance manager. The investment of funds requires a number of decisions to be taken in a situation in which funds are invested and benefits are expected over a long period. Funds procured from different sources have to be invested in various kinds of assets. Long term funds are used in a project for various fixed assets and also for current assets. Investment of funds has to be made after careful assessment of the various projects through capital budgeting. Asset management policies are also laid down regarding various items of current assets. Investment in equity shares is a complex procedure; this is because unlike debt and preference shares there is no fixed rate of interest or dividend against ordinary shares. So, while evaluating the concept of investment in equity shares requires the behaviour of investors and their expectations. "The outstanding performance of equity markets in the 1980s and the 1990s, technological innovations that have made widespread participation in the equity market more feasible and more marketable and the demographic imperative of baby-boomer saving has generated significant interest in equity derivatives. In addition to the listed equity options on individual stocks and individual indices, a burgeoning over-the-counter (OTC) market has evolved in the distribution and utilization of equity swaps." (Equity Swaps). One of the major long term sources of finance is that of making investment in equity shares. Because raising funds by issue of equity shares are beneficial due to several reasons; It is a permanent source of finance. The issue of new equity shares increases the flexibility of the company; The company can make further issue of share capital by making a right issue; There is no mandatory payment to shareholders of equity shares. The investors in equity shares are the real owners, as far as the company is taken in to fact. Equity holders are ready to undertake the risks of business. They should have optimum control over the management of the company. Equity share holders shall be paid off only in the event of liquidation of the company. They are entitled to get dividend, only there are distributable profits. However, the cost of ordinary shares is the highest. This is due to the fact that such share holders expect a higher rate of return on their investment as compared to other suppliers of long term funds. Further, the dividend payable on shares is an appropriation of profits and not a charge against profits. This means that it has to be paid only out of profits after tax. Similarly, one of the common methods of venture capital financing is equity financing. The venture capital undertaking generally requires funds for a longer period, but may not be able to provide returns to the investors during the initial stages. Therefore, the venture capital financing is generally provided by way of equity share capital. The equity contribution of venture capital firm does not exceed the total equity capital of venture capital undertakings, so that the effective control and ownership remains with the entrepreneur. "The best course of action for investing is to focus on the long term and maintain conviction in the financial plan. There will be market fluctuations, economic ups and downs, and the uncertainty that comes in an age of sophisticated technology; however, by maintaining a diversified portfolio created to address the long-term goals, the investors will be well poised to meet whatever financial challenges the new millennium brings" (Miller 1999). Owners equity means share capital, both equity and preference share capital, and reserves and surplus. While evaluating the capital structure ratios, equity capital is playing a prominent role. Because, Owner's equity/Total equity, indicates that the proportion of owner's fund to total fund invested in the business. Similarly, Debt Equity ratio= Debt/ Equity. In addition to this, profitability ratios are crucial for measuring the profitability or the operational efficiency of the firm. Profitability can be measured from owner's point of view, on the basis of assets or investments, and on the sales of the firm. The major profitability ratios in respect of equity share investments are as follows- 1. ROE (Return on Equity) = Profit after tax/Net worth. 2. EPS (Earnings per Share) = Net profit available to equity holders/Number of equity shares outstanding. 3. Dividend per share = Total profits distributed to equity share holders/number of equity shares. 4. ROI (Return on Investment) = Return/Capital employed*100 5. ROA (Return on Assets) = Net profit after taxes/Average total assets. Here, the term capital employed consists of equity share capital, reserves and surplus, preference share capital, debenture and other long term loans. Among these, if there is any miscellaneous expenditure and losses, as well as non trade investments are existing, it should be deductible. Rather than this, investment analysts or performance indicators are giving more stress for the book value per share, earnings per share, dividend, pay out ratio, price earning ratio etc. As far as the investment pattern is taken in to consideration, the higher the ratios better is the shareholders' position in terms of return and capital gains. "Systematic Investment Plan (SIP) means making periodic investments of the same amount of money in an equity fund regardless whether the stock market is declining or ascending. The idea behind this strategy is that by investing the same amount each month over a period of time, investors do not have to worry about right time or the wrong time to invest. Besides, this cuts down on the risk that an investor faces when ends up investing a lump sum amount at market highs, as it is very difficult to predict the movement of the market in the short-term" (Ramalingam 2006). However, it is quiet difficult to find out an optimum debt and equity mix where the capital structure would be optimum, because it is difficult to measure a fall in the market value of an equity share on account of increase in risk due to high debt content in the capital structure. In this context, the finance manager has to carefully look in to the existing capital structure and also consider the raising of funds properly. Under these circumstances, finance manager should maintain a proper balance between both long term and short term funds. The raising of appropriate long term funds is essential to utilize or finance the fixed assets and other long term investments, to provide for the permanent needs of working capital. Within the total volume of long term funds, it is essential to maintain a proper balance between the loan funds and own funds of the entity. Long term funds raised from outsiders have to be in a certain proportion with the funds procured from the owners of the organization. There are various options available for procuring outside long term funds also. "Setting an investment objective simply means prioritizing the investor needs into short, medium and long-term investment goals. For instance, planning for vacation (short-term), planning to buy property (medium to long-term), and planning for retirement (long-term). Often investors stumble at the starting point while defining investment objectives; this in turn gets their financial plan in a tizzy" (Investing without a plan. 2007). It is very clear that the concept of investment and risks are related to each other. Every business entity is aiming for maximizing its returns, but the business dealing with the investment in different securities by the investors is beneficial to a great extend but at the same time it is quiet risky too. Moreover, in the globalized competitive scenario it is not enough to depend on the available ways of raising finance, but it is possible to undertake the resource mobilization through various recent technological and innovative measures. In addition to this, the theory of financial management is giving appropriate stress for the importance of time value of money. It is because the time preference of money is highly relying on certain facts like risk, various investment opportunities, and the preference for present consumption. It is necessary to undertake investment in equity more systematically. While undertaking the investment in equity markets, it is necessary to taken in to consideration about the concept of timing. The concept of investment and timing are inter related to each other. For evaluating capital expenditure projects or investment decisions, it is necessary to consider the fundamental concepts of equity investments and timing strategy. Conclusion: It is necessary to scrutinize the timing of investment, while undertaking the investment in equity shares. Equity financing and timing of investment is considered to be the two sides of a same coin, this is because, both these concepts are crucial for taking an appropriate investment decision and for obtaining effective rate of return on such investments. Both investments and financing decisions are closely related to each other. This is because; the issue of equity shares or investment in equity are closely related with the stock markets also. Making investment in equity shares is quiet risky, but at the same time it is the most beneficial return on investments, as compared to other forms of finance. So, equity financing is a fundamental concept with risk and return concept, and the timing of such investment is prominent in nature. Bibliography Equity Swaps. Financial pipe line. Last accessed 11 December 2007 at: http://www.finpipe.com/equityswaps.htm Investment Analysis Software. (2007). [online]. Investment Companies. Last accessed 11 December 2007 at: http://investment-companies.qarchive.org/ Investing without a plan. (2007). 5 Common Investment Mistakes. [online]. FEMINA. Last accessed 11 December 2007 at: http://www.femina.in/woman/features-moneywise/5-common-investment-mistakes-0 MILLER, Dickinson J (1999). The reasons behind the global domino effect; a quiz assessing your risk tolerance. Personal Business: Y2K and your investments: Should you worry [online]. Pubs page. Last accessed 11 December 2007 at: http://pubs.acs.org/hotartcl/tcaw/99/may/miller.html RAMALINGAM, K (2006). Strategies to ride through volatility. [online]. NDTV.com. Last accessed 11 December 2007 at: http://ndtv.com/mb/readreply.asptopicid=4067&tablename=Business&id=582202 Read More