Recently, the International Accounting Standards Board (IASB) issued two IFRIC (International Financial Reporting Interpretations Committee) interpretations that seek to clarify accounting treatments for two critical areas of accounting — construction contracts and net investment in a foreign operation with effect from January 1, 2009.
IFRIC 15
IFRIC 15 standardises accounting practice across jurisdictions for the recognition of revenue by real-estate developers for sales of units, such as apartments or houses, ‘off plan’ — that is, before construction is complete.
The fundamental issue is whether the developer is selling a product (goods) — the completed apartment or house — or a service — a construction service as a contractor engaged by the buyer.
The revenue from selling products is normally recognised at delivery. And the revenue from selling services is normally recognised on a percentage-of-completion basis as construction progresses.
IFRIC 15 provides guidance on how to determine whether an agreement for the construction of real estate is within the scope of IAS 11 ‘Construction Contracts’ or IAS 18 ‘Revenue’ and, accordingly, when revenue from the construction should be recognised:
An agreement for the construction of real estate is a construction contract within the scope of IAS 11 only when the buyer is able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not).
If the buyer has that ability, IAS 11 applies.
If the buyer does not have that ability, IAS 18 applies.
If IAS 11 applies, the revenue is recognised on a percentage-of-completion basis provided that reliable estimates of construction progress and future costs can be made.
Even if IAS 18 applies, the agreement may be to provide construction services rather than goods.
This would likely be the case, for instance, if the entity is not required to acquire and supply construction materials.
If the entity is required to provide services together with construction materials in order to perform its contractual obligation to deliver real estate to the buyer, the agreement for the sale of goods falls under IAS 18.
IFRIC 16
IFRIC 16 clarifies that the presentation currency does not create an exposure to which an entity may apply hedge accounting.
Consequently, a parent entity may designate as a hedged risk only the foreign exchange differences arising from a difference between its own functional currency and that of its foreign operation.
IFRIC 16 concludes that the hedging instrument(s) may be held by any entity or entities within the group.
IFRIC 16 concludes that while IAS 39 must be applied to determine the amount that needs to be reclassified to profit or loss from the foreign currency translation reserve in respect of the hedging instrument, IAS 21 must be applied in respect of the hedged item.
Construction contracts have always proved tricky to both accountants as well as the taxman.
In a recent judgment in the Magus Construction Pvt. Ltd vs Union of India (2008-TIOL-321-HC-GUW-ST) case, the Guwahati High Court held that the activity of construction of flats by a builder for their subsequent sale was not chargeable to service tax under construction of complex services.
Although the POC (percentage of completion) method is popular and acceptable to the realtor, auditor as well as the taxman, the agreement entered into by the parties to a transaction assumes importance and could alter accounting and tax treatments.
Thursday, July 17, 2008
RBI may squeeze money supply to curb inflation
The Reserve Bank may go in for further tightening of money supply as there is no likelihood of inflation coming to single digit in the next six months, according to indications given by the RBI governor to a parliamentary panel. Some more mon etary measures may be taken to contain the aggregate demand to counter inflation, said Mr Reddy to the members of the Parliamentary Standing Committee.
Mr Reddy admitted that there will be no easing of inflation in the next six months and it may go over 12 per cent. When some members asked why is inflation inching towards 12 per cent mark, while in countries like Britain it is below four per cent, Redd y replied that different countries have different yardsticks for measuring inflation.
Last month, the central bank has raised short-term lending rates for banks -- repo-- by 0.75 per cent in two instalments, while also increasing mandatory cash deposits of banks by 0.50 per cent in two phases to suck out excess liquidity. RBI is now slat ed to announce quarterly review of credit policy on 29th July, when it may announce further measures to absorb money supply.
For the week ended June 28, inflation rose to 11.89 per cent.
Mr Reddy admitted that there will be no easing of inflation in the next six months and it may go over 12 per cent. When some members asked why is inflation inching towards 12 per cent mark, while in countries like Britain it is below four per cent, Redd y replied that different countries have different yardsticks for measuring inflation.
Last month, the central bank has raised short-term lending rates for banks -- repo-- by 0.75 per cent in two instalments, while also increasing mandatory cash deposits of banks by 0.50 per cent in two phases to suck out excess liquidity. RBI is now slat ed to announce quarterly review of credit policy on 29th July, when it may announce further measures to absorb money supply.
For the week ended June 28, inflation rose to 11.89 per cent.
ICAI struggles with forged certificates
Publication:Economic Times Delhi;
Date:Jul 17, 2008;
Section:Career & Business;
Page Number:5
The Institute of Chartered Accountants of India (ICAI), is struggling with people issuing forged certificates. Currently, ICAI with a membership base of over 1.45 lakh CAs is dealing with at least 250 cases of forged use of signature seal of CAs. The matter is sub judice in 105 cases of impersonation and alleged forged use of signature and seal of CAs following the cases filed by ICAI and aggrieved parties. There are many more cases filed by either ICAI or aggrieved parties that are at different level
Date:Jul 17, 2008;
Section:Career & Business;
Page Number:5
The Institute of Chartered Accountants of India (ICAI), is struggling with people issuing forged certificates. Currently, ICAI with a membership base of over 1.45 lakh CAs is dealing with at least 250 cases of forged use of signature seal of CAs. The matter is sub judice in 105 cases of impersonation and alleged forged use of signature and seal of CAs following the cases filed by ICAI and aggrieved parties. There are many more cases filed by either ICAI or aggrieved parties that are at different level
Checks on inter-co loans
In a bid to check fund manipulation by companies, the government may introduce greater safeguard provisions to govern inter-corporate loans. The proposed changes, likely to be introduced as part of the new company law amendments, would require companies to be more transparent in their efforts to avail such finance options. While the government’s efforts would not be directed to cap companies’ rights to raise funds through the route, the ministry of corporate affairs wants them to be totally transparent about loans and reasons for any deviation from standard procedure. Officials say the government was not in favour of curbing the rights of companies for easier access to financing. The proposed steps would ensure that corporates are made to follow greater standards of compliance before availing such loans. To check fund manipulation, it is proposed that the capacity of the corporate houses to invest or lend surplus funds should be established transparently. It is believed that detailed disclosures in the annual report of the lending company on the end-use of the loans and advances by the recipient entity for the intended purpose will usher greater transparency to such operations. While the new provisions are unlikely to put in place regulatory hurdles for corporates to comply before reaching such an arrangement, the idea is to ensure that companies do not misuse their rights. The rights of corporates to enter into inter-corporate loans are covered under Section 372A of the company law. The proposed regulatory changes are in consonance with the J J Irani committee’s recommendations stating that provisions of the company law on such loans should be strengthened to prevent misuse of the exemptions by corporates. Officials, however, say the proposed legislative changes would not affect the interests of the corporates. The expert committee had also recommended that regulatory changes should not reintroduce a regime of government approvals. It is believed that India Inc should not be placed at a disadvantage compared to the companies incorporated in other jurisdictions in any international competitive bidding for acquisition
VAT E-FILING COMPULSORY
E-filing returns compulsory from this quarter, last date July 20
Ludhiana, July 16 If you are among those who claim VAT refunds from the State Excise and Taxation department, you will have to e-file your returns from this quarter onwards. The last date to file e-return is July 20.
Nearly 3,000 industrialists all across the state will come under the net from this quarter onwards, said A Venuprasad, Excise and Taxation Commissioner, Punjab.
“The process will only benefit the industrialists and once e-filing is over, there will be no mismatch of data and hence VAT refunds will be issued swiftly,” he added.
Industrialists have been complaining of the delay in VAT refunds since long. Venuprasad said, “In the last financial year, we had issued Rs 325 crore VAT refunds.”
The public notice for compulsory e-filing was issued two days ago and a number of industrialists have started taking the passwords as well. The project was on the cards for long and is finally being implemented, said Venuprasad.
Advocates, however, have a different point of view. Jatinder Khurana, president of district young lawyers association, said: “The timeframe given to the industry is too less and a number of industrialists are not even ready for e-filing. At least six months time should have been given to start the process.” Rajiv Johar, president of district sales tax bar association, supported Khurana’s views.
Venuprasad, however, says the process will not be much of a hassle and would rather help the industry.
Service tax rules leave India Inc vexed
Many taxation issues pertaining to inter-state delivery of services are being envisaged when states are given the power to tax a set of services. Two principal questions that seem to arise are — whether revenue will go to the jurisdiction of production or that of consumption; and how to identify the place of supply and that of actual use of the services in the case of inter-state delivery of services. Tax authorities are mulling solution to the first question taking cue from the destination principle followed by most countries to tax international transactions with VAT imposed on imports and rebated on exports. The second question is much more complex, and its solution involves greater efficiency of administration. The state governments are making their demand for the power for levy of service tax more vociferous. Tax policy managers at the centre would, however, do well to put the necessary administrative systems in place before the states’ demand is met. Another vexed issue in regard to taxation of services is linked to how export of services is defined. The Export of Service Rules notified by the government are ambiguous and increasingly disputatious. The matter is relevant as exports are meant to be tax-neutral while consumption of specified services locally is taxable. Let us pore over a few niceties. Currently, only if the services rendered from India are ‘fully used’ outside India, the process qualifies as exports. In the BPO industry, there are different possibilities of partial use of some composite services rendered by an Indian entity within the territory of India and while part of the services is used outside India. If you go strictly by the wording in the Export of Services Rules, it would seem that even if 99% of the services rendered by an Indian entity in a particular transaction is used outside India and the balance 1% used by local entities, the transaction cannot be treated as exports. That means the relevant entity will not be eligible for refund of input taxes. There is already a spate of litigation over this question which is fundamental.
Another possibility— which is also real given the flurry of court cases that have come up of late— is certain cases where the service is rendered from or performed “outside” Indian territory as defined in the tax rules but by an India-based entity subject to Indian tax laws. For example, certain offshore oil and gas production could be construed to be performed outside Indian territory and there could therefore be a claim for refund/credit of input taxes. It is open to interpretation whether this claim is valid. Also, with the government adding more services to the service tax net, the scope of definition issues in relation to taxability of certain services have anyway become much larger in the recent years. (With Budget 2008-09, 106 services are under the tax net and scores of other services which are not taxable now are proposed to be taxed under the state list). There are also cases of the tax authorities failing to understand the subtleties of commercial world and as a result amplifying the scope of the tax to proportions that the industry would find onerous. Double taxation issues also come up before the adjudicatory and judicial bodies and this is sometimes harmful to even the well-meaning industry. The revenue department has already issued a master circular to address the growing incidence of service tax disputes, but the circular has still left some points unexplained. The scuffle between the authorities and assessees over service tax issues is increasingly recurrent. This is obviously because the stakes are huge and assessee base has considerably widened to the current number of 5 lakh-plus. No longer is service tax a marginal factor in the government’s revenue estimates. Service tax collections grew 33.6% to Rs 9,774 crore in the first quarter of this fiscal, while the growth required to reach the target of Rs 64,460 crore is 26.1%. The last four years have seen phenomenal growth in service tax collections. With this kind of growth, in the next few years, service tax could emerge as the largest component of the central government’s indirect tax revenue. It is imperative, therefore, that the room for interpretation of service tax rules is minimised. When the taxman is not too intrusive, compliance level would only move up.
Professional tax may rise by Rs 5,000
Doctors, lawyers and other professionals, both salaried and self-employed, may now have to pay a higher professional tax. Acceding a long-pending demand of the state governments, the Centre has decided to raise the ceiling on professional tax from Rs 2,500 to Rs 7,500 per annum. The Union Cabinet is expected to take up the proposal on Thursday. Professional tax is levied by state governments or local bodies on professions, trades, callings and employment. The power to levy the tax flows from Article 276 of the Constitution that also caps the tax amount. The Centre will amend Article 276 to raise the limit. Although Delhi does not impose the tax, states such as Karnataka, Maharashtra, West Bengal, Andhra Pradesh, Tamil Nadu and Gujarat do so. The limit was fixed in 1998 at Rs 2,500 per annum. Increase in tax has been a long-pending demand of the states, pointing at rise in income levels in the past few years. The Centre’s reluctance to state governments’ demand for a hike in the limit is borne out of the fact that taxpayers who pay professional tax are eligible for a deduction under the Income-Tax Act. So, while the state governments’ revenues grow, the Centre loses tax on this count. However, with the direct tax collections witnessing stupendous growth, state governments had intensified pressure on the Centre. Their argument is that the tax does not have a substantial impact on Centre’s total kitty as the collection under this head by states was only Rs 3,500 crore. Some state governments wanted the limit to be increased to Rs 10,000 per annum, but the Centre has agreed to raise it to Rs 7,500.
INFLATION
...............CONTINUED FROM YESTARDAY
Causes of inflation
In the long run inflation is generally believed to be a monetary phenomenon while in the short and medium term it is influenced by the relative elasticity of wages, prices and interest rates.[6] The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian schools. In monetarism prices and wages adjust quickly enough to make other factors merely marginal behavior on a general trendline. In the Keynesian view, prices and wages adjust at different rates, and these differences have enough effects on real output to be "long term" in the view of people in an economy.
A great deal of economic literature concerns the question of what causes inflation and what effect it has. There are different schools of thought as to what causes inflation. Most can be divided into two broad areas: quality theories of inflation, and quantity theories of inflation. Many theories of inflation combine the two. The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the equation of the money supply, its velocity, and exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production.
Keynesian economic theory proposes that money is transparent to real forces in the economy, and that visible inflation is the result of pressures in the economy expressing themselves in prices.
There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle model":
Demand-pull inflation: inflation caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion. The failing value of money, however, may encourage spending rather than saving and so reduce the funds available for investment.
Cost-push inflation: presently termed "supply shock inflation," caused by drops in aggregate supply due to increased prices of inputs, for example. Take for instance a sudden decrease in the supply of oil, which would increase oil prices. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.
Built-in inflation: induced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up (gross wages have to increase above the CPI rate to net to CPI after-tax) with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built-in inflation reflects events in the past, and so might be seen as hangover inflation.
A major demand-pull theory centers on the supply of money: inflation may be caused by an increase in the quantity of money in circulation relative to the ability of the economy to supply (its potential output). This is most obvious when governments finance spending in a crisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a condition where prices can double in a month or less. Another cause can be a rapid decline in the demand for money, as happened in Europe during the Black Plague.
The money supply is also thought to play a major role in determining moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economics, by contrast, typically emphasize the role of aggregate demand in the economy rather than the money supply in determining inflation. That is, for Keynesians the money supply is only one determinant of aggregate demand. Some economists consider this a 'hocus pocus' approach: They disagree with the notion that central banks control the money supply, arguing that central banks have little control because the money supply adapts to the demand for bank credit issued by commercial banks. This is the theory of endogenous money. Advocated strongly by post-Keynesians as far back as the 1960s, it has today become a central focus of Taylor rule advocates. But this position is not universally accepted. Banks create money by making loans. But the aggregate volume of these loans diminishes as real interest rates increase. Thus, it is quite likely that central banks influence the money supply by making money cheaper or more expensive, and thus increasing or decreasing its production
TO BE CONTINUED TOMORROW..........................
Causes of inflation
In the long run inflation is generally believed to be a monetary phenomenon while in the short and medium term it is influenced by the relative elasticity of wages, prices and interest rates.[6] The question of whether the short-term effects last long enough to be important is the central topic of debate between monetarist and Keynesian schools. In monetarism prices and wages adjust quickly enough to make other factors merely marginal behavior on a general trendline. In the Keynesian view, prices and wages adjust at different rates, and these differences have enough effects on real output to be "long term" in the view of people in an economy.
A great deal of economic literature concerns the question of what causes inflation and what effect it has. There are different schools of thought as to what causes inflation. Most can be divided into two broad areas: quality theories of inflation, and quantity theories of inflation. Many theories of inflation combine the two. The quality theory of inflation rests on the expectation of a seller accepting currency to be able to exchange that currency at a later time for goods that are desirable as a buyer. The quantity theory of inflation rests on the equation of the money supply, its velocity, and exchanges. Adam Smith and David Hume proposed a quantity theory of inflation for money, and a quality theory of inflation for production.
Keynesian economic theory proposes that money is transparent to real forces in the economy, and that visible inflation is the result of pressures in the economy expressing themselves in prices.
There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle model":
Demand-pull inflation: inflation caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion. The failing value of money, however, may encourage spending rather than saving and so reduce the funds available for investment.
Cost-push inflation: presently termed "supply shock inflation," caused by drops in aggregate supply due to increased prices of inputs, for example. Take for instance a sudden decrease in the supply of oil, which would increase oil prices. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.
Built-in inflation: induced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up (gross wages have to increase above the CPI rate to net to CPI after-tax) with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built-in inflation reflects events in the past, and so might be seen as hangover inflation.
A major demand-pull theory centers on the supply of money: inflation may be caused by an increase in the quantity of money in circulation relative to the ability of the economy to supply (its potential output). This is most obvious when governments finance spending in a crisis, such as a civil war, by printing money excessively, often leading to hyperinflation, a condition where prices can double in a month or less. Another cause can be a rapid decline in the demand for money, as happened in Europe during the Black Plague.
The money supply is also thought to play a major role in determining moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economics, by contrast, typically emphasize the role of aggregate demand in the economy rather than the money supply in determining inflation. That is, for Keynesians the money supply is only one determinant of aggregate demand. Some economists consider this a 'hocus pocus' approach: They disagree with the notion that central banks control the money supply, arguing that central banks have little control because the money supply adapts to the demand for bank credit issued by commercial banks. This is the theory of endogenous money. Advocated strongly by post-Keynesians as far back as the 1960s, it has today become a central focus of Taylor rule advocates. But this position is not universally accepted. Banks create money by making loans. But the aggregate volume of these loans diminishes as real interest rates increase. Thus, it is quite likely that central banks influence the money supply by making money cheaper or more expensive, and thus increasing or decreasing its production
TO BE CONTINUED TOMORROW..........................
Golden Quotes
“The movement you think of giving up ,think of the reason you Held so long ……..Do or Die is an old saying ,Do it before you die is the latest ….”
Wednesday, July 16, 2008
Buffet's Toll Bridge-MUST READ
BYLANES - Buffet's Toll Bridge
Imagine a river with a commercial district on one side and residential on the other. Now, imagine a bridge spanning the river, joining the two districts. And imagine that you own the bridge, and can charge a small fee for using the bridge. A few thousand cars pass over the bridge every day, and you charge each car a little something for using the bridge. I bet you have already started counting the money. Warren Buffet keeps this perspective in mind while choosing a stock. Some basic advantages of such a `toll bridge` should be understood. One is that the cash register keeps ticking without a stop. The other advantage is that there are no sundry debtors. Further, the maintenance and expenditure is low and the profits can grow at a predictable rate, and that too for a number of years. If you (that is. the owner) do not become irrationally greedy and maintain the fees for crossing at a reasonable level, the customers will continue to use your bridge, and you will make money for a number of years to come. Many businesses reach the status of a toll bridge because of the strong relationships their products build with the customers. The first sign of such a company is apparent when the customers demand the product by its brand name and don`t even know the name of the company that produces it. The second sign is that it has little, or no competition, and the third sign is that it is essential either as a necessity, or for its universal appeal, and, therefore, every store has to carry it.Let us consider some examples in the Indian context. `Cadbury`s` chocolate, `Cherry Blossom` shoe polish (how many know the name of the company? (Viz. Reckitt & Coleman), `Dettol` disinfectant, `Aspro` and `Anacyn`--the headache cures--and `Amul` butter easily come to mind. In pharmaceuticals, Glaxo is one such name, which has many products in demand. Can any store afford not to have these products on their shelves? If the store does not have it, the customer just walks over to the next store and gets it. Companies making such products are in a unique position. They have established the manufacturing process, people have accepted the quality and specifications, they do not have to invest large sums in the plant and machinery every year, and their supply chains and distribution network are well established. The net result is steadily growing profits. These companies have some more advantages. They do not need exceptional management, just an honest management capable of grabbing a good thing when they see it and not to make a mess of it. These companies do not require too much of research and development (R&D), as they invented the formula many years ago and their customers don`t want any change. Would you like Dettol to smell differently? A good friend of mine even used it as an after-shave for many years. The management may add a gift with the purchase of a bottle, or add a new flavor to the product range to grab a little extra of the market share, but a wise management will leave the main product untouched. In Dettol`s case, even the shape of the bottle is important. Such structurally sound and `in-demand` toll bridges are great businesses to own. They give rise to plenty of free cash, which can be invested in building or buying another such toll bridge. These businesses survive through economic downturns, and continue to give the same returns. This feature makes it easier to predict their profitability. Value investors love this.The return for the investor is on the one side the earnings per share (EPS) (or dividend) and on the other increase in the share price. If the annual EPS/dividend is predictable, and if the share is purchased at a low enough price, the investor is happy to get such a return year after year. Many times, we see such companies showing an increasing EPS trend. This is still better for the investor, because this increases the price of the share faster. Much has been said and written about the intrinsic value of the business and how it is to be arrived at, but with insufficient justice to the discipline involved. Value investors eye the company first, but their decision to buy is a function of the price. Everything else about the company may be perfect and the value investor may be itching to own a part of it, but a disciplined investor will wait for the right price. Once purchased, the stock is not sold for a long time. The argument is simple. Why give away something `good` till something `better` comes along? Remember that a good toll bridge has a minimum life of 25 years. If the EPS is in the region of 20% and above on the price you paid, calculate the compounded value at the end of those 25 years and see for yourself. Yet there is a sad side. Like everything else in this world, bridges also deteriorate. Weather and time take a heavy toll of steel, and the bridge becomes unsafe. Those car owners who drove to work over that bridge for a number of years realise that the bridge is no longer safe and avoid using it. Some competitor senses the unease and builds a new bridge, and the owner of the original bridge dies an unsung death. We know what happened to some automobile companies from the pre- liberalisation days. From the mid-50s to the mid-80s, Premier Padmini and Hindustan Motor`s Ambassador were the two cars ruling the market. For years, they continued to thrive without making any major changes in the models, and Indians had no choice but to buy those cars. Whatever was produced was sold, and that too against cash. Sub-standard goods were produced for years and dumped on the helpless customers. With little R&D and no improvement in the basic car, these plants were just waiting to receive a deathblow, and `Maruti` did just that. Customers had found another safer, newer, and cheaper bridge. Sometimes, some management decisions cause problems. Excess cash poses a problem. The management does not know what to do with it, and then instead of buying another toll bridge, or improving the existing one, it buys a pyramid, which is just a tourist attraction and a place for the dead. The pyramid bleeds the parent company, and finally both perish. Acquisitions and mergers are good, but only of the same kind. In the recent past, we have seen the merger of Times Bank with HDFC Bank. Synergy in operation was evident, and the balance sheet proved it. The market also appreciated it, and the shareholders have reaped the benefit.It is easy to say that one should invest in such `consumer monopolies`, as Warren Buffett calls them, but it is another thing to actually buy these shares. No one has monopoly over such a wisdom, and generally we find these shares selling at a high P/E multiple. Yet, occasionally, these shares sell at low prices. John Neff`s advice is worth following while waiting for a good price. He advices the investors to regularly scan the `New Lows` list in the financial newspapers. If you have earmarked a share, then this list alerts you when it starts coming down. Consider this example, In March 2000, Glaxo hit a new low of Rs 422. In August, it is trading at 480/490. Reckitt & Coleman hit a new low of Rs 192 in March. Now it is trading around 210/220. If someone had earmarked the share, then surely it was a good time to buy. Sometimes, a `consumer monopoly` company remains unnoticed for a long time. These are the companies engaged in manufacturing some product, without which the big guns cannot do. An example could be that of a company manufacturing some critical chemical required for steel making. This company may also own the patent for the product and, thus, the monopoly remains assured for a long time. Such companies spend very little on advertising and, hence, are not widely known. Some event of social or political nature makes it conspicuous, and suddenly the great value of the share gets unlocked, and the price starts climbing. Mario Gabelli, a well-known investor from the US calls the event a `catalyst`. Noticing such a company in advance and then waiting patiently for a long enough time is what is needed. The rewards are great. The best way to notice consumer monopolies is to visit various stores. If you find the same product on all the stores you visited, chances are that it is a consumer monopoly. Watch for the advertising campaigns. If there is a blitz, rest assured that the company is not confident about the demand. If the advertising is subdued and regular, just to tickle your memory cells, there is a good chance that the monopoly is operating. Some companies don`t advertise at all; for example, Amrutanjan, the headache balm. Many years ago in Pune, a man started stamping his name on all goods that entered the city. The stamp was inconspicuous, yet readily visible. He did not charge a farthing for stamping the goods. Traders let him stamp their goods thinking of him as some harmless eccentric person, and soon goods which did not have his stamp were overlooked by customers in the city. So the traders started coming to him for getting their goods stamped, and then he started charging a small fee. In due course, he became a rich man. He had created his own `Toll Bridge`.
Imagine a river with a commercial district on one side and residential on the other. Now, imagine a bridge spanning the river, joining the two districts. And imagine that you own the bridge, and can charge a small fee for using the bridge. A few thousand cars pass over the bridge every day, and you charge each car a little something for using the bridge. I bet you have already started counting the money. Warren Buffet keeps this perspective in mind while choosing a stock. Some basic advantages of such a `toll bridge` should be understood. One is that the cash register keeps ticking without a stop. The other advantage is that there are no sundry debtors. Further, the maintenance and expenditure is low and the profits can grow at a predictable rate, and that too for a number of years. If you (that is. the owner) do not become irrationally greedy and maintain the fees for crossing at a reasonable level, the customers will continue to use your bridge, and you will make money for a number of years to come. Many businesses reach the status of a toll bridge because of the strong relationships their products build with the customers. The first sign of such a company is apparent when the customers demand the product by its brand name and don`t even know the name of the company that produces it. The second sign is that it has little, or no competition, and the third sign is that it is essential either as a necessity, or for its universal appeal, and, therefore, every store has to carry it.Let us consider some examples in the Indian context. `Cadbury`s` chocolate, `Cherry Blossom` shoe polish (how many know the name of the company? (Viz. Reckitt & Coleman), `Dettol` disinfectant, `Aspro` and `Anacyn`--the headache cures--and `Amul` butter easily come to mind. In pharmaceuticals, Glaxo is one such name, which has many products in demand. Can any store afford not to have these products on their shelves? If the store does not have it, the customer just walks over to the next store and gets it. Companies making such products are in a unique position. They have established the manufacturing process, people have accepted the quality and specifications, they do not have to invest large sums in the plant and machinery every year, and their supply chains and distribution network are well established. The net result is steadily growing profits. These companies have some more advantages. They do not need exceptional management, just an honest management capable of grabbing a good thing when they see it and not to make a mess of it. These companies do not require too much of research and development (R&D), as they invented the formula many years ago and their customers don`t want any change. Would you like Dettol to smell differently? A good friend of mine even used it as an after-shave for many years. The management may add a gift with the purchase of a bottle, or add a new flavor to the product range to grab a little extra of the market share, but a wise management will leave the main product untouched. In Dettol`s case, even the shape of the bottle is important. Such structurally sound and `in-demand` toll bridges are great businesses to own. They give rise to plenty of free cash, which can be invested in building or buying another such toll bridge. These businesses survive through economic downturns, and continue to give the same returns. This feature makes it easier to predict their profitability. Value investors love this.The return for the investor is on the one side the earnings per share (EPS) (or dividend) and on the other increase in the share price. If the annual EPS/dividend is predictable, and if the share is purchased at a low enough price, the investor is happy to get such a return year after year. Many times, we see such companies showing an increasing EPS trend. This is still better for the investor, because this increases the price of the share faster. Much has been said and written about the intrinsic value of the business and how it is to be arrived at, but with insufficient justice to the discipline involved. Value investors eye the company first, but their decision to buy is a function of the price. Everything else about the company may be perfect and the value investor may be itching to own a part of it, but a disciplined investor will wait for the right price. Once purchased, the stock is not sold for a long time. The argument is simple. Why give away something `good` till something `better` comes along? Remember that a good toll bridge has a minimum life of 25 years. If the EPS is in the region of 20% and above on the price you paid, calculate the compounded value at the end of those 25 years and see for yourself. Yet there is a sad side. Like everything else in this world, bridges also deteriorate. Weather and time take a heavy toll of steel, and the bridge becomes unsafe. Those car owners who drove to work over that bridge for a number of years realise that the bridge is no longer safe and avoid using it. Some competitor senses the unease and builds a new bridge, and the owner of the original bridge dies an unsung death. We know what happened to some automobile companies from the pre- liberalisation days. From the mid-50s to the mid-80s, Premier Padmini and Hindustan Motor`s Ambassador were the two cars ruling the market. For years, they continued to thrive without making any major changes in the models, and Indians had no choice but to buy those cars. Whatever was produced was sold, and that too against cash. Sub-standard goods were produced for years and dumped on the helpless customers. With little R&D and no improvement in the basic car, these plants were just waiting to receive a deathblow, and `Maruti` did just that. Customers had found another safer, newer, and cheaper bridge. Sometimes, some management decisions cause problems. Excess cash poses a problem. The management does not know what to do with it, and then instead of buying another toll bridge, or improving the existing one, it buys a pyramid, which is just a tourist attraction and a place for the dead. The pyramid bleeds the parent company, and finally both perish. Acquisitions and mergers are good, but only of the same kind. In the recent past, we have seen the merger of Times Bank with HDFC Bank. Synergy in operation was evident, and the balance sheet proved it. The market also appreciated it, and the shareholders have reaped the benefit.It is easy to say that one should invest in such `consumer monopolies`, as Warren Buffett calls them, but it is another thing to actually buy these shares. No one has monopoly over such a wisdom, and generally we find these shares selling at a high P/E multiple. Yet, occasionally, these shares sell at low prices. John Neff`s advice is worth following while waiting for a good price. He advices the investors to regularly scan the `New Lows` list in the financial newspapers. If you have earmarked a share, then this list alerts you when it starts coming down. Consider this example, In March 2000, Glaxo hit a new low of Rs 422. In August, it is trading at 480/490. Reckitt & Coleman hit a new low of Rs 192 in March. Now it is trading around 210/220. If someone had earmarked the share, then surely it was a good time to buy. Sometimes, a `consumer monopoly` company remains unnoticed for a long time. These are the companies engaged in manufacturing some product, without which the big guns cannot do. An example could be that of a company manufacturing some critical chemical required for steel making. This company may also own the patent for the product and, thus, the monopoly remains assured for a long time. Such companies spend very little on advertising and, hence, are not widely known. Some event of social or political nature makes it conspicuous, and suddenly the great value of the share gets unlocked, and the price starts climbing. Mario Gabelli, a well-known investor from the US calls the event a `catalyst`. Noticing such a company in advance and then waiting patiently for a long enough time is what is needed. The rewards are great. The best way to notice consumer monopolies is to visit various stores. If you find the same product on all the stores you visited, chances are that it is a consumer monopoly. Watch for the advertising campaigns. If there is a blitz, rest assured that the company is not confident about the demand. If the advertising is subdued and regular, just to tickle your memory cells, there is a good chance that the monopoly is operating. Some companies don`t advertise at all; for example, Amrutanjan, the headache balm. Many years ago in Pune, a man started stamping his name on all goods that entered the city. The stamp was inconspicuous, yet readily visible. He did not charge a farthing for stamping the goods. Traders let him stamp their goods thinking of him as some harmless eccentric person, and soon goods which did not have his stamp were overlooked by customers in the city. So the traders started coming to him for getting their goods stamped, and then he started charging a small fee. In due course, he became a rich man. He had created his own `Toll Bridge`.
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