FPI vs. FII

FPIs include a broad range of investors, while Foreign Institutional Investors (FIIs) refer specifically to institutional investors. Alongside FPIs, Domestic Institutional Investors (DIIs) also play a key role in the Indian market.

Key Effects of FPIs

1. Liquidity
   FPIs inject capital, boosting funds available in the market, enhancing price discovery, and ensuring smoother trading.
2. Market Volatility
   FPI inflows can drive market rallies, while outflows may trigger corrections. This volatility often reflects global economic trends and geopolitical events.
3. Currency Impact
   FPI movements influence the Indian Rupee: Inflows strengthen the Rupee and Outflows weakens it.

Current Trends (as of November 21, 2024)

The U.S. Dollar (USD) is valued at ₹84.46, with greater purchasing power than the Indian Rupee. This allows foreign institutions to pump money into Indian markets on a much larger scale than domestic investors.

• DII and FPI Activity: DIIs purchased ₹4,200 crore, while FPIs exited ₹5,320 crore. (Source: NSE Report)
• Market Index: Nifty50 closed at 23,349 points, continuing its decline due to FPI outflows. (Source: Market Indices)
• Currency Trends: The Rupee is weakening, reflecting FPI withdrawals. (Source: USD-INR Chart)

FPIs have a profound impact on liquidity, market stability, and currency trends, underscoring their importance in the Indian financial ecosystem.

• Wealth Creation: Billionaires have built their wealth through the stock market, either via direct trading or indirectly via. entrepreneurship.
• Investment Caution: Blindly following investment advice from friends or brokers can lead to significant losses. Don’t invest in businesses you do not understand.
• Investing in Quality Stocks: If a stock has strong fundamentals, don’t hesitate to invest more, even if its price has already doubled or tripled. A stock at a 52-week high can still appreciate if it’s a quality investment.
• Avoid Attachment: Treat stocks as investments, not possessions. Once you achieve significant returns, exit and redeploy your capital elsewhere. Clear reasons for purchase make exiting easier.
• Cut Losses Early: If an investment turns out to be a mistake, exit quickly rather than waiting for a potential recovery.
• Avoid Market Timing: Don’t sell stocks to buy back at a lower price, as timing the market is difficult. Instead, average your buying price over time.
• Emotional Control: Refrain from checking stock prices daily to avoid emotional decisions and premature profit-booking.
• Diversification Strategy: Be cautious of over-diversifying. A portfolio with 80 stocks can still be poorly balanced, while a focused portfolio of 10–20 stocks is ideal. Diversify across sectors, but don’t end up creating an index, you’re better off investing in an Index fund.
• Quality Over Quantity: Don’t split investments by market cap unnecessarily; holding only large-cap quality stocks is fine if they’re strong. The stock’s past price movements don’t guarantee future performance—only fundamentals do.
• Capital Preservation: Protect your capital, frequent trading leads to high frictional costs. During market corrections, focus on accumulating high-quality stocks. Frictional costs are Securities Transaction Tax (STT), service tax, exchange fees, and Capital Gains Tax (CGT).
• Gold as a Hedge: Gold can be used as a hedge against market volatility.
• Avoid Red Flags: Steer clear of companies with a market cap below ₹200 crore and promoter holdings under 20%, except for professionally managed firms like L&T. Be cautious of all-time low stocks to avoid catching a “falling knife.”

Retail Investors

• Retail Investor (RI): An RI is someone with a regular job who invests part of their income in stocks.
• Avoid Complex Instruments: Intraday trading and Futures & Options (F&O) are risky for retail investors and are better suited for institutions and high-net-worth individuals.
• Real Estate vs. Stock Market: Real estate requires substantial capital, making the stock market a more accessible option for retail investors.
• Bull Market Illusion: In a bull market, even poor investment strategies may seem effective.
• Long-Term Strategy: Invest in solid businesses and allow time to grow your wealth.
• Risks of Borrowing to Invest: Using borrowed money to invest, especially by pledging stocks, can lead to forced liquidation to cover collateral requirements.
• Return Expectations: Investments earning less than 9% CAGR are losing money; a target of 12%+ CAGR is preferable.
• Financial Independence: Achieving a 20%-30% CAGR over 15-20 years can lead to financial independence.
• Risk and Return Expectations: People often accept a 7% return from fixed deposits but unrealistically expect 50% returns from equities.

Valuation

• Valuation Challenges: While valuation models may be theoretically sound, they are impractical due to the difficulty of predicting future cash flows. Even small errors in assumptions can lead to large discrepancies.
• Value Investing: Buying low PE stocks isn’t automatically value investing. Always conduct a thorough fundamental analysis (FA).
• Valuation and Growth: A company’s valuation depends on the potential for future earnings growth.
• Valuation as an Art: There is no perfect or universal method for valuation;
  • Discounted Cash Flow (DCF): This method estimates a company’s present value based on future cash flow projections, discounted to reflect that future money is less valuable than current money. – Most common model.
  • Other Valuation Methods:
    • Asset-Based Valuation
    • Liquidation Value Method
    • Reproduction Cost Method

Qualitative Metrics to consider:

• Profit vs. Cash Flow: Large profits or sales don’t necessarily indicate good cash flow, as financial figures can be manipulated. Amateur investors often focus on these figures without understanding underlying financial health.
• Importance of Management: Quality management can transform underperforming companies. Indicators of management quality include shareholding patterns, dividend yield history, and consistent ROE.
  • Shareholding Pattern: The division between promoters and the public matters. An increase in promoter stake is a positive sign, while the reverse is concerning.
  • Institutional Investors: FII (Foreign) and DII (Domestic) investments can indicate confidence in the company.
• Competitive Advantage (Moat): Companies with a strong moat have superior products/services, customer lock-in strategies, and high switching costs, like the difficulty of moving from WhatsApp to Telegram.
• Industry and Growth Potential: Analyze the overall industry size and the company’s total revenue. If growth potential is limited, the stock price may decline.

Quantitative Metrics to consider:

• ROE (Return on Equity): Indicates the profit a company generates from shareholders’ funds.
• Dividend Consistency: A steady dividend payout signals a stable and solid business.
• Reliable ROE: Consistent ROE suggests genuine financial performance, as manipulating sales and profits would affect ROE.
• Valuation Matters: Even the world’s best company can be a poor investment if bought at the wrong price. Pay attention to Price-to-Earnings (PE) ratios.
• Valuation Ratios:
  • Price-to-Sales (PS): Useful for assessing cyclic stocks.
  • Price-to-Book (PB): Relevant for banking and NBFCs but less so for service companies.
• Stock Prices: A stock’s price doesn’t necessarily indicate its value. A low-priced stock can be overpriced, and a high-priced one may be undervalued. Price alone is just a number.
• Financial Metrics for Screening:
  • 3-year ROCE where ROCE > 20%
  • Debt-to-Equity (DE) < 1
  • Pledged Promoter Holdings (PP) < 1%
  • Sales growth rate (Sales R) > 10%
  • Profit growth rate (Profit R) > 12%
• PE Ratio Strategy: If a stock’s PE ratio fluctuates within a known range (e.g., 18–21), buying below the average (e.g., 20) and selling above it can be effective, assuming all other fundamentals are strong.
• Banking Stocks: Pay attention to Non-Performing Assets (NPA) and Net Interest Margin (NIM) for banking investments.

Closing Notes

• Performance Realism: Outperforming a mutual fund (MF) doesn’t mean you’re a genius. MFs face stricter regulations and compliance.
• Market Behavior: The market may react erratically in the short term, but it follows fundamentals over the long term. If a stock underperforms despite seeming strength, investigate thoroughly

Unsecured loans, like credit cards, are loans that do not require collateral to be availed. To address potential vulnerabilities associated with such loans, the RBI announced on November 16 that the risk weights on unsecured retail loans and credit card exposures for banks and Non-Banking Financial Companies (NBFCs) will be raised by 25 percentage points.

What Are Risk Weights and Capital Requirements?

Risk weight is a regulatory metric used in banking and finance to calculate the amount of capital a financial institution must hold to cover possible losses. The Capital Adequacy Ratio (CAR), also known as the Capital-to-Risk Weighted Assets Ratio (CRAR), reflects a bank’s available capital as a percentage of its risk-weighted assets. It is a safeguard designed to protect depositors and ensure the stability of financial systems globally.

For example, if a bank has a loan portfolio worth ₹100 crore and the average risk weight of these loans is 50%, the risk-weighted assets amount to ₹50 crore. By increasing the risk weight to 125%, banks must hold more capital to cushion potential losses, especially from consumer credit, such as personal loans and credit card receivables.

The Impact on Banks and Credit Limits

Due to the increase in risk weights, banks are required to allocate more capital to maintain a satisfactory Capital Adequacy Ratio (CRAR). To manage this higher capital requirement, banks are left with two main options: either set aside more funds or reduce their exposure to these high-risk loans.

Most banks have opted for the latter, leading to a reduction in credit limits for consumers. By cutting down on the credit available to individuals, banks aim to better balance their capital requirements and reduce potential exposure to unsecured lending risks.

References:

• Unsecured Loans: RBI Raises Risk Weights | Assessing The New Rules & Analysts’ Views | N18V
• Regulatory measures towards consumer credit and bank credit to NBFCs