Sunday, 31 May 2009

Predictions of Corporate Failure

The ability to predict corporate failure will be of interest to many stakeholders such as shareholders, lenders, suppliers, management, employee, etc. For example, banks and other lenders need to monitor loans and creditworthiness of customers, auditors need to assess the going-concern status of their clients and the companies themselves need to assess whether they are in danger of financial crisis.

Major cause of corporate failure is insolvency, which is inability to pay debts when they fall due. There are a number of reasons for a company to experience insolvency.
  • One reason is overtrading which leads to shortage of working capital.
  • Another is when a company invests heavily and is not able to recover its investment or earn a fair return, owing to changes in the business and economic environment and the company is not able to respond to the changes.
  • Loss of major customers is also a reason, and
  • Excessive amount of bad debts could lead to insolvency.

Over the last five decades considerable research has been made to determine the extent to which ratio analysis may help predict corporate failure. Often the various key ratios calculated have been done one ratio at a time. They have been grouped on some basis for inter-company comparison or comparison of performance or postion over a period fo time. It is possible to take a combination of a number of key ratios and calculate a score which is compared to a predetermined target or pass mark. When a company scores above the threshold pass mark then it is considered safe. This is referred to as multi-variate analysis or Z-score analysis. A number of models were developed to use key ratios to determine corporate failure. To date the two best-know Z-scores are Altman's Z-score and Taffler's Z-score.

Limitations of Analysis based on Financial Statements

Limitations of Analysis based on Financial Statements

Traditional analysis has certain weaknesses.

The analysis is based on financial statements prepared and presented by the company.
  • These statements provide information of the recent past, which may not be very relevant.
  • The financial statements could also have been subjected to 'creative accounting'. For example, a revolving loan, which is renewed every three months, may be shown as a current liability when in fact it could be a long-term loan in substance.
Different companies will use different accounting policies.
  • Therefore a comparison between companies may not be completely reliable.
  • To make useful inter-firm comparisons the companies selected have to be in the same industry, be similar in size, face similar challenges, etc. It may be near impossible to get a company similar to the one being studied.

Financial statements and the lenders

Financial statements and lenders

The lenders to the company may be trade creditors, banks, debenture holders, etc. They may stipulate different repayment periods and duration of the borrowing may be short, medium or long term.

Consequently, the information required by each category of lenders vary owing to their terms and conditions of the borrowings.

Short-term creditors need information about the creditworthiness of a company. They will need to know the company's liquidity, short-term solvency, profitability and asset utilization. Relevant ratios are the current ratios, acid test ratio, debtor payment period, creditors payment period, inventory turnover and gross profit margin.

Medium-term and long-term lenders are interested in the solvency, gearing, asset utilization, interest cover, cash flow, and cash flow projection. Some medium and long-term loans are secured on the assets of a company, in which case the realisable value (estimated net selling price) will be a useful indication of financial security.

Financial statements are historical statements. Important information such as forecast cash flow and ovrdraft facilities are not provided in published financial statements while current asset composition can alter tremendously over a short period of time.

One should be wary of "window dressing", which is manipulating the composition of current assets and liabilities on the balance sheet date to achieve a satisfactory current ratio or even a liquidity ratio.

Financial Statements and the Investors

Interpretation and Analysis of Financial Statements for the Investors

The investor has to identify changes and trends in the financial statements to help explain some fundamental questiona and raise supplementary questions. For example:

Turnover: Is it Increasing?

If Yes:
  • Is there a corresponding increase in Profits?
  • Is there an additional investment in Fixed Assets?
  • How is the additional investment Financed?

Investors derive their information from published sources such as annual reports, daily newspaper and magazines. Information contained in the annual reports is outdated, and is useful only for forecasting for the future plans and development. Information in newspapers and magazines may be more current and relevant for evaluating investments, but nonetheless still historical information.

Investors vary in their preferences. Some prefer high dividend pay-out rates and otheres prefer high capital gains: yet others may invest to gain control. Investors have to first establish their preferences.

A fundamental technique used to determine the share price is to study the dividend pay-out trend of the company. Investors who prefer a high dividend pay-out rather than capital appreciation should analyse the dividend policy of the company to decide whether to invest in, hold on to or dispose of, shares. Such investors should use dividend cover and dividend yield ratios to analyse the business. Companies with high ratios are preferred to those with low ratios.

Those who prefer capital appreciation to high dividends should study the PE ratio. The PE ratio relates the current price to the latest earnings per share. The PE ratio published daily in the newspapers compares the current market price of the share to the previous year's earnings per share.

The PE ratio represents the market's perception of a company's future performance in relation to its growth, gearing, risks and dividend policy.

  • The value of PE ratio depends on the stock market environment and the industry a company is in.
  • The average PE ratio varies from industry to industry. A careful study of the industry average gives an indication of the performance of the company in question.
  • Shares with a PE ratio higher than industry averages are generally attractive to investors.

A high PE ratio of a particular share could imply that the company concerned has a high growth potential and is a leader in the industry. Alternatively the shares may just be overvalued. By contrast, a low PE ratio may indicate poor performance or undervalued shares.

Reference: How to Read Financial Statements by Jane Lazar

Financial education for Life

Finally I read something MAKE SENSE from our education ministry : ONLY TEN SUBJECTS for SPM. This is looooong over-due(like the correction in KLSE? Haha) ... and many not-so-knowledegable-cum-kiasu-cum-kiasi parents were wanting their kids to take 14As if possible!! The crazy rush was from the weakness in our un-educated education ministers officers(they are POLITICIANS with their hidden political agenda ... u think they care how u people feel about education ar? Bodoh la ... kita cari makan saja. Makan, they did.)

Parent 1 : How many A's your daughter scored ar?

Parent 2: Hai ya ... that lazy girl arr ... I told her to take 14 subjects, she took 12 only. So, only get 12 A's la. Luckily she got all A1 la, otherwise I don't know where to put my face leh.

Parent 1 : Wah .... 12 A1 arr. Next year my boy taking SPM. I must ask him to take 15 subjects la. Currently he is also planning to take only 12 subjects. What you think arr?

Parent 2 : Ya loh ... ya loh ... must leh. Otherwise hor, u will 'drop your spec' leh. Regret like me now too late liao.

Parent 3 : Excuse me ladies ... u didnt read the paper ar? Our gov said next year onwards students can only take max 10 subjects leh.

Parent 1 : WHAT!! Stupid goverment hor ... now my son could not beat MRS XYZ of 12A's liao. Hai yo ...

Parent 2 : Hehe ... don't worry, MRS ABC. Ask him to tak piano test, ballet test, swimming test and may be SIDC test also la. That add up also 14 subjects ma. Haha

Parent 1 : %&##*&^%

Parent 3 : My son and daughter doing very well now tho they only took 8 subjects and obtained only 3-5 A's. I teach them 'financial prudency' at home and they learnt 'investment' from their dad. They do not need to get all the A's to get employed but they are employing others to manage a wealth-management company at the moment. I m so proud of them.

Parent 1 and Parent 2 are very puzzled. How on earth could a parent taking it so cool that their kids not getting ALL A's? You mean the subjects in our school will not teach them financial-survival in REAL lives? But ... but ... they are taking Economy, Accounting, Business Studies, Mathematics, Additional Mathematics ... surely they know how to count $$$ la.

Yeah, right. You scored A in your MORAL subject doesnt mean you are morally correct, ok? Do I need to give more examples WHY our education system is irrelevant when it comes to personal FINANCIAL? I was never taught to be financial-savvy, ok?


Nikkei 225 and the Lost Decade

Nikkei 225

The postwar rise in Japanese stocks is quite remarkable. The Nikkei Dow Jones Stock Average, patterned after the U.S. Dow Jones Average and containinng 225 stocks, was first published on May 16, 1949. The day marked the reopening of the Tokyo Stock Exchange, which had been officially closed since August 1945. On the opening day, the value of the Nikkei was 176.21 - virtually idential to the U.S. Dow Jones Industrials at that time. By December 1989, the Nikkei soared to nearly 40,000 more than 15 times that of the Dow. Japan's bear market brought the Nikkei below 10,000 following the terrorist attacks in September, 2001, just above the level reached by the American Dow. On February 1, 2002, the Nikkei closed at 9,791, below the Dow for the first time.

However, comparing U.S. and Japanese Dow indexes overstates the extent of the Japanese decline. The gain in the Japanese market measured in DOLLARS far exceeds that measured in YEN. The yen was set at 360 to the dollar 3 weeks before the opening of the Tokyo Stock Exchange - a rate that was to hold for more than 20 years. Since then, the dollar has fallen to about 130 yen. In dollar terms, therefore, the Nikkei climbed to over 100,000 in 1989 and is currently over 30,000, three times its American counterpart, despite the great bear market that has enveloped Japan in the past decade.

Nikkei 225 was 9,522.50 on 29th May 2009.... reminiscent of the lost decade.

The Price Level and Gold

The Price Level and Gold

In each country, the price level at the end of World War II was essentially the same as it was 150 years earlier. Since World War II, however, the path of inflation changed dramatically. The price level rose almost continuously over the past 55 years, often gradually but sometimes at double-digit rates, as in the 1970s. Excluding wartime, the 1970s witnessed the first rapid and sustained inflation ever experienced in U.S. history.

The dramatic changes in the recent inflationary trend should not come as a surprise. During the nineteenth and early twentieth centuries, the United States, the United Kingdom, and the rest of the industrialized world were on a gold standard. A gold standard restricts the supply of money and hence the inflation rate. From the Great Depression through World War II, however, the world shifted to a paper money standard. Under a paper money standard, there is no legal constraint on the issuance of money, so inflation is subject to political as well as economic forces. Price stability depends on the ability fo the central banks to limit the supply of money and control the inflationary policies of the federal governements.

The chronic inflation that the United States and other developed economies have experienced since World War II does not mean that the gold standard was superior to the current paper money standard. The gold standard was abandoned because of its inflexibility in the face of economic crises, particularly the banking collapse of the 1930s. The paper money standard, if administered properly, can avoid the banking panics and severe depressions that plaqued the gold standard. However, the cost of this stability is a bias toward chronic inflation.

It is not surprising that the price of gold has followed the trend of overall inflation closely over the past two centuries. The price of gold soared to $850 per ounce in January 1980, following the rapid inflation of the preceding decade. When inflation was brought under control, the price of gold fell. One dollar of gold bullion purchased in 1802 was worth $14.38 at the end of 2001. That is actually less than the change in the overall price level! In the long run, gold offers investors some protection against inflation but little else. Whatever hedging property precious metals possess, these assets will exert a considerable drag on the return of a long-term investor's portfolio.

#Ironically, despite the inflationary bias of a paper money system, well-preserved paper money from the early nineteenth century is worth many times its face value on the collectors' market, far surpassing gold bullion as a long-term investment. An old mattress found containing nineteenth-century paper money is a better find for the antique hunter than an equivalent sum hoarded in gold bars!


Dr. Marc Faber on the risk of hyperinflation

Marc Faber ger rid of your cash buy commodities while they are still cheap !!!!!!

Marc Faber "U S will default on debt or enter hyperinflation" 02-05-09

10 shares that pay good dividends

10 shares that pay good dividends

Dividend payments are once again under pressure – no sooner had BT announced a 60pc cut in its dividend than M&S said its payout to shareholders would be 30pc lower– its first cut for nine years.

Last Updated: 1:24PM BST 27 May 2009

Nick Raynor of The Share Centre, a stockbroker, said: "The past year has been one of turmoil for income-seeking investors as historically favoured sectors such as banking have either seen an aggressive cut or a complete erosion in dividends as the credit crunch took effect.

"However, there are still some great opportunities for those wishing to generate income from their investments. In particular, investors should be looking out for companies that are traditionally defensive, coupled with an ability to expand operations around the world."

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The Share Centre has identified a number of investment opportunities for income seekers.

National Grid
Currently trading at 590p and offering a yield of 5.7pc.

Comment from The Share Centre: "National Grid said recently that it intended to grow its dividends by at least 8pc this year and is due to progress at the same level until 2012. In the long term we feel that this is a solid performer; income and growth seekers can expect stable dividend payments from a good solid company."

Northumbrian Water
Currently trading at 245p and offering a yield of 4.7pc

Comment: "The last trading update from Northumbrian Water reported a 1pc (£4m) fall in revenue. Considering the performance of other water companies in the utilities sector this is not bad.

"From a cash position the company is financially sound, currently sitting on a cash pile of £371m with a further £75m available through drawdowns. With this in mind we expect the dividend to remain secure, and a rise should not be ruled out."

British American Tobacco (BAT)
Currently trading at £16.61 and offering a yield of 4.2pc.

Comment: "BAT's defensive nature has helped to keep the company buoyant in a choppy market. Last year pre-tax profits rose from £3.1bn to £3.7bn, therefore the likelihood of BAT cutting its dividend is minimal. BAT also has a reasonable dividend cover of 1.76 and is therefore suitable for income seekers and the risk averse."

Currently trading at 243p and offering a yield of 5.6pc.

Comment: "As well as being the biggest provider of gas in the UK, Centrica now generates a quarter of revenues in the US, which could protect it from the group's exposure to the volatile commodity market."

Currently trading at 501p and offering a yield of 7.5pc.

Comment: "For those wanting exposure to the oil sector, we believe BP is the best bet. Dependency on oil is unlikely to reduce and BP's profits remain strong. BP has a high level of reserves, and as a financially strong company it has plenty of cash available to purchase additional reserves should the need arise."

Currently trading at £10.52 and offering a yield of 5.2pc.

Comment: "Despite the company's share price dropping by around 20pc so far this year, we believe GSK's defensive nature will stand the company in good stead throughout 2009. GSK has a significant pipeline of drugs either at late stage testing or due for release very soon. It is suitable for investors seeking income and growth."

Currently trading at 115p and offering a yield of 6.5pc.

Comment: "Vodafone continues to be a favourite of The Share Centre. Vodafone recently announced a strong set of full-year figures, after the weaker pound helped boost the value of overseas sales. Due to the increase in profit, Vodafone has an attractive dividend and growth prospects."

Scottish & Southern Energy
Currently trading at £11.63 and offering a yield of 5.4pc.

Comment: "In these volatile times a well managed utility has many attractions for investors seeking a safer haven. Scottish & Southern pays consistent dividends to shareholders and is attractive for those looking for steady growth and a reasonable income.

"Due to the company's steady and solid earnings figures, the management has set its sights on improving performance of its assets and pushing up the dividend further."

Currently trading at 302p and offering a yield of 6.6pc.

Comment: "Rexam is one of the world's leading packaging companies, specialising in beverage cans and bottles. The promise of a long hot summer is something Rexam can look forward to and it will be hoping that this will give the company a boost. The dividend looks as if it will remain unchanged and stands at well over 6pc."

RSA Insurance
Currently trading at 127.5p and offering a yield of 5.8pc.

Comment: "Now that the reconstruction of RSA [formerly Royal & Sun Alliance] is finally complete, shareholders will hope that chief executive Andy Haste shows as much flair for increasing profits as he did for stemming losses. This signs are good so far, with a refocusing on new markets and a hefty dividend increase.

"Recent figures were solid but not exciting. However, there has been no news of any cut in the dividend, so for those looking for an income this should remain a favourite."

What's the commercial driver of the UK economy going to be if it's not financial services?

What's the commercial driver of the economy going to be if it's not financial services?

This is no time for modesty," wrote Lord Davies, the trade minister in The Daily Telegraph on Monday in a call for us Brits to start telling the world that we're great.

By Richard Tyler
Last Updated: 9:44AM BST 26 May 2009

Comments 17 Comment on this article

But what are we great at? The City has been demonised; large scale manufacturing is on its knees. Davies insists: "It's time for change in the way that we perceive ourselves and how we talk about the economy."

But change our perception to what? If financial services are no longer going to rule the roost as the economy is "rebalanced" (somehow) and we are all going to live in a Gordon Brown's new world order of allotment capitalism (he prefers "sustainable capitalism"), exactly what commercial activity is going to drive the economy out of recession and back to long term trend growth rates?

Large chunks of the New Forest are being sacrificed as industry and the Government examine this issue. Some of the studies' findings are intriguing. The report team led by former Ford chief technology officer Richard Parry-Jones set out the automotive industry's 20-year vision for vehicle-making in the UK earlier this month.

They compared Britain's position relative to our economic competitors and concluded that "the UK still has a competitive, yet fragile, automotive industry". Britain is reliant on foreign investment – the car industry in Britain is now largely Japanese – and the report concludes that "there is no natural choice to do the work in the UK".

There is also no natural choice for those car makers that are here to source components from British suppliers. Industry bosses said that UK sourcing was likely to decline further over the next five years, making suppliers less competitive to the point where the manufacturers decide they need to more abroad.

It is trends like this that can make you pessimistic about Britain's prospects. Ministers talk up the low carbon economy and promise to use public money to fund trials of the next generation of electric cars. But the chances of them being mass produced in Britain are slim.

Most depressing is the fact that the issues facing the industry identified in this report are exactly the same ones identified by previous studies commissioned by successive governments since 1975. They include currency fluctuations, exchange rates and the need for better skills and training.

"One also has to see this as a failure to address sufficiently these issues in the past, given that they are mentioned repeatedly by industry leaders," thunders the report.

This sense of lack of direction from Whitehall is echoed in the other industry reports being published. An assessment of the UK's ability to build an industrial biotechnology sector, which could produce energy, chemicals and materials from renewable resources, concluded that the country has the scientific know-how but, to quote from the report: "Unlike other countries (in particular USA and Germany), no policies are currently in place to support the bio-based materials and chemicals sector."

Cue Lord Mandelson, the Business Secretary, and his "industrial activism" strategy that, he insists, will see the Government listen and act.

This will not involve the Government returning to the discredited practices of the 1960s and 1970s of picking industrial winners, he says. The Government will simply identify industries in which Britain is and/or could become a world leader and then enable them to prosper.

So it seems the Government is finally offering what industry wants: a clear, coherent framework of support. But doubts remain. How are Whitehall officials going to pick which industries should be helped? The automotive industry seems to have a case. But then so does aerospace; composite materials; plastic electronics; life sciences and pharmaceuticals; information technology; renewable energy; professional services and engineering construction.

Another Lord, Lord Drayson, the science minister, told me that the Government has to decide which industries it will support by the end of this year at the latest. The clock is ticking. Commissioning reports is one thing. Picking the right new technology to back is quite another. Last time, the Whitehall mandarins tried they failed. Wouldn't it be better to learn to love the City again.

Sterling surges as investors seize on global green shoots

Sterling surges as investors seize on global green shoots

Sterling surged against the dollar on Friday as investors seized on new evidence that the downturn in the global economy may be easing.

By Telegraph staff
Last Updated: 4:53PM BST 29 May 2009

The pound stormed beyond $1.61, its highest level since November, after Nationwide figures showed an unexpected rise in house prices this month. The better number in the UK was added to by Japan, where industrial production rebounded, and the strong performance of the Indian economy in the first quarter.

The currency closed at $1.6125 in London, up almost two cents on the day.

Although economists have generally cautioned that any recovery will be very slow, financial markets are currently focused on any evidence of improvement from the free fall seen in the wake of Lehman Brothers' collapse.

"Sterling was absolutely hammered in the fourth quarter and people were loathe to hold it because it was seen as very risky," said Paul Robinson of Barclays. "But as risk appetite comes back into the market, then that's good for the currency."

It's that return of investors' willingness to take risks that is also hurting the dollar, explained Mr Robinson. At the height of the banking crisis last autumn people flocked to the dollar because it is the world's most liquid currency and provided shelter during the turmoil. That logic is now ebbing, he said.

In the UK, house prices gained 1.2pc - only their second gain in the last year. Sentiment was also buoyed after a survey showed that UK consumers are now at their most confident in almost a year. The news from GfK comes a day after the CBI said that retailers are feeling more optimistic than at anytime since 2007.

However, Nationwide's own chief economist, Martin Gahbauer, was quick to downplay suggestions that house prices may have reached a bottom.

"Although the short-term trend in house prices has clearly improved from where it was at the beginning of the year, it is still too early to say that the market is turning definitely," said Mr Gahbauer.

The best investment returns of tomorrow

The best investment returns of tomorrow will be generated by businesses with the strongest balance sheets today – in this respect, cash is king. Such investments remain our focus.

A review of Questor's share portfolio over six months

The good, the bad and the ugly – a review of Questor's share portfolio over six months

The current Questor editor has been in the hot seat at The Daily Telegraph for six months, so now seems like a good time to review the performance of the portfolio over that time.

By Garry White
Last Updated: 3:46PM BST 26 May 2009

Since the end of November last year, all of the shares recommended as buys in the Questor column are up 17pc, compared with a gain of 4.6pc in the FTSE 100. In aggregate, the portfolio is outperforming the market as a whole.

These figures are in terms of share price appreciation only and any dividends accrued or dealing costs are not included. Questor has pursued a relatively conservative investment strategy in these unprecedented market conditions, with a focus on balance sheet strength and dividends. So the income stream from these shares should also be strong – but that is not accounted for in this review. The accompanying graphic shows the 10 best recommendations and the 10 worst performing recommendations based on closing price on Friday May 22.

Questor aims to continue with the strategy that beat the market in the last six months and improve on the performance so far.

The Good

Questor has had considerable success riding the recovery in mining stocks. Vedanta shares, which are now rate a hold, have considerably outperformed the market – rising 185pc.

Questor recommended buying the shares because of its very strong cash position and its exposure to India. Other miners that have proved lucrative are Centamin Egypt (up 96pc), which is set to mine its first gold at its Sukari project in Egypt within weeks, Mexican silver miner Fresnillo (up 80pc) and Rio Tinto (up 55pc), which is currently battling to slash its crippling pile of debt.

Questor took profits in Fresnillo and Rio Tinto because of uncertain market conditions, although the shares have moved higher since then.

Questor makes no apology for this. The most difficult decision in investing is when to sell and investors do not go broke if they continue to bank gains.

Despite the recovery in appetite for risk, Questor believes a cautious investment strategy is the best way to play these markets and it is good to bank profits when they present themselves.

The bad

Questor's worst-performing tip is Gem Diamonds , which is down 37pc. Questor first recommended buying shares in the group because of its prize asset – the Letseng mine in Lesotho. The mine has produced three of the world's largest 20 diamonds in the last three years alone. In total, four of the largest 20 rough diamonds ever recovered have come from this one mine.

However, diamond prices continued to tumble, although there is some evidence of stabilisation in the market at present. Questor has restrained from closing out of this position because of the conviction that diamond prices will recover.

Perhaps Questor's worst tip so far was the premature recommendation to buy into an oil exchange traded fund, ETF Securities CRUD fund. Questor sold out of this position, advising investors to take the loss on the chin because the oil futures market moved against the investment and the capital investment was being eroded. The resulting loss was 30pc.

Gem Diamonds and ETF CRUD are the only two recommendations Questor regards as duds over the last six months. Shares in Lloyds insurer Catlin are down 18pc and defence group QinetiQ shares are off 17pc, but both shares still have a buy stance.

Catlin shares were hit after a £200m rights issue, but the group managed to post a 17pc year-on-year increase in the first quarter of the year.

QinetiQ, although it is facing some industrial dispute issues at the moment, has ambitious plans for its US unit, where it is forecasting double-digit growth.

The future

Questor remains to be convinced that the recent market rally is the start of the next bull run. A number of market commentators suggest that the weight of money sitting on the sidelines means that share-price gains will be a self fulfilling prophecy.

Questor feels it is best to be cautious and maintains a defensive strategy, while making some long-term strategic plays such as JP Morgan Indian Investment Trust (up 41pc) and BG Group (up 11pc), as well as dividend plays such as BP (up 3pc) and Northern Foods (up 21pc). Indeed, as the appetite for risk returned, defensive sectors such as utilities have been out of favour. Now looks like a good time to buy into these underperforming sectors.

Taking a long-term view, now is a great time to buy into the stock market. However, it is likely to be a bumpy ride as the year progresses.

The UK government has refused a freedom of information request to see the results of stress tests at major banks, which is concerning.

The full effects of the recession have not made their way into the real economy and unemployment is likely to continue to rise. When the property market will bottom out is anyone's guess.

As we move in to the second part of the year, the phrase "sell in May and go away" comes to mind. Questor does not suggest selling your portfolio, just banking good gains and watching out for opportunities to buy good companies at decent valuations when the opportunity arises. Questor aims to bring you the best of these opportunities over the coming months.

Friday, 29 May 2009

When It's Too Late to Buy Stocks

When It's Too Late to Buy Stocks
By Selena Maranjian May 27, 2009 Comments (1)

There are good times to buy stocks, and bad times to buy stocks. But how do you tell the difference?

That's a tough question, especially recently. It's easy to look at bargains across a wide range of stocks and conclude that this must be a once-in-a-lifetime opportunity. Still, some will argue that even after recent massive losses, the stock market can fall further.

Both of those viewpoints are valid.

But even though stocks could see more drops, there are still good reasons why you should consider buying anyway:
  • A falling market isn't the only risk. Since no one knows for sure which way stocks will move, it's possible you could find yourself sitting on the sidelines while the market rises.
  • Warren Buffett's longtime partner Charlie Munger recently noted, "If you wait until the economy is working properly to buy stocks, it's almost certainly too late ... I have no feeling that just because there's more agony ahead for the economy you should wait to invest."
  • Buffett himself has recommended that we: "Be fearful when others are greedy, and be greedy when others are fearful." Although the recent rally has rekindled greedy thoughts among investors, many are still fearful -- the stock market is still down substantially from its 2007 highs. That's why we've got so many bargains in plain sight.

Screening for possibilities In fact, you can pick up companies that have a combination of attractive features, including strong dividends, good growth prospects, and beaten-down prices. Witness the following selection of stocks, each of which has earned a top rating of five stars from our Motley Fool CAPS community:

1-year return
Dividend yield
Est. 2010 EPS growth
NYSE Euronext (NYSE: NYX)
ConocoPhillips (NYSE: COP)
Arcelor Mittal (NYSE: MT)
Total SA (NYSE: TOT)
Diageo (NYSE: DEO)
Arch Coal (NYSE: ACI)
Source: Motley Fool CAPS.

Of course, these aren't recommendations -- just ideas for further research. Given how far some of these companies have seen their earnings fall, you'd expect to see high growth figures for 2010, even if they just return to their normal, pre-recession levels.

The market's handed us a huge platter of lemons over the past year, and it might just be time to start making lemonade. Take advantage of bargains while they last -- they might be gone before you know it.

Youtube Video Lessons on Basic Accounting

Khan Academy - Finance

Introduction to interest
Interest (part 2)
Introduction to Present Value
Present Value 2
Present Value 3
Present Value 4 (and discounted cash flow)
Introduction to Balance Sheets
More on balance sheets and equity
Home equity loans
Renting vs. Buying a home
Renting vs. buying a home (part 2)
Renting vs. Buying (detailed analysis)
The housing price conundrum
Housing price conundrum (part 2)
Housing Price Conundrum (part 3)
Housing Conundrum (part 4)
Return on capital
Mortgage-Backed Securities I
Mortgage-backed securities II
Mortgage-backed securities III
Collateralized Debt Obligation (CDO)
Introduction to the yield curve
Introduction to compound interest and e
Compound Interest and e (part 2)
Compound Interest and e (part 3)
Compound Interest and e (part 4)
Bailout 1: Liquidity vs. Solvency
Bailout 2: Book Value
Bailout 3: Book value vs. market value
Bailout 4: Mark-to-model vs. mark-to-market
Bailout 5: Paying off the debt
Bailout 6: Getting an equity infusion
Bailout 7: Bank goes into bankruptcy
Bailout 8: Systemic Risk
Bailout 9: Paulson's Plan
Bailout 10: Moral Hazard
Credit Default Swaps
Credit Default Swaps 2
Investment vs. Consumption 1
Investment vs. Comsumption 2
Bailout 11: Why these CDOs could be worth nothing
Bailout 12: Lone Star Transaction
Bailout 13: Does the bailout have a chance of working?
Wealth Destruction 1
Wealth Destruction 2
Bailout 14: Possible Solution
Bailout 15: More on the solution
Banking 4: Multiplier effect and the money supply
Banking 3: Fractional Reserve Banking
Banking 2: A bank's income statement
Banking 1
Banking 2: A bank's income statement
Banking 3: Fractional Reserve Banking
Banking 4: Multiplier effect and the money supply

Khan Academy - Credit Crisis

Credit Crisis
The housing price conundrum
Housing price conundrum (part 2)
Housing Price Conundrum (part 3)
Housing Conundrum (part 4)
Mortgage-Backed Securities I
Mortgage-backed securities II
Mortgage-backed securities III
Collateralized Debt Obligation (CDO)
Bailout 1: Liquidity vs. Solvency
Bailout 2: Book Value
Bailout 3: Book value vs. market value
Bailout 4: Mark-to-model vs. mark-to-market
Bailout 5: Paying off the debt
Bailout 6: Getting an equity infusion
Bailout 7: Bank goes into bankruptcy
Bailout 8: Systemic Risk
Bailout 9: Paulson's Plan
Bailout 10: Moral Hazard
Bailout 11: Why these CDOs could be worth nothing
Bailout 12: Lone Star Transaction
Bailout 13: Does the bailout have a chance of working?
Credit Default Swaps
Credit Default Swaps 2
Wealth Destruction 1
Wealth Destruction 2
Bailout 14: Possible Solution
Bailout 15: More on the solution
Banking 1
Banking 2: A bank's income statement
Banking 3: Fractional Reserve Banking
Banking 4: Multiplier effect and the money supply

Khan Academy - Banking and Money

Banking and Money
Banking 1
Banking 2: A bank's income statement
Banking 3: Fractional Reserve Banking
Banking 4: Multiplier effect and the money supply
Banking 5: Introduction to Bank Notes
Banking 6: Bank Notes and Checks
Banking 7: Giving out loans without giving out gold
Banking 8: Reserve Ratios
Banking 9: More on Reserve Ratios (Bad sound)
Banking 10: Introduction to leverage (bad sound)
Banking 11: A reserve bank
Banking 12: Treasuries (government debt)
Banking 13: Open Market Operations
Banking 14: Fed Funds Rate
Banking 15: More on the Fed Funds Rate
Banking 16: Why target rates vs. money supply
Banking 17: What happened to the gold?
Banking 18: Big Picture Discussion

Remember, Nobody's Perfect

Remember, Nobody's Perfect

No investor - not even the greatest investors in the world - are right all the time.

Don't be discouraged when your system calls for you to lock in losses on a stock; not even the best investors in the world are right all the time.

Martin Zweig says:

"In the long run,
a 60% success rate translates into huge gains,
a 50% rate into solid gains, and
even a 40% rate can beat the market."

When it comes to the stock market, no one is right all the time - or even nearly all the time. Even the great Warren Buffett makes bad investments. Just read Berkshire Hathaway's annual report, and Buffett will often speak candidly about where he's gone wrong.

Some examples from a fund manager. A particular portfolio of theirs, by being right 62.7% of the time - on less than two-thirds of its picks - had more than tripled the gains of the S&P over 5 years. For the most part, their portfolios had accuracies between 50 and 60 % - far from perfect - and most had still doubled, tripled, or quadrupled the market. Being aware that no one can be right all the time, or even nearly all the time, can make it easier on your ego when your selling system calls for you to take a loss on a stock.

While you'll never be right all the time, you can be right more than you're wrong, however. In the end, the key is to develop a fundamental-based selling and rebalancing plan and stick with it, NO MATTER WHAT. When your portfolio does lose ground from time to time, you'll inevitably feel the urge to sell certain stocks and go after others on a whim or a hunch to make up ground. But if you have a detailed, quantitative selling system in place, you can help keep short-term emotions from wreaking havoc with your long-term performance.

Stay Disciplined Over the Long Haul

Stay Disciplined Over the Long Haul

1. It is essential to stick to your strategy for the long term. Even the best strategies have down periods, and it can sometimes take over a year to reap the benefits of a good method. If you try to time your use of a strategy, you'll likely miss out on some big gains.

2. Expectations shape reactions; be prepared for short-term 10 to 20 % downturns that are inevitable in the stock market - and the less frequent but also inevitable 35 to 50% downturns you'll occasionally experience. You can't predict when they'll happen, so you just have to roll with them if you want to reap the market's long-term benefits.

3. Give the Internet a rest. Checking your portfolio every day, let alone every 10 minutes, can make you want to jump in and out of the market, which hurts your long-term performance.


You should have the right mindset going into your market endeavors.

As you're building your portfolio, at some point, you're bound to experience a short-term 10 to 20 % drop, and that you'll also endure less frequent larger drops.

About 6 years after his retirement, Peter Lynch addressed this idea in an interview. Lynch said that 10% declines in the market had occurred in more than half the years in the twentieth century; 25% declines - a bear market - had occurred on average, every 6 years.

"They're gonna happen," Lynch said, "If you're in the market, you have to know there's going to be declines. And they're going to cap and every couple of years you're going to get a 10% correction. That's a euphemism for losing a lot of money rapidly.... And a bear market is a 20-25-30% decline. They're gonna happen. When they're gonna start, no one knows. If you're not ready for that, you shouldn't be in the stock market. I mean stomach is the key organ here. It's not the brain. Do you have the stomach for these kind of declines?"

Lynch was speaking about the broader market, but the same applies to your own portfolio. Joel Greenblatt stresses again and again that his strategy won't beat the market every year. In fact, his testing found that the formula underperformed the market one out of every four years from 1988 through 2004. But if you had used the formula for any two-year period during that time, your chances of underperforming fell to one in six. And, over three-year periods, the formula beat the market 95% of the time - and it never lost money in any of the three-year periods over that 17-year span. (Greenblatt says that even in its worst three-year period during that 17-year span, the formula actually gained 11 percent).

It's a similar story for just about any strategy you can imagine. All of the greats - Lynch, Buffett, Dreman, Graham - have had years when they failed to beat the market. But they stuck with their strategies, and that's what enabled them to post such great long-term returns.

If you acknowledge at the outset that all strategies - even great ones - go through down periods, you won't be surprised when your portfolio does take a short-term hit. As with many things in life, it's the surprise that often leads to anxiety and fear. If you're ready for those down times, you'll be amazed at how much more calm you'll remain when your portfolio takes some short-term lumps.

Unfortunately, most investors don't do that. (In fact, Lynch has supposedly said that while he was at Magellan's helm, more of the fund's investor LOST money than gained money because they would jump out of the fund when things got rought - selling low - and then jump back in when the fund was doing well - buying high.) Not being prepared for those downturns makes it all the more easy to be bowled over by emotions when times get tough. And if you give in to your emotions, you'll probably end up selling after big losses, and buying only after the market has made some big gains.

Hulbert said the newsletter (The Prudent Speculator) that his group rated as the best performer since mid-1980, has demonstrated great faith in the market's upward trend and been rewarded for it. The newsletter "has been the most buffeted by short-term market gyrations" of any he has monitored, he said. "And yet, none surpasses it in its willingness to either ignore or tolerate those gyrations." Hulbert said a testament to the newsletter's faith in the market's long-term benefits came after its model porfolio lost 57% in the crash of 1987. While others panicked, The Prudent Speculator kept its fully invested approach, and ended up winning big over the long haul. "Long-term investors need not lose sleep over the markets' short-term gyrations because the markets' long-term patterns will eventually assert themselves," Hulbert wrote.

The Key Selling Points

The Key Selling Points

1. Rebalance your portfolio at fixed intervals (i.e., every months, every quarter, every year), selling stocks that no longer meet the fundamental criteria you used to buy them in the first place. Replace them with new stocks that do meet your criteria.

2. Sell stocks immediately if they are involved in accounting or earnings scandals, or if they become a major bankruptcy concern. In these cases, do not wait until your net rebancing date to sell.

3. For tax reasons, it's generally best to sell winning positions after you've held them for a year and losing positions before you've held them for a year. If a stock you've made money no longer meets your investment criteria and you've held it for close to a year, consider holding it until you pass that one-year mark to limit taxes.

4. Don't be discouraged when your system calls for you to lock in losses on a stock; not even the best investors in the world are right all the time.

Selling Smart

Selling Smart

"Flying isn't the hard part; landing in the net is." - Mario Zacchini, one of the original "Flying Cannonballs"

How do you stave off emotion and make good, sensible "sell" decisions?

The same way that you keep emotion at bay when deciding what stocks to buy: By using a disciplined system that makes sell decisions based on cold, hard fundamentals - not emotion-driven hunches, or arbitrary price targets.

To sell smart, you have to go back to the basic premise behind our "buy" strategy. And that is that over the long term, investors gravitate toward stocks with strong fundamentals because those are the strongest companies, and that causes those stocks' prices to rise over time. We buy because of the fundamentals - not just because the price is high or low or rising or falling. Remember, the only way price comes into the decision to buy is in how it relates to the stock's fundamentals - that is, in the form of such variables as the price-sales ratio or price-earnings ratio.

When you're building your portfolio, you want to pick the stocks that have the best fundamentals - because over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.

What does this have to do with selling stocks?

If you're buying stocks because they have strong fundamentals, and over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.

Whether the stock has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand RIGHT NOW. Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stocks P/E or P/S ratios are, for example).

Many investors will sell a stock because its price has fallen and they think they need to cut their losses, or because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down.

But those are arbitrary, emotional decisions. Remember, you bought the stock because its strong fundamentals make it a good bet to gain value; if its fundamentals are still strong, why wouldn't it still be a good bet to gain more value?

If the stock's fundamentals have slipped, however, so that it no longer meets the criteria you used to buy it, it's time to sell and replace it with another stock that does meet your criteria (and one that thereby has better prospects of rising in value).

The selling assessment is thus an ongoing reevalution of where a stock stands right now. You must continually reassess what the stock's prospects are going forward - not what they were a month ago, six months ago, or whenever you bought it.

Whether you use a one-month rebalancing or a different time frame that works for you, the important point is - you need to re-examine your portfolio at set intervals, to assess how your holding stand relative to the reasons you bought them. If they no longer meet the criteria you used to pick them, you should consider replacing them with new stocks that do make the grade.

You can also use your rebalancing period to reweight your portfolio in case some of your holdings have gained or lost a bunch, and now make up a disproportionate part of your portfolio. The idea here is to keep things close to equally weighted. It doesn't have to be perfect, though; if one stock gains a little ground so that it makes up a few more percentage points of your portfolio than the other stocks, you don't need to go selling a couple shares - and getting hit with trading charges - just to even things out exactly.

To keep this simple, you might want to set a reweighting target percentage. For example, anytime a holding's weight in your portfolio becomes 10 percent more or less than your target weight, you buy or sell shares of it to bring it back to that target.

By sticking to a firm rebalancing plan, you keep emotion and hype from impacting your selling decisions. You sell at regular intervals, and you sell based on fundamentals. Just as with buying stocks, there's no place for hunch-playing or knee-jerk reactions here.

When do You need to Sell Urgently?

There are a couple rare occasions, however, when you should sell a stock without waiting for the rebalancing date to arrive.

  • If a firm is involved or allegedly involved in a major accounting or earnings scandal, you should sell the stock immediately, because you can no longer trust its publicly disclosed financial data.
  • In addition, if a firm has become a serious bankruptcy risk since the last rebalancing, you should also sell its stock immediately.

Six Guiding Investing Principles

Six Guiding Investing Principles

Principle 1: Combining strategies to minimise risk and maximise returns.
Principle 2: Stick to the numbers - or the market will stick it to you.
Principle 3: Stay disciplined over the long haul.
Principle 4: Diversify, but you can't beat the market by owning it.
Principle 5: Size- and style-focused systems only limit investment possibilities.
Principle 6: You don't have to hold stocks for the long term to be a long-term investor.

Thursday, 28 May 2009

Investing: Discipline, First and Foremost

Investing: Discipline, First and Foremost

"The essence of mathematics is not to make simple things complicated, but to make complicated things simple."

If you want to beat the market, you need to pick a strategy and stick with it - NO MATTER WHAT. In What Works on Wall Street, O'Shaughnessy writes that in order to beat the market, it is crucial that you stay disciplined. "Consistently, patiently, and slavishly stick with a strategy, even when it's performing poorly relative to other methods."

O'Shaughnessy believed that emotions were perhaps the greatest enemy of the investor because feelings like fear, anxiety, and excitement can cause an investor to ditch his long-term plan for hot strategies or hot stocks that turn out to be financial mirages. "We are a bundle of inconsistencies," he continues, "and while that may make us interesting, it plays havoc with our ability to invest our money successfully.... Disciplined implementation of active strategies is the key to performance."

A decade later, his thoughts about sticking with strategies haven't changed. "What always work on Wall Street is strict adherence to underlying strategies that have proven themselves under a variety of market environments."

Martin Zweig - The Conservative Growth Investor

Martin Zweig - The Conservative Growth Investor

"Nothing can stop the man with the right mental attitude from achieving his goal; nothing on earth can help the man with the wrong mental attitude." - THOMAS JEFFERSON

Martin Zweig may not have been born a great investor, but it took him less time than perhaps any other guru we follow to start making himself into one.

Thanks to a birthday gift from his uncle of 6 shares of General Motors stock, Zweig was just 13 years old in 1955 when he began following the stock market. He started tracking GM and some other stocks, and before long, he was hooked. By the time he was in high school, Zweig writes in his book, Winning on Wall Street, he had made up his mind: He was going to become a millionaire, and he would do so by investing in stocks.

Millions of people have made a similar decision over the years. But unlike the vast majority of them, Zweig followed through. He began paying more and more attention to the market. Soon he was wowing his high school teachers with his knowledge of stocks. By the time he was in college, Zweig was buying and selling stocks, and as a graduate student he performed groundbreaking research in the field of stock analysis. It wasn't long before he'd reached the goal he'd set for himself in high school. In fact, you might say he obliterated it, becoming not only a millionaire, but also the owner of what Forbes reported was the most expensive apartment in New York City and the eighth most expensive home in the world - a $70 million penthouse that sits atop Manhattan's chic Pierre Hotel.

Given how fixated he was on beating the market at such an early age, it almost seems Zweig was destined to become one of the world's best investors. "Ever since I can remember," he wrote in Winning on Wall Street, "I have had an almost overwhelming desire to learn all I could about the stock market and to play it successfully. Perhaps my urge was not too different from that attributed to the mountain climber who must assualt the mountain just because it's there... From an early age I wanted to surmount the summit of the stock market, so to speak. It was a challenge I couldn't resist."

Zweig's intense desire and ambition may have been a gift of birth but his stock market success - his stock recommendation newsletter was ranked number one based on risk-adjusted returns by Hulbert Financial Digest during the 15 years Hulbert monitored it - wasn't simply due to natural ability. His development into a great investor was marked by years of study and hard work, and the ability to adhere to a strict, thorough investment strategy.

With some hard work and discipline of your own, you can make your strategy work for you too.