QUICKIES: Seven investment myths you should not fall for

Text: Prerna Katiyar | ET Bureau

Pick this stock, it's trading at 52-week low.' 'That stock is a multi-bagger, trading at such a low PE.' 'Penny stocks make fortunes while stocks trading below book value are a sure pick for making quick bucks.'

Haven't we all heard such statements at some point in our lives? If you are one of those who believe in such assertions, read on. For, these are among the many myths in investing.



Here we list seven of them


Myth No 1: Stocks trading below book value are cheap

Book value (BV) is the actual worth of a stock as in a company's books/balance sheet, or the cost of an asset minus accumulated depreciation.

BV depends more on historical cost and depreciation and often has little correlation to the current share price.

Shares of industries that are capital intensive trade at lower price/ book ratios, as they generate lower earnings. On the other hand, those business models that have more human capital will fetch higher earnings and will trade at higher price/book ratios.

"Price/book (ratio) of below 1 may be cheap but one should see other aspects such as earnings forecast, guidance, management and debt on the books of the company ," says Angel Broking's equity derivatives head Siddarth Bhamre.


Myth No 2: Stocks trading at low P/E are under-valued

Price to earning ratio (P/E) is one of the most talked about ratios in the market. This is based on the theory that stocks with low P/Es are cheap.

However, P/E alone doesn't tell much about the stock price. P/E multiples may be a quick way to value a stock but one should look at this in correlation with expected growth earnings, the risk factors involved, company's performance and growth potential .

"This is surely a myth. It is also an indication of uncertain future earning of the stock concerned," says Birla Sunlife Mutual Fund CEO A Balasubramanian.

The idea behind dividing price with earnings is to create a levelplaying field where some kind of comparison can be made between high- and low-priced stocks.

Since P/E ratios vary across sectors, with growth stocks consistently trading at higher P/E, one can only compare the P/E ratio of a stock to the average P/E ratio of stocks in that sector.


Myth No. 3: Penny stocks make good fortunes

Penny stocks by nature are lowpriced , speculative and risky because of their limited liquidity, following and disclosure.

If it's easy to invest in penny stocks - as here you shell out much less money per share than you would require for a blue-chip firm - it's also easy to lose.

Says Bhamre, "Fortune can be made by high-denomination stocks also. Denomination has nothing to do with the rationale for picking a stock. Generally , retail investors are fond of stocks that are at sub- Rs 100 levels. But there may be stocks that may be trading in Rs 1,000-plus price but may well be cheap. Clarity on earnings is more important here. Anytime, I would be more comfortable buying an ICICI Bank (currently trading at Rs 1,038) than an IFCI at Rs 45. One should look at earnings visibility."


Myth No. 4: The worst is over in the stock market

Timing the market, a common strategy among investors, means forecasting and that should best be left to astrologers and tarot readers.

If one has done one's valuation studies, one shouldn't worry about timing the market. No one had predicted the bull run would take the Sensex from a level of 10,000 in February 2006 to over 21,000 in January 2008 - just as no one had any idea of the following crash, which saw the same index plummeting to 9,000 in March 2009.

"Timing the market is more of a gut feeling. It's more on the basis of perception, as there is no such thing (that the worst is over) when the future is uncertain. One can never surely time the market. The worst is over is more of a probability than a certainty. Timing the market is very difficult as market is driven not just by earnings but also by sentiments ," says Balasubramanian.


Myth No 5: Stocks that give high dividends are the best bet

This comes from the notion that regular dividends are extra income in the shareholder's hand. This may not always be true.

While a company may be making decent payouts every year, the share price appreciation may not be comparatively high. Before investing in companies paying high dividends, it's important to analyse if the company is reinvesting enough profit to grow its earnings consistently.

Says Brics Securities' research VP Sonam Udasi: "It's not dividend that matters but the yield. For eg, a company may pay a 100% or even a 300% dividend on a stock with face value of Rs 10.

So, the investor may receive Rs 10 or Rs 30 per share when the stock may be currently trading at Rs 800 or Rs 1000. This would translate into an yield of 1% or 3% only. Also, such companies may not necessarily be reinvesting their earnings in the business to generate future earnings and so there may be no stock movement. The dividend may be high but the EPS and growth per se may be constant."



Myth N0 6: Index stocks are the best stocks

If this was true, most investors would safely park their money in such stocks in anticipation of maximum profit without looking out for other value stocks.

Most indices are a collection of stocks with the highest market cap. Take, for eg, the Sensex.

Companies that make up the index are some of the largest, with stocks that are highly traded based on their free-float.

"Index stocks may not necessarily be the best stocks as they are mostly based on market-cap or free-float of the company and not earnings. This doesn't mean that all stocks of the Sensex are highearning stocks. One must take a stock-by-stock call," says Balasubramanian of Birla Sun Life Mutual Fund.

The stock price of a company depends on its earnings. One can find high-earning stocks outside the key indices as well, he says. The risk is certainly less with index stocks as they are well researched and leaders in their respective sectors, but, again, the margins may not be very high. So it's better to keep your eyes open to other stocks, too.



Myth No 7: Stocks trading at 52-week low are cheap

Says Udasi: "There may be a time in the economic cycle when a blue-chip stock may hit a 52-week low.

But the first thing that should come to one's mind is why did the stock hit the 52-week low.

There must be something fundamentally wrong with the stock if it has hit a 52-week low, and chances are they may hit a new 52-week low.

52-week low in itself guarantees nothing. If at all one is picking stocks at 52-week lows, they should have a long-term horizon so that when the economic cycle turns, the stock is able to recover."

Needless to say, quality matters most while buying any stock.


http://economictimes.indiatimes.com/seven-investment-myths-you-should-not-fall-for/quickiearticleshow/9438662.cms

Cash Flow from Financing Activities

Investing activities tell what a firm does with cash to increase or decrease fixed assets and assets not directly related to operations.

Financing activities tell where a firm has obtained capital in the form of cash to fund the business.

Source of cash for financing: Proceeds from the:

• sale of company shares or
• sale of bonds (long-term debt).

Use of cash for financing: If a company:

• pays off a bond issue,
• pays a dividend, or
• buys back its own stock.

A consistent cash flow from financing activities indicates excessive dependence on credit or equity markets. Typically, this figure oscillates between negative and positive.

A big positive spike reflects a big bond issue or stock sale. In such a case, check to see whether the resulting cash is used:

• for investments in the business (probably okay) or
• to make up for a shortfall in operating cash flow (probably not okay), or,
• if the generated cash flows straight to the cash balance, you should wonder why a company is selling shares or debt just to increase cash, although often the reasons are difficult to know. Perhaps an acquisition?
  

An illustration:

Company X's statement shows a happy story for investors:

• $15.4 m paid to investors as dividends
• $8.2 m paid out in "Sale Purchase of Stock" (- this is most likely for a share buyback. In fact, the company X actually repurchased $17.2 million in its own stock on the market; then issued $8.9 million in stock, most likely for employee stock options ESOS, and compensation.)

Still, this isn't bad - shareholders benefited from both the dividend and the repurchase.

Bottom line: Company X is using surplus cash generated from operations to give something back to shareholders. That's a good thing.

Dividend Yield

Dividend Yield

The yield figure published in the newspapers is usually the historical one.

Analysts will often provide forecasts for dividends in terms of earnings per share (EPS) and thus the forecast yield can then be calculated. Forecast can, of course, go wrong, and consequently there is some risk in relying upon them.

WHY IT IS IMPORTANT

Yield, after the price/earning ration (P/E), is one of the most common methods of comparing the relative value of shares.

The majority of investors like to see a cash income from their shares, althoug to some extent this is a cultureal thing. There are more companies in the U.S., for example, that pay no dividends than in the U.K.

HOW IT WORKS IN PRACTICE

Yields can be compared against the market average or against a sector average, which in turn gives you some idea of the relative value of the share against its peers.

Other things being equal, a higher yield share is preferable to that of an identical company with a lower yield.

The higher yield share is cheaper.

In practice of course, there may well be good reasons why the market has decided that the higher yielder should be so - possibly it has worse prospects, is less profitable, and so on. This is not always the case; the market is far from being a perfectly rational place.

AN ADDITIONAL FEATURE OF YIELD (unlike many of the other share analysis ratios), is that it enables comparison with cash.

You can compare the yield from the interest rate in a bank without capital risk with the yield on shares, which are far riskier. This produce a valuable basis for share evaluation.

If, for example, you can get 4% in a bank without capital risk, you can then look at shares and ask yourself how this yield compares - given that, as well as the opportunity for long-term growth of both the share price and the dividends, there is plenty of capital risk.

TRICKS OF THE TRADE

Care is necessary, however, because unlike banks paying interest, companies are under no obligation to pay dividends at all.

Frequently, if they go through a bad patch, even the largest, most well-known household name companies will cut dividends or even abandon paying them altogether.

So, share yield is greatly less reliable than bank interst or government stock interest yield.

Despite this, yield is an immensely useful feature of share appraisal. It is the only ratio that tells you about the CASH RETURN TO THE INVESTOR, and you cannot argue with cash. EPS, for example, is subject to accountants' opinions but a dividend once paid is an unarguable fact.

3 measures of a stock's value

Value can be a subjective term depending on who is talking about it and how they measure values for themselves.

3 long-held fundamental measures of value are:

P/E
P/B
DY

Price: Price by itself without any other analytical factor is in fact worthless.

Earning: Earning can be a nebulous figure. Earnings can be modified and adjusted according to what the company's needs are. Sometimes if the company likes to have a different tax basis for one quarter, they may adjust their earnings up or earnings down. There are companies that depress earnings for one quarter and then lifted up earnings the next quarter to facilitate selling of stock options to important executives.

Earnings are what accountants say they are. P/E s are somewhat suspect, because earnings themselves can be suspects.

Book value: Book value also can be quite nebulous.

Often a company carries an asset at cost of 30 years to 40 years ago. Therefore, the book value does not give measure of true value of these assets of this company.

Dividend: Dividend tells us 3 things.

1. Dividend can only come as a result of earnings. In other words, company cannot pay what it doesn't have. In order for a company to pay dividend, it has to have earnings. This let us know that the company we are investing in, is a profitable concern.

2. Dividend represents income. It is a tangible return on your investment you receive every quarter. It is cash in your pocket. You can spend it on your needs, or you can reinvest that dividend into other dividend paying stocks and compound your returns.

3. Dividend helps us provide a basis for value. High quality stocks have some shared characteristics and repetitive patterns. These stocks tend to trade between 2 different bands of dividend yield. One band is when the price is low and the yield is high. The second band is when the price is high and the yield is low. Also, these stocks tend to trade in between these 2 bands over long period of time which gives us a good range to understand when to buy the stock and when to sell the stock.

To summarise: Dividend does 3 things.
1. It shows us our company is a profitable concern.
2. It puts income into our pocket.
3. It tells us when to buy and when to sell a stock.

http://articles.moneycentral.msn.com/learn-how-to-invest/new-investor-center-video-ap.aspx?cp-documentid=9d33155e-df9b-43b7-8535-9f2a8d87c769

Also read:
Why dividends are important for investors' portfolios.

Dividends Without Debt

Dividends Without Debt

By JACK HOUGH
An 18% dividend yield is usually a warning sign. It might mean investors have little confidence in a company's ability to preserve its share price and keep making payments. Often, debt adds to the anxiety. Newspaper publisher Gannett pays 18%, but has sinking sales and profits and carries long-term debt of nearly double its stock-market value. Capstead Mortgage pays 21%. Its business of borrowing cheap-to-hold government-sponsored mortgage debt isn't as risky as it sounds, unless financing dries up -- something investors are clearly worried about.
Biovail yields 18% and owes nothing. It, too, has warts. But maybe the stock has gotten cheap enough to make up for them.
Ontario-based Biovail, Canada's largest traded drug company, has focused since the mid-1990s on making alternative versions of existing drugs. But the thinning development pipelines of big drug makers have given Biovail less to work with.
Its biggest hit, Wellbutrin XL, has faced generic competition since late 2006. Ultram ER, a once-daily pain pill released in 2006, hasn't caught on as quickly as hoped. Demand for Zovirax, a herpes cream, and Cardizem LA, a pill for high blood pressure, is cooling, too. Companywide sales are on pace to shrink to $748 million this year and $695 million next year. Shares, which multiplied in price from 50 cents in 1994 to more than $50 in 2001, have since fallen below $9.
Biovail is plowing money into purchasing and developing a new roster of drugs, an effort analysts say won't reverse sales declines for at least two years. The company is still plenty profitable. A drop of 50 cents per share in profit this year and another foreseen for next year of 24 cents will leave 2009 profit of $1.13 a share. That puts the stock at less than eight times earnings. But investors have their pick of low-P/E stocks about now.
If they can rely on pocketing 18% for a few years, though, shares are certainly cheap enough. The company can afford the payments. Even with dwindling drug sales, it will clear enough free cash. What's unknown is whether management will fund its new drug efforts with a dividend trim or with already-budgeted research dollars. Shareholders surely hope for the latter. Few investments reward investors as richly at the moment as cash in the pocket.
For more debt-free companies with big dividends, if not quite double-digit ones, have a look at the list below.

Click on the image to get the full version.