Managing Risks and Benefiting from Risks

Risks


There are numerous risks involved in investing in the stock market.
- Knowing that these risks exist should be one of the things an investor is constantly aware of.
- The money you invest in the stock market is not guaranteed.


For instance, you might buy a stock expecting a certain dividend or rate of share price increase.
- If the company experiences financial problems it may not live up to your dividend or price growth expectations.
- If the company goes out of business you will probably lose everything you invested in it.
- Due to the uncertainty of the outcome, you bear a certain amount of risk when you purchase a stock.


Stocks differ in the amount of risks they present.
- For instance, Internet stocks in 2000 have demonstrated themselves to be much more risky than utility stocks.


One risk is the stocks reaction to news items about the company.
- Depending on how the investors interpret the new item, they may be influenced to buy or sell the stock.
- If enough of these investors begin to buy or sell at the same time it will cause the price to rise or fall.



Managing risks

One effective strategy to cope with risk is diversification.
- This means spreading out your investments over several stocks in different market sectors.
- Remember the saying: “Don’t put all your eggs in the same basket”.


As investors we need to find our “Risk Tolerance”.
- Risk tolerance is our emotional and financial ability to ride out a decline in the market without panicking and selling at a loss.
- When we define that point we make sure not to extend our investments beyond it.


Benefiting from risks

The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy.
- It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!


The Internet has make investing in the stock market a possibility for almost everybody.
- The wealth of online information, articles, and stock quotes gives the average person the same abilities that were once available to only stock brokers.
- No longer does the investor need to contact a broker for this information or to place orders to buy or sell.
- We now have almost instant access to our accounts and the ability to place on-line orders in seconds.
- This new freedom has ushered in new masses of hopeful investors.


Still this in not a random process of buying and selling stock. We need a strategy for selecting a suitable stock as well as timing to buy and sell in order to make a profit.

Bull Market – Bear Market

1.  Bull Market and Bear Market. What do they mean?

(a)  What is a bull market?

A bull market is defined by steadily rising prices. 

The economy is thriving and companies are generally making a profit.

Most investors feel that this trend will continue for some time.


(b)  What is a bear market?

By contrast a bear market is one where prices are dropping. 

The economy is probably in a decline and many companies are experiencing difficulties.

Now the investors are pessimistic about the future profitability of the stock market.

Since investors’ attitudes tend to drive their willingness to buy or sell these trends normally perpetuate themselves until significant outside events intervene to cause a reversal of opinion.



2.  Investing in a bull market

In a bull market the investor hopes to buy early and hold the stock until it has reached it’s high.

Obviously predicting the low and high is impossible. 

Since most investors are “bullish” they make more money in the rising bull market.

They are willing to invest more money as the stock is rising and realize more profit.



3.  Investing in a bear market

Investing in a bear market incurs the greatest possibility of losses because the trend in downward and there is no end in sight.

An investment strategy in this case might be short selling. 

Short selling is selling a stock that you don’t own.

You can make arrangements with your broker to do this.

You will in effect be borrowing shares from your broker to sell in the hope of buying them back later when the price has dropped.

You will profit from the difference in the two prices. 

Another strategy for a bear market would be buying defensive stocks. 

These are stocks like utility companies that are not affected by the market downturn or companies that sell their products during all economic conditions.

Investments and Risk Reward Ratio

It is always interesting that there are so many different types of investments around us, ranging from regulated investments such as bonds and stocks, all the way to unregulated investment vehicles such as collectibles, antiques and many others. In this post, I’m slightly more inclined to talk about some common investments, mainly money markets, bonds, stocks and derivatives as well as their risk-reward relationships. To illustrate this, let’s start with a picture.

I do hope that the picture is pretty clearcut. Basically, it says that the higher the return, the higher the risk. Note that in the picture, derivatives has lower return, but higher risk and I will explain why it is so in the picture. I am actually taking into account expected rewards, which is different from potential rewards. Potential rewards mean the high end spectrum of what is achievable, whereas expected rewards basically mean the aggregate returns of all investors who participate in the investing of the instrument.

Now, after having explained my definition, let’s look at the investments and their risk rewards ratio. It is seen from the diagram that for taking more risk, the expected rewards is greater, with the exception of derivatives. The explanation is that derivatives are theoretically zero sum games, which means that when someone makes money, another has to lose it. After commissions, spreads and other charges, they are practically negative sum games.

I have friends who said that stock markets are negative sum games too, because the same principle applies. However, they missed an important point, which is the fact that wealth is created through the stock market and the evidence is in the issuance of dividends. For example, I bought a stock at $10 and sell it for $9.50. I may seem to have lost money, but what if I got a dividend payout of $1.00 while holding the stock? From this example, we can see that the purchase of stocks is not a zero sum game and that the general direction of the stock market in the long run is an uptrend. Of course, I am assuming that there is no large scale war or natural disaster that will destroy a significant amount of wealth. Even if there is though, wealth will be recreated as long as humans survived.

Just like stocks, bonds and money markets are also both not zero sum games, since there is an effective yield that you can get. While some of them may default their payments, we are looking at the aggregate of all investments in the instrument, which makes it a positive sum game.

For derivatives though, it is a clear cut zero sum game, because there is absolutely no payouts linked to the instrument. You don’t get dividends for holding options or futures. However, I would like to argue from another standpoint that perhaps it is not really that much of a zero sum game. The reason I would like to input this perspective is the prevalence of people who like to hedge their investments. Therefore, they may have holdings of stocks and buying options to offset the downside. Hedging in such a way often gives them an effective yield almost equilvalent to the risk-free rate. Therefore, they may not care if their derivative products lose money, since their overall portfolio gives them the desired return that they want.

This seems to get quite complicated, but I am suggesting that if there are really quite a number of hedgers out there in the financial world, it is possible that they are all holding the derivatives that lose money. Consequently, this may mean that it may be slightly easier to profit from derivatives than a strict zero sum game, since some people participate in the game without the intention of winning. Of course, if we aggregate all the positions, we are still back to a strict zero sum game. 

However, my purpose in this post is only to bring about another perspective that perhaps not everybody wants to make money from every market. Some people may participate in some markets and lose constantly but still persist because they satisfy them in some other way. Therefore, it may mean that for those who are serious about making money in the markets, the chances are slightly higher. After all, it is easier to win in a race against leisure runners than national runners who are committed to getting that next medal.

Of course, with everything said, it’s just my hypothesis and it may or may not be right. 

http://www.firstmillionchallenge.com/investments-and-risk-reward-ratio/


This article was first posted on 24.11.2011.

Are you interested in investing into Dutch Lady?

The Greatest Cash Flow Machine in the History of Capitalism

Stansberry Investment Hour

Warren Buffett Says, "I'm Buying Stocks".

@1.00 min to 1.39 min

I am buying stock and I am not buying because I think the stock is going up next year.

I am buying because I think the stock will be worth a bit more money 10 or 20 years from now.

I don't know whether they are going to go up or down tomorrow, next week, next  month or next year.

I do know good business is, in relation .... you have to measure investments in relation to each other.... and the alternative for most people it is fixed income and you get 3.02% or something like that for 30 years.

So, would you be better to invest in a company that is earning 15 to 20% on the invested capital and compound it or have a 3% bond which can never earn more than 3% while you own it?

Dividend Yield Theory - Buying and Selling tied to the Underlying Yield

THE DIVIDEND-YIELD THEORY:  BUYING AND SELLING ARE TIED TO THE UNDERLYING YIELD

UNDERVALUE – YIELD IS HIGH AND PRICE IS LOW

OVERVALUE – YIELD IS LOW AND PRICE IS HIGH


http://www.betterinvesting.org/NR/rdonlyres/837880CD-BF8D-41C8-8C38-033ECA4643F5/0/DividendsStillDontLie.pdf

Should You Sell Company ABC At This PE Ratio of 36.4x?

Should You Sell Company ABC At This PE Ratio?


ABC is trading with a trailing P/E of 36.4x, which is higher than the industry average of 23.5x.

• While ABC might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 
• You should understand what the P/E ratio is, how to interpret it and what to watch out for. 

1.   Breaking down the P/E ratio

The P/E ratio is one of many ratios used in relative valuation. 

• By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.

P/E Calculation for ABC

Price-Earnings Ratio = Price per share ÷ Earnings per share



On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies.

• Your goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ABC, such as company lifetime and products sold. 
• A quick method of creating a peer group is to use companies in the same industry. 
• ABC’s P/E of 36.4x is higher than its industry peers (23.5x), which implies that each dollar of  ABC’s earnings is being overvalued by investors. Therefore, according to this analysis, ABC is an over-priced stock.

2.  Assumptions to watch out for

Before you jump to the conclusion that ABC should be banished from your portfolio, it is important to realise that your conclusion rests on two assertions. 

(a)  Firstly, your peer group contains companies that are similar to ABC.

• If this isn’t the case, the difference in P/E could be due to other factors. 
• For example, if you compared lower risk firms with ABC, then investors would naturally value it at a lower price since it is a riskier investment. 

(b)  The second assumption that must hold true is that the stocks we are comparing ABC to are fairly valued by the market.

• If this is violated, ABC’s P/E may be lower than its peers as they are actually overvalued by investors.

3.   What this means for you:


(a)  Are you a shareholder? 

You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to ABC.

Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.


(b)  Are you a potential investor? 

If you are considering investing in ABC, looking at the PE ratio on its own is not enough to make a well-informed decision.

You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.

PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. 

Another limitation of PE is it doesn’t properly account for growth, you can use a list of stocks with a high growth potential and see if their PE is still reasonable.




The thought process using Relative Valuation

Price based on past earnings
PE 36.4x
ABC is overvalued based one earnings compared to the industry average.
ABC is overvalued based on earnings compared to the local market.


Price based on expected growth
PEG 3.0x
ABC is poor value based on expected growth next year.


Price based on value of assets
P/B 15.3x
ABC is overvalued based on assets compared to the industry average

Investing in Foreign Shares

There are many stock markets in the world.

All of them are susceptible to both good and bad news.

Every market's behaviour is dictated by global events.

Each market presents diverse opportunities for one to invest and realise financial gains.



What are some of the reasons for investing in foreign markets?

1.  The high transaction values in certain markets

• High transaction values indicate the dynamic volume and value of the shares traded.
• Bursa Malaysia in 2011 (Jan to Nov) had a market turnover of about USD 126b (RM410,507.51 million).
• Here are 4 markets in the world's top 10 Stock Exchanges and their rankings in term of transaction values in 2011 are:

                                     a)  NYSE  USD 20,161b

                                     b)  Nasdaq USD 13,552b

                                     c)  HKEX USD 1,447b

                                     d)  ASX USD 1,197b

Source: http://www.world-stock-exchanges.net

2.  Some countries are homes to many multinational companies and major financial institutions.  

3.  Some countries maybe a proxy for another country's economic growth

• For example, Hong Kong HKEX being the proxy for China.

4.  Some countries have stronger currencies than our home country and the disparity in currency strength between the two currencies will most likely continue to widen over time.

• For example, some invest in SGX listed shares because of the strength of the Singapore Dollar (SGD).  
• In 1993, the RM was trading at RM 1.55 against the SGD.  In Sept 2013, it was trading at RM 2.58.

5. Greater opportunity to discover undervalued companies due to more choices.

• Combined, the NYSE, NASDAQ, ASX, HKEX and SGX have almost 10,000 companies while Bursa Malaysia has about 1000.
• With more choices, there is greater opportunity to discover an undervalued company that suits your investment needs.

6.  Some stock markets lag behind others.

• You can invest in one market first, and then shift your funds to another stock market which is lagging behind the former and make your second round of profit.  
• You can also invest in one industry first, then move to another industry within the same stock market.

7.  Owning a world-class brand.   

• Most of these shares are mainly listed in the foreign stock exchanges.
• They offer you the chance to own world-class companies and participate in their global growth.

8.  Owning a piece of the cutting edge technology.

• Listed in the NASDAQ are many start-up internet and biotechnology companies at the forefront of new technology or new drug discoveries.

9.  Shares in a foreign stock exchange may have dividend yields better than your current FD rate.

• However, the dividend yield should never be the sole factor affecting your investment decision.

10.  Hedge against global economic uncertainties.

• The USD will always be the 'safe haven' currency in times of economic turmoil.  Owning shares in USD does help to pare down losses during such times.
• Similarly, the HKD being traded against the USD within a narrow band, can be an alternative 'safe haven' currency.

Summary:

Be brave and open your mind.

You can always find an undervalued company in any stock market if you are meticulous in your stock selection.

A value investor seeks a company that is undervalued with great potential to grow its business, locally and globally.

Always look at the risks before looking at the rewards in your long term investing

In investing, always look at the risks before looking at the rewards.

Understand the risks you are taking and then decide for the potential rewards you can hope to get, whether this reward/risk ratio makes business or investing sense.

Also, determine what is the likelihood of the reward appearing, its quantum and when.

Remember, "a bird in the hand today is worth two or more in the bush tomorrow."



How to look at risks in investing?

Back to the teaching of Warren Buffett's 4 tenets of his investing method.

1.  Understand the business.
2.  A business having durable competitive advantage.
3.  Managed by people with integrity.
4.  Available at fair price (margin of safety).

His tenets are very simple, and yet so few are following these.


If the business is too hard to understand, avoid investing into it.  You need to be able to understand the business.  What are the products or services it is selling?  Who are its customers?  How are its revenues generated?  Its profit margins?  Who are its competitors?  Only invest into a company you understand.  This is having business sense.

A company with durable competitive advantage enjoys certain unique advantages that allow it to compete in its competitive business environment.  The company may be selling a unique product or service, protected by patents or it enjoys a brand that people like for a long time.  Perhaps, the business is the lowest cost producer, or the cost of switching by its customers to another competitor is high.  Some businesses enjoy networking effect.  Avoid businesses with no durable competitive advantage.

People with integrity can be difficult to judge with certainty.  In general, a reputation build up slowly over 30 years can disappear over 5 minutes.  Anyone whom you have even a slight suspicion of his integrity, just avoid investing into that company.

When all the above 1, 2, and 3 tenets are met, you can then determine the price to buy and how much to buy?  You need to be patient.  The market is volatile and stock prices are volatile.  These market volatility and price volatility reflect the fluctuating sentiments of the investors and players in the market.  Don't time the market, always price the market.  You buy when the price is right.  Avoid when the price is obviously too high.  Invest when a great company is available at a fair price or even a slightly above fair price.  Be greedy and invest a lot, when a great company is available rarely at a huge bargain price.



Managing risks

The above few paragraphs explore how you will manage risks as applied to each tenets of Buffett in your stock investing.  In a very general sense, risks can be managed in 4 ways:

1.  Avoid
2.  Retain or embrace
3.  Reduce
4.  Transfer.

Whenever you are prospecting a new stock, you will need to determine that this stock meets the 4 business tenets of Buffett.  At each stage, you should avoid this stock altogether if you determined its risk is too high.

• Note that not able to understand the company's business is high risk too and you will need to avoid investing into it.  
• Not able to determine what confers to it its long term durable competitive advantage, is also another investing risk that should be avoided or perhaps embraced sometimes, but you need to have a very good reason.  
• Of course, avoid counters managed by people whose integrity you doubt.  
• Not able to value the business either because it is too complex to understand or its accounting is too difficult to fathom, you are better to avoid investing into this company.

Eventually, you are left with those stocks which you understand very well.

• QUALITY OF THE COMPANY (QUALITATIVE ASSESSMENT):  You understand their businesses, their durable competitive advantages and their management.  
• VALUATION OF THE COMPANY (QUANTITATIVE ASSESSMENT):  And, you too understand how to value them and this gives you an advantage to buy and own them at a reasonable, fair or good prices.  

Every stock you own has gone through this thorough risk analysis and also the reward potential analysis.  For the stocks you have in your long term portfolio, you have retain and embrace the risks associated with investing in them and also have a very clear idea of their reward potentials.  You know their risk/reward ratios over the long term and the probability of their investing returning  predictable positive returns (driven by the durable competitive advantage possessed by these companies).

When the stocks in your portfolio are priced too high during certain market situations, you may, if you wish to, also reduce the risks or transfer the risks using various strategies.


Through managing your risks, you avoid losses or minimise your losses and the modest positive returns from the other stocks in your portfolio will translate into reasonable returns.

Investing is fun and profitable in the long run.

Good luck to all.

Determining the Payback Period. When are borrowings excessive?

In the balance sheet, the total liabilities exceed the total equity overwhelmingly.  What does this mean?

There are 3 possible types of scenarios when this happens:

1.  The company has excessive long term borrowings.
2.  The company has excellent business that uses very little equity and its business is funded mainly by its creditors.
3.  The low equity is due to accumulated deficit, the result from continuing losses in operations.




Let us look at scenario No. 1:  The company has excessive long term borrowings.

Companies normally borrow money from financial institutions to fund their expansion.

• This is even more prevalent in an environment where the interest rates are low.
• Some companies will also refinance their debt by taking advantage of the low interest rate so that they can enjoy some savings in the interest payable.
• Yet others will refinance their debt with a higher interest rate to extend the maturity date of the debt.

All the above make business sense, when the return on capital is higher than the cost of capital.  

But, if the business continues to suffer despite the injection of additional funds through borrowings, then the company could be in dire straits.

When are borrowings excessive?  How do you determine this?

The key is in the payback period.

Look at the amount of long-term borrowings (normally found under the heading of Non-Current Liabilities) and then the Net Profit (found in the Income Statement).

Assuming that the company can utilise ALL its Net Profits in its present financial year to pay off its long term borrowings AND the SAME Net Profit recurs every year, you have this formula:

Payback Period in years = Long Term Borrowings /Net Profit.

The resulting answer is the payback period for the long-term borrowings.

A prudent KPI for the payback period is not more than 5 years.

Yes, you can argue that the company can achieve tremendous profit growth in the next few years.  If that happens, the number of years required to pay off its debts can be reduced dramatically.  

By the same argument, what if the economy suffers and a loss is incurred?

F&N’s earnings to be driven by export growth, cost efficiency

F&N’s earnings to be driven by export growth, cost efficiency
August 20, 2018, Monday



KUCHING: Analysts project the future earnings of Fraser & Neave Holdings Bhd (F&N) to be driven by the continued strong export growth and improved cost efficiency as a result of cost optimisation efforts and better economies of scale.

Following a visit to F&N Dairies Manufacturing plant in Selangor Halal Hub, the research arm of MIDF Amanah Investment Bank Bhd (MIDF Research) highlighted that F&N targets total export revenue to reach RM800 million by 2020.

According to MIDF Research, as of the first nine months of financial year 2018 (9MFY18), export contributes 16 per cent of total revenue whilst for F&N’s Malaysia and Thailand segments, these grew 20 per cent year on year (y-o-y) and 10 per cent y-o-y respectively.

“We estimated export revenue to contribute between the range of RM642.9 million to RM710.6 million for FY18,” the research arm said.

“Assuming the same rate of growth, F&N poised to achieve its total export revenue target before 2020.”

MIDF Research noted that F&N’s two main segments, the Malaysian and Thailand segments, which contribute 57.1 per cent and 42.9 per cent respectively to total revenue (including export) are currently facing intense completion.

The research arm further noted that F&N’s domestic market share for sweetened condensed milk has slipped from 59 per cent in FY14 to 52.4 per cent as of the first half of FY18 (1HFY18).

“Despite the declining market share, revenue dropped marginally by 0.4 per cent y-o-y and 0.3 per cent y-o-y in the 9MFY18.

“Nevertheless, we expect a stronger revenue growth due to pre-sales and services tax (SST) purchase and new innovative products set to be launched in Malaysia and Thailand market next year.”



http://www.theborneopost.com/2018/08/20/fns-earnings-to-be-driven-by-export-growth-cost-efficiency/

Internal Rate of Return

Internal Rate of Return (IRR)

• is the discount rate that generates a zero net present value for a series of future cash flows
• it equates the present value of the future net cash flows from an investment project with the initial cash outflow of the project
• it is calculated by employing trial and error method
• a higher cost of capital lowers the value of NPV and vice versa
• it takes into account the concept of time value of money
• project with IRR more than the required rate of return is considered as acceptable and profitable.

IRR > Required rate of return, accept the project

IRR < Required rate of return, reject the project

IRR = DISCOUNT RATE for positive NPV  + [DISCOUNT RATE DIFFERENCE x (Positive NPV / (Positive NPV - Negative NPV)]



Example:

DISCOUNT RATE @ 18%
Initial Investment 160,000
Cash flows of constant 55,000 for year 1 to year 5.
Given that the discount rate or required rate of return is 18%.
Total Present Value 171,994.41 #
Total Investment  (160,000)

Net Present Value 11,994.41

DISCOUNT RATE @ 24%
IRR is the discount rate that generates zero NPV.
Increasing the discount rate will lower the NPV.
To generate negative NPV, we have to increase the discount rate.
Let this discount rate or cost of capital to be 24%.

Using discount rate of 24%, the values are as follow:

Initial Investment 160,000
Cash flows of constant 55,000 for year 1 to year 5.
Given that the discount rate or required rate of return is 24%
Total Present Value 150,996.15 #
Total Investment  (160,000)

Net Present Value -9,003.85



CALCULATION

IRR

= DISCOUNT RATE for positive NPV  + [DISCOUNT RATE DIFFERENCE x (Positive NPV / (Positive NPV - Negative NPV)]
= [18% + (24% - 18%) {11,994/(11,994-(-9,003.85)}] x 100%
= 18% + 3.4%
= 21.4%

As the cost of capital for this project is 21.4% and the firm will only receive 18% for each dollar invested, the company should not accept this project.




# Note:  The total present value can be calculated thus
CF1/[(1+r)^1]  + CF2/[(1+r)^2] + CF3/[(1+r)^3] + .... CF3/[(1+r)^n]

Net Present Value and Profitability Index

Net Present Value (NPV)

• an indicator of how much value an investment could contribute to the firm
• takes into account the concept of time value of money
• the Present Value Interest Factor (PVIF) Table can be used to calculate present value
• the criteria below should be considered before accepting for rejecting a project or an investment:

NPV > 0  

The investment would add value to the firm.

The project should be accepted.

NPV < 0

The investment would subtract value from the firm, that means the project reduces shareholder wealth.

The project should be rejected.

NPV = 0

The investment would neither gain nor lose value for the firm.

We would be indifferent in the decision whether to accept or reject the project.  This project adds no monetary value.  Decision should be made based on OTHER CRITERIA.

Total Present Value = sum of the discounted value of all future cash flows.

NPV =  Total Present Value - Total Investment.

Probability Index 

The project is not profitable when its profitability index (PI) is less than 1.00

PI = Total Present Value / Total Investment

Payback Period

Payback Period (PBP) is the period of time required for the cumulative expected cash flows to equalize the initial investment or cash outflow.


1.  Equivalent or constant cash inflow.

PBP = Initial Investment / Cash Inflow


2.  Unequal Cash Inflow

PBP = N + [ (Initial Investment - Accumulated Cash Inflow for Year N)/Cash Flow for Year M ]

N = the number of years for the accumulated cash flows that had not exceeded the capital or investment.

M = the year where the total accumulated cash flow is equal to or more than the capital or investment.

Accounting Rate of Return or Average Rate of Return (ARR)

Accounting Rate of Return or Average Rate of Return (ARR)

• a financial ratio used in capital budgeting
• does not take into account the concept of time value of money
• calculates the return generated from net income of the proposed capital investment.

1.  Investment without scrap value

Depreciation = Total Investment / Useful Life

ARR = [(Average Cash Flow - Depreciation) / Initial Investment] x 100%

2.  Investment with a scrap value

Depreciation = (Total Investment - Scrap Value) / Useful Life

ARR = [(Average Cash Flow - Depreciation) / Initial Investment] x 100%

Project Evaluation

The decisions of where to invest the company's resources have a major impact on the future competitiveness of the company.

Trying to get involved in the right projects is worth an effort, both to

• avoid wasting the company's time and resources in meaningless activities, and 
• to improve the chances of success.

Project evaluation is a process used to determine whether a firm's investments are worth pursuing.

Producing new products, buying a new machine and investing in a new plant are examples of firm's investment.

Investing in those activities involves a major capital expenditure, and management needs to use capital budgeting techniques to determine which projects will yield the most return over an applicable period of time.



Capital Budgeting Factors

Factors involved in capital budgeting are:

1.  Initial Cost
The initial investment or cash capital required to start a project.

2.  Cash In Flow
The estimated cash amount that flows into a business due to operations of the project or business.

3.  Investment Period
The duration of the project and when it is estimated to be completed.

4.  Discount Factor
The value of interest that will be received or charged during the period of the project's execution and it will affect the present value of cash in flows for different years.

5.  Time Value of Money
The idea that a ringgit now is worth more than a ringgit in the future, even after adjusting for inflation, because a ringgit now can earn interest or other appreciation until the time the ringgit  in the future would be received.This theory has its base in the calculation for present value.



Factors influencing investment decision

A firm must make an investment decision to improve or increase the incomes of the company in order to compete in the market.

Investment environments include:

1.  Product development/enhancement
2.  Replacing equipment/machinery
3.  Exploration of new fields or business.



Project Evaluation Methods

Common methods used in evaluating projects, investments or alternatives are:

1.  Payback Period (PBP)
2.  Accounting Rate of Return/Average Rate of Return (ARR)
3.  Net Present Value (NPV)
4.  Profitability Index (PI)
5.  Internal Rate of Return (IRR)


In choosing an investment or project, select the project which generates HIGHER ARR, NPV, PI and IRR; and SHORTER PBP.



APPENDIX:

Turning investing principles into good investing habits

So just what is a habit?

A habit is:

• a recurrent, often unconscious pattern of behaviour that is acquired through frequent repetition, and,
• an established disposition of mind or character.

As an investor,you need to not only learn to do it well but also to do it with some consistency, and do it without struggling to remember what you did last time.  

As a low volatility investor, you are not likely to be as active trading in the markets as some other investors, and you may not watch as closely.

Any investor - active, inactive, aggressive or low volatility - has a duty to keep up with his or her investments.

For the low volatility investor and others, it is important to develop certain habits, routines, or thought processes for:

• choosing investments,
• watching and managing investments, and
• selling or replacing investments.

With the right habits, you will increase the chances of success.

Turning principles into habits

Investors have obvious goals:  to produce wealth and to preserve capital.

Anything an investor does should address both goals, preferably simultaneously.

As an investor, you are motivated to succeed and, over time, you build a set of strategies and tactics to help you achieve those goals.

"Motivation is what gets you started.  Habit is what keeps you going."

It is easy to get motivated.  It is harder to learn the ropes - the skills and techniques - required to become a good investor.  

But what may be hardest of all, once you gain experience and enjoy some investing success, is to turn those skills into habits.

Habits that become built in, second nature, repeatable and predictable, and not only lead to good results but help you avoid bad ones.

Without consistent habits, low volatility investors will make mistakes and find themselves off in the weeds. 

Good investing habits are like a good golf swing: apply those habits to every investment choice and you won't succeed every time, but your chances for success will brighten considerably.

The thought processes in building a portfolio that works.

You want an investment portfolio that meets your financial objectives. 

Investors have obvious goals:  to produce wealth and to preserve capital.

You also want that portfolio to accomplish those goals quietly, with a minimum of upsets, a minimum of nerves, a minimum of complex mathematics, and most likely, a reasonable amount of effort on your part, because you are busy doing other things in life too.

The tiered portfolio is divided into three primary tiers:

1.  The Foundation portfolio
2.  The Rotational portfolio
3.  The Opportunistic portfolio.



The Foundation portfolio (80%)

This is set up to meet or slightly beat expected market returns, often with stable and somewhat defensive investments.

Dividend-paying stocks with rising dividends and growing prospects while at the same time exhibiting low downside risk and volatility are a pretty good fit.

These investments can be stocks or funds, and can be augmented by fixed-income securities, real estate, or other investments that meet this general profile.



Rotational (10%) and Opportunistic (10%) portfolio

The purpose of these is to achieve better-than-market returns, perhaps with more volatility, but these portfolios are small enough to contain risk and to avoid consuming too much of your investing time and bandwidth.



Putting together your portfolio

How your portfolio is put together is entirely up to you, not only because the portfolio needs to suit your tastes, intuitions and the facts at the time, but also because many of the investments (and the mix of investments) may not even be available, or priced right, at the time.

Building a tiered portfolio

This tiered portfolio has three segments:

1.  Foundation investments
2.  Rotational investments
3.  Opportunistic investments.


Foundation investments (80%)

These are like dividend-paying stocks that produce market (or better) returns with relatively less risk.


Rotational investments (10%)

These are mostly ETFs and inverse investments.  They add some defense and sector diversification to your portfolio.


Opportunistic investments (10%)

These employ a little more risk to boost returns.



Aim

The net result should be a portfolio that generates above-market returns with below-market risk.