Investment question:
I have a short period of time (1 year or less) during which I will have money to invest. What are my investment options?
Answer:
If you only have a short period of time in which to invest your money (i.e. less than one year), there are several investment options you should consider outside of the typical checking and savings accounts, which pay very little or no interest. These alternative short-term investments are known as money market securities.
For example, you might want to consider a Treasury bill (T-bill), a U.S. government debt security with a maturity of less than one year. T-bills ares one of the most marketable securities around the world, and their popularity is mainly due to their simplicity. The maturity for a T-bill is either three, six or 12 months, and new ones are typically issued on a weekly basis. The constant issue of new T-bills and the competitive bidding process mean that T-bills can be easily cashed in at any time.
Furthermore, banks and brokerages traditionally charge a very low commission on trading T-bills. You can purchase Treasury bills in the U.S. through any of the 12 Federal Reserve banks or 25 branch offices.
Commercial paper is another investment you might want to consider. It is an unsecured, short-term loan issued by a corporation, typically for financing accounts receivable and inventories. It is usually issued at a discount to reflect current market interest rates. Maturities usually range no longer than nine months and, because of their slightly higher risk, they usually offer a higher rate of return than a T-bill.
Certificates of deposits (CDs) are time deposits at banks. These time deposits may not be withdrawn on demand like with a checking account and are generally issued by commercial banks, although they can also be bought through brokerages. They carry a specific maturity date (three months to five years), a specific interest rate that is slightly higher than T-Bills and can be issued in any denomination. However, the amount of interest you can earn depends on the amount and length of the investment, the current interest rate environment and the specific bank. While nearly every bank offers CDs, rates can vary widely, so it's important to shop around.
Banker's acceptance (BA) are short-term credit investments created by non-financial companies and guaranteed by a bank. They are traded at a discount to face value in the secondary market. For corporations, a BA acts as a negotiable time draft for financing imports, exports or other transactions in goods. This is especially useful when the creditworthiness of a foreign trade partner is unknown. The advantage of BAs is that they do not need to be held to maturity and can be sold off in the secondary markets where they are constantly traded. (For further reading on these subjects, check out Money Market Tutorial.)
http://www.investopedia.com/ask/answers/109.asp
Sunday 24 May 2009
Spotting A Market Bottom
Spotting A Market Bottom
by Chris Seabury (Contact Author Biography)
Stock market bottoms can be challenging to spot. And many times, investors think that they have found this point, only for the major averages to head even lower. The big question many have is: just how do you know when a market bottom has taken place? This requires the tools and indicators that have identified major market bottoms in the past, and an understanding of what they are, how they work and that each indicator must correlate a similar reading.
Stock Market Bottoms
Since the end of World War II, stock prices have generally bottomed six months into a recession. Once it becomes official that the country is in a recession, it is generally a rearview mirror indicator meaning that there have already been two or more quarters of negative GDP growth. On the other hand, when we are emerging out of a recession, we will not know until many months later. This is one of the reasons that it can be so confusing for investors to spot major bottoms taking place. (Learn more about taking advantage of an unstable market, read Profiting From Panic Selling.)
Things to Watch for
Just imagine how wonderful it would have been to buy stocks at bargain prices before major upward moves, such as January, 1975, August, 1982, or even March, 2003. All of those periods share some common patterns that should be observed in order to determine if the market is bottoming.
The Double Bottom Pattern
The double bottom pattern is considered to be one of the most reliable of all the technical patterns. In this pattern, the major market averages will hit a low on heavy volume, then bounce back up and then retest the previous low on light volume.
The key is to watch and see how the averages trade when approaching that second low point. If the averages have a sizable break below the previous low, it is advisable to watch and see what happens. However, if the averages test that low point and then have some type of reversal, this could be a sign that a double bottom pattern is forming.
A second area to watch is volume. This is the total amount of buying and selling that is occurring. Generally, heavy volume on up or down moves shows strong conviction from either the buyers or sellers. When you see the volume lighten up on the downward moves and increase substantially on the upward moves, there is a large amount of buying taking place. After a major market bottom has occurred, you will see this heavy volume accompanied by a strong upward move in the major market averages.
Economic Numbers
Generally, the stock market will bottom and start moving higher before you see it represented in economic numbers or headlines. In many cases, the more negative economic news headlines you see, the better. When the press represents the psychology of the moment, and we start to see consistent headlines showing how bad the economy is, it suggests that the sentiment of the crowd has become so negative that the vast majority have already moved out of their positions.
A second number to pay attention to is the consumer confidence index. During and after market bottoms have occurred, you will see consumer spending and consumer confidence increase. When this happens, consumers are spending more money and corporate earnings are starting to rise.
A third economic number to watch is purchasing managers' index, which measures the economic health of the manufacturing sector. When these two numbers have bottomed, then started to consistently rise for more than three months in a row, the manufacturing and service sectors are on the road to expansion once again. (For further reading, see Economic Indicators For The Do-It-Yourself Investor.)
High Yield Bonds
Another indicator to watch is the high yield bond spread. High yield bonds are the bonds issued by companies who have a high possibility of default. To be able to attract investors to loan them money, they have to offer a higher interest rate. When lending standards are becoming easier, you will see the amount of interest or the spreads on these bonds drop. When this happens, it is a sign that investors and banks are becoming more willing to take risk. This would signal that economic conditions are starting to improve. (For more, see Top 6 Uses For Bonds.)
Copper Prices
Copper prices are a good indicator as to how strong or weak the global economy is. This metal is used in economic expansion in products such as pipes, radiators, air conditioners, electronics and computers, to name a few. Watching to see if the price of copper has bottomed or has room to fall further will help determine the overall worldwide demand for the metal. When demand has increased, you will start to see prices rise; when demand is falling, prices will follow.
Look for copper prices to finish declining and start to move in a similar upward pattern with the financial markets. This would be a real-time signal that manufacturers and home builders are seeing their businesses pick up. To keep up with the increases in demand, they have to use more copper, causing the price to rise. (For more, see Guard Your Portfolio With Defensive Stocks.)
The Bottom Line
Market bottoms are accompanied by a variety of factors, such as:
- high amounts of fear,
- a decrease in the volume on downward moves,
- a large increase in the volume on upward moves,
- double bottom patterns,
- improving economic numbers,
- the spread on high yield bonds narrowing and
- an increase in copper prices.
However, it is important to remember that the financial markets look forward at least six months prior to any real improvement in the economic numbers. By using all of the indicators together, you have the key to spotting a market bottom. (For more, see Market Bottom: Are We There Yet?)
by Chris Seabury, (Contact Author Biography)
http://www.investopedia.com/articles/economics/09/spotting-a-market-bottom.asp
Saturday 23 May 2009
Financial genius in a rising market
It is good to have friends who are smart intelligent investors. These people are fun to meet. They share precious personal knowledge and experience. On many occasions, you can coattail on their hardwork profitably. At times, they prevented you from committing an obvious investing mistake.
How to spot these smart intelligent investors? Yes, they maybe of any ages. The younger investor maybe smart, but it does take time to build up an experience. Seek out those in their 50s or older with a good track record. There are many who invest in the market; a record they do have but not that of the truly committed smart intelligent investor.
The truly smart intelligent investors are those with a record of good total return accumulated over MANY years of investing. They are passionate, hardworking and perhaps well-networked. They have a philosophy and strategy. They may even sound boring as they are so predictable. They are not many but not rare. Make friends with them. Rub shoulders with them. There is little to lose and a lot more to gain.
Of course, beware the financial genius in a rising market. As the saying goes, when the tide recedes, many of them are found swimming naked.
How to spot these smart intelligent investors? Yes, they maybe of any ages. The younger investor maybe smart, but it does take time to build up an experience. Seek out those in their 50s or older with a good track record. There are many who invest in the market; a record they do have but not that of the truly committed smart intelligent investor.
The truly smart intelligent investors are those with a record of good total return accumulated over MANY years of investing. They are passionate, hardworking and perhaps well-networked. They have a philosophy and strategy. They may even sound boring as they are so predictable. They are not many but not rare. Make friends with them. Rub shoulders with them. There is little to lose and a lot more to gain.
Of course, beware the financial genius in a rising market. As the saying goes, when the tide recedes, many of them are found swimming naked.
Bear Trap(s)
Bear Trap(s)
There is an interesting post on this topic here: http://ssinvesting.blogspot.com/2008/05/how-to-define-bear-trap-if-public-bank.html
One of the challenges in investing for the long term is to have a personal strategy in handling volatility of stock prices.
You can choose to avoid such volatilities by investing in stalwarts like Nestle. This stock has long term revenue and profit growth. Its share price is trending upwards in keeping with its business performance. The consistency and predictably attracts certain types of investors. Yet, there are others who feel investing in this stock is not for them. Too slow and the returns are at best moderate!
Then, there are stocks with high volatilities or Beta. Their prices swing greatly, often based on rumours. Long term investors will be better off ignoring these fluctuations and monitor the quarterly reported results instead.
A good safety strategy in investing is to assume the attitude that all shares in the market are overpriced. This will prevent you from making big mistakes and forces you to carry out the appropriate valuation to counter this belief before putting good money to work.
What to do when the price of a good stock suddenly dropped drastically?
Instead of looking at price, follow PE. PE fluctuations up or down 20% are quite normal. You can usually ignore these, assuming you know the business of your investments well.
However, do not ignore the big fall in the PE of more than 20%. Check the news. What might be causing this sudden fall in price? Is there any fundamental deterioration in the business of the company? Will this be a temporary or permanent situation? You may have to decide to hold or sell quickly depending on your assessment.
Should you be buying more? If yes, when?
Let's review some recent events in the market.
Transmile: When news first broke a few years ago, that the auditor was unwilling to approve the accounts without qualification, the shares got sold down. This was a good learning experience. Some thought this was a buying opportunity. With the benefit of hindsight, cutting loss by selling at $9 to $11 was definitely better than the below $1 price the stock is trading at present. Wonder why related Kuok's company bought the shares during the particular period? The objectives of the majority or significant shareholders may not be in congruent with those of the minority shareholders. It was more to inspire some confidence in investors in Transmile.
PBB: Public Bank too was sold down since last year. Another drop occurred in Feb and March 09. Generally, the banking industry is going into a tough period. The price of the stock will reflect this. Is this a sell or a buy? Is this a temporary or a permanent setback to PBB core business?
Selling or buying into Transmile and PBB when their stock prices sunk are 2 entirely different operations. Which is a bear trap? Which is an opportunity or investment?
Usually the price will remain low for sometime after a bad news was known. You have time to pick these stocks. The important thing is to do the homework, check out and follow the news as this unfold. What is its impact on the long term durability of the business of the company? If you have done the homework, the analysis, the assessment of the impact of the news, the risks, and you understand the business and issues, be courageous. Make your own decision based on your own analysis. Don't be swayed by the crowd, or follow the crowd or look for affirmation by others.
The link: http://ssinvesting.blogspot.com/2008/05/how-to-define-bear-trap-if-public-bank.html rightly pointed out that the bear trap need only be applied to lousy companies with no prospect of recovery in their business. Those investing in good high quality companies need not fear the "bear traps" situations. Thanks for sharing this point. Instead the best opportunity to buy good quality companies is when they are being sold at low prices on some temporary bad news, assuming that these companies are within your circle of competence.
There is an interesting post on this topic here: http://ssinvesting.blogspot.com/2008/05/how-to-define-bear-trap-if-public-bank.html
One of the challenges in investing for the long term is to have a personal strategy in handling volatility of stock prices.
You can choose to avoid such volatilities by investing in stalwarts like Nestle. This stock has long term revenue and profit growth. Its share price is trending upwards in keeping with its business performance. The consistency and predictably attracts certain types of investors. Yet, there are others who feel investing in this stock is not for them. Too slow and the returns are at best moderate!
Then, there are stocks with high volatilities or Beta. Their prices swing greatly, often based on rumours. Long term investors will be better off ignoring these fluctuations and monitor the quarterly reported results instead.
A good safety strategy in investing is to assume the attitude that all shares in the market are overpriced. This will prevent you from making big mistakes and forces you to carry out the appropriate valuation to counter this belief before putting good money to work.
What to do when the price of a good stock suddenly dropped drastically?
Instead of looking at price, follow PE. PE fluctuations up or down 20% are quite normal. You can usually ignore these, assuming you know the business of your investments well.
However, do not ignore the big fall in the PE of more than 20%. Check the news. What might be causing this sudden fall in price? Is there any fundamental deterioration in the business of the company? Will this be a temporary or permanent situation? You may have to decide to hold or sell quickly depending on your assessment.
Should you be buying more? If yes, when?
Let's review some recent events in the market.
Transmile: When news first broke a few years ago, that the auditor was unwilling to approve the accounts without qualification, the shares got sold down. This was a good learning experience. Some thought this was a buying opportunity. With the benefit of hindsight, cutting loss by selling at $9 to $11 was definitely better than the below $1 price the stock is trading at present. Wonder why related Kuok's company bought the shares during the particular period? The objectives of the majority or significant shareholders may not be in congruent with those of the minority shareholders. It was more to inspire some confidence in investors in Transmile.
PBB: Public Bank too was sold down since last year. Another drop occurred in Feb and March 09. Generally, the banking industry is going into a tough period. The price of the stock will reflect this. Is this a sell or a buy? Is this a temporary or a permanent setback to PBB core business?
Selling or buying into Transmile and PBB when their stock prices sunk are 2 entirely different operations. Which is a bear trap? Which is an opportunity or investment?
Usually the price will remain low for sometime after a bad news was known. You have time to pick these stocks. The important thing is to do the homework, check out and follow the news as this unfold. What is its impact on the long term durability of the business of the company? If you have done the homework, the analysis, the assessment of the impact of the news, the risks, and you understand the business and issues, be courageous. Make your own decision based on your own analysis. Don't be swayed by the crowd, or follow the crowd or look for affirmation by others.
The link: http://ssinvesting.blogspot.com/2008/05/how-to-define-bear-trap-if-public-bank.html rightly pointed out that the bear trap need only be applied to lousy companies with no prospect of recovery in their business. Those investing in good high quality companies need not fear the "bear traps" situations. Thanks for sharing this point. Instead the best opportunity to buy good quality companies is when they are being sold at low prices on some temporary bad news, assuming that these companies are within your circle of competence.
Friday 22 May 2009
Keep Investing Simple and Safe (KISS)
Keep Investing Simple and Safe
When is the best time to buy share?
Anytime really. You should track a list of high quality stocks. Buy when the stock is selling at a bargain price, that is, when the risk of losing your capital is low or negligible and the return substantially higher. The good investors aim for high returns with minimal risk taking.
Is there a time when you should not be buying any stocks?
1. Generally, when the market is trading at a high valuation. There is always another time to buy the stock. Be patient.
2. However, if you are not knowledgeable in stock selection (QVM) and money management, you should not be investing directly in the stock market. You are better buying a mutual fund when the market is trading at low valuation or to park your fund with a personal fund manager. The stock market is a dangerous place for the uninitiated.
3. Avoid investing money in the stock if the money you invested may be needed urgently anytime or in a short time. Investing in the market should be for the longer term. There is too much uncertainties in the returns over a short time frame.
Is now a good time to buy stocks?
Anytime is a good time to buy stock.
Rather than timing the market, one should buy or sell base on the price of the stock offered by the market. Even in the peak of the bull market, one can pick up some bargains. Of course, in the depth of a bear market, there are many good stocks selling at very low prices.
Is buy and hold, a safe strategy?
The recent severe downturn in the market brought this strategy into question once again. It is very safe for those who employs this strategy using certain criterias. It is safe for selected stocks. These stocks should be of the highest quality (QVM). These stocks should be bought at a bargain price with a margin of safety. The only time you may have to sell the stock urgently is when there is a fundamental deterioration in the business of the company. Other than this, you have the leisure of selling.
The market is cyclical. The bull-bear-bull-bear cycles ensure that the bull will always follows a bear and vice-versa. Here are a selection of Malaysian stocks that have stood the test of time over at least 3 severe bear markets: Nestle, DLady, Petdag, Guinness, Petgas, PBB, PPB, Resorts. There are also others too. At certain short period of time, each of these stocks may underperform but if assessed over a longer period of time, the returns have ALL been positive. By minimising the downside and aiming only for modest returns, investing can be surprisingly rewarding for a large number of investors and with little effort.
How to maximise returns?
1. First, ensure that there is safety of your capital. Remember not to lose your capital. By ensuring that you do not lose money and aiming for moderate returns, you can maximise total returns too with low risk. Don't be greedy for high returns by taking unnecessarily high risks.
2. Stick to the few high quality stocks you are familiar with. This is the circle of competence mentioned by Buffett. Stay within your circle of competence and never, never, never, never, get out of this circle. :-) If your circle of competence is only 6 stocks, stick to these 6 stocks.
3. Only buy high quality stocks at bargain price. At a certain price, the stock is a bargain and at another price, it is trading at a fair price. Never, never, never buy these high quality stocks when it is trading at high price. By buying these good quality stocks at a bargain price, one is buying with a margin of safety to minimise loss to your capital in the event you got it wrong. At the same time, if the event turned out to be as you expected, your return will be greater.
4. Also do not over-diversify. According to Buffett, adding the 7th stock into your portfolio reduces the overall return of your portfolio. Bet big if you are very certain of your selection.
5. Allow the wonder of compounding to grow your return over a long period of time.
Investing can be very safe. Keep it simple and safe. (K.I.S.S.)
When is the best time to buy share?
Anytime really. You should track a list of high quality stocks. Buy when the stock is selling at a bargain price, that is, when the risk of losing your capital is low or negligible and the return substantially higher. The good investors aim for high returns with minimal risk taking.
Is there a time when you should not be buying any stocks?
1. Generally, when the market is trading at a high valuation. There is always another time to buy the stock. Be patient.
2. However, if you are not knowledgeable in stock selection (QVM) and money management, you should not be investing directly in the stock market. You are better buying a mutual fund when the market is trading at low valuation or to park your fund with a personal fund manager. The stock market is a dangerous place for the uninitiated.
3. Avoid investing money in the stock if the money you invested may be needed urgently anytime or in a short time. Investing in the market should be for the longer term. There is too much uncertainties in the returns over a short time frame.
Is now a good time to buy stocks?
Anytime is a good time to buy stock.
Rather than timing the market, one should buy or sell base on the price of the stock offered by the market. Even in the peak of the bull market, one can pick up some bargains. Of course, in the depth of a bear market, there are many good stocks selling at very low prices.
Is buy and hold, a safe strategy?
The recent severe downturn in the market brought this strategy into question once again. It is very safe for those who employs this strategy using certain criterias. It is safe for selected stocks. These stocks should be of the highest quality (QVM). These stocks should be bought at a bargain price with a margin of safety. The only time you may have to sell the stock urgently is when there is a fundamental deterioration in the business of the company. Other than this, you have the leisure of selling.
The market is cyclical. The bull-bear-bull-bear cycles ensure that the bull will always follows a bear and vice-versa. Here are a selection of Malaysian stocks that have stood the test of time over at least 3 severe bear markets: Nestle, DLady, Petdag, Guinness, Petgas, PBB, PPB, Resorts. There are also others too. At certain short period of time, each of these stocks may underperform but if assessed over a longer period of time, the returns have ALL been positive. By minimising the downside and aiming only for modest returns, investing can be surprisingly rewarding for a large number of investors and with little effort.
How to maximise returns?
1. First, ensure that there is safety of your capital. Remember not to lose your capital. By ensuring that you do not lose money and aiming for moderate returns, you can maximise total returns too with low risk. Don't be greedy for high returns by taking unnecessarily high risks.
2. Stick to the few high quality stocks you are familiar with. This is the circle of competence mentioned by Buffett. Stay within your circle of competence and never, never, never, never, get out of this circle. :-) If your circle of competence is only 6 stocks, stick to these 6 stocks.
3. Only buy high quality stocks at bargain price. At a certain price, the stock is a bargain and at another price, it is trading at a fair price. Never, never, never buy these high quality stocks when it is trading at high price. By buying these good quality stocks at a bargain price, one is buying with a margin of safety to minimise loss to your capital in the event you got it wrong. At the same time, if the event turned out to be as you expected, your return will be greater.
4. Also do not over-diversify. According to Buffett, adding the 7th stock into your portfolio reduces the overall return of your portfolio. Bet big if you are very certain of your selection.
5. Allow the wonder of compounding to grow your return over a long period of time.
Investing can be very safe. Keep it simple and safe. (K.I.S.S.)
Thursday 21 May 2009
Benjamin Graham 113 wise words
This post is just an occasional reminder for this blogger to revisit Benjamin Graham's 113 wise words.
COASTAL
Buy 1.60
Sell 1.61
PBBANK
Buy 8.55
Sell 8.60
PPB
Buy 11.10
Sell 11.30
(Buy below 9.00)
"The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement." - Benjamin Graham
COASTAL
Buy 1.60
Sell 1.61
PBBANK
Buy 8.55
Sell 8.60
PPB
Buy 11.10
Sell 11.30
(Buy below 9.00)
"The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement." - Benjamin Graham
Conventional Wisdom
Conventional Wisdom
The investor should be able to make up lists of bonds and preferred stocks meeting the rigorous requirements of stable income investment.
The investor should reject many stocks which sell at full prices but which do not pass his test of safety. These stocks are frequently bought nonetheless by investors who have confidence in the business and are attracted by their higher-than-standard dividend yields. There are logical objections to such stocks.
How to select the most attractive stock at their current prices?
How to recommend "those which are likely to perform best in the future"?
By intensive study of the various industries and their prospects, and by close familiarity with individual companies and their managements, an investor can undoubtedly reach conclusions of value. To a great extent these are the results of the application not of formal standards to a set of facts and figures, but rather of business judgment and foresight to an intimate knowledge of conditions in the industry and its companies.
One cannot be taught how to weigh the future. In fact, the emphasis should be placed in the opposite direction. The investor should not trust his projections of the future too far, and especially not to lose sight of the price of the security he is analysing. No matter how rosy the prospects, the price may still be too high.
Conversely, the shares of companies with unpromising outlooks may sell so low that they offer excellent opportunities to the shrewd buyer. Also, the wheel of time brings many changes and reversals. "Many shall be restored that now are fallen, and many shall Fall that now are in honor."
Advice for investor
The investor should select a group of good quality company stocks that are fairly priced suitable to the investor's financial and temperamental requirements.
1. The investor should keep away from buying inferior stocks during periods of enthusiasm and high prices.
2. Next, the investor should be encouraged to buy the selected stocks when the market level is below, rather than above, its indicated long-term normal figure.
3. Finally, the investor should always consciously avoid paying extremely high prices for good stocks.
The investor should be able to make up lists of bonds and preferred stocks meeting the rigorous requirements of stable income investment.
The investor should reject many stocks which sell at full prices but which do not pass his test of safety. These stocks are frequently bought nonetheless by investors who have confidence in the business and are attracted by their higher-than-standard dividend yields. There are logical objections to such stocks.
How to select the most attractive stock at their current prices?
How to recommend "those which are likely to perform best in the future"?
By intensive study of the various industries and their prospects, and by close familiarity with individual companies and their managements, an investor can undoubtedly reach conclusions of value. To a great extent these are the results of the application not of formal standards to a set of facts and figures, but rather of business judgment and foresight to an intimate knowledge of conditions in the industry and its companies.
One cannot be taught how to weigh the future. In fact, the emphasis should be placed in the opposite direction. The investor should not trust his projections of the future too far, and especially not to lose sight of the price of the security he is analysing. No matter how rosy the prospects, the price may still be too high.
Conversely, the shares of companies with unpromising outlooks may sell so low that they offer excellent opportunities to the shrewd buyer. Also, the wheel of time brings many changes and reversals. "Many shall be restored that now are fallen, and many shall Fall that now are in honor."
Advice for investor
The investor should select a group of good quality company stocks that are fairly priced suitable to the investor's financial and temperamental requirements.
1. The investor should keep away from buying inferior stocks during periods of enthusiasm and high prices.
2. Next, the investor should be encouraged to buy the selected stocks when the market level is below, rather than above, its indicated long-term normal figure.
3. Finally, the investor should always consciously avoid paying extremely high prices for good stocks.
Wednesday 20 May 2009
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.
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.
Price/Earnings Ratio
P/E
If a quoted company has a share price of $100 and EPS of $12 for the last published year, then it has a historical P/E of 8.3. If analysis are forecasting for the next year EPS of $14, then the forecast P/E is 7.1.
In the above example, the P/E of 8.3 tells us that investors at the current price are prepared to pay 8.3 years of historical EPS for the share, or 7.1 years of the forecast next year's EPS.
Theoretically, the faster a company is expected to grow, the higher the P/E ratio that investors would award it.
P/E is one measure of how cheap or expensive a share appears.
HOW IT WORKS IN PRACTICE
The P/E ratio is predominantly useful in comparisons with other shares rather than in isolation.
For example, if the average P/E in the market is 20, there will be many shares with P/Es well above and well below this, for a variety of reasons.
If a quoted company has a share price of $100 and EPS of $12 for the last published year, then it has a historical P/E of 8.3. If analysis are forecasting for the next year EPS of $14, then the forecast P/E is 7.1.
In the above example, the P/E of 8.3 tells us that investors at the current price are prepared to pay 8.3 years of historical EPS for the share, or 7.1 years of the forecast next year's EPS.
Theoretically, the faster a company is expected to grow, the higher the P/E ratio that investors would award it.
P/E is one measure of how cheap or expensive a share appears.
HOW IT WORKS IN PRACTICE
The P/E ratio is predominantly useful in comparisons with other shares rather than in isolation.
For example, if the average P/E in the market is 20, there will be many shares with P/Es well above and well below this, for a variety of reasons.
Similarly, in a particular sector, the P/Es will frequently vary quite widely from the sector average, even though the constitutent companies may all be engaged in broadly similar businesses.
The reason is that even two businesses doing the same thing will not always be doing it as profitably as each other. One maybe far more efficient, as demonstrated by a history of rising EPS compared with the flat EPS picture of the other over a series of years, and the market might recognize this by awarding the more profitable share a higher P/E.
TRICKS OF THE TRADE
1. Take care.
- The market frequently gets it wrong and many high P/E shares have in the past been the most awful long-term investments, losing investors huge amounts of money when the promise of future rapid growth proved to be a chimera.
- In contrast, many low P/E companies, often in what are perceived as dull industries, have proved over time to be outstanding investments.
How To Deal With Risk
How To Deal With Risk
People often do not properly assess the potential rewards for taking a risk. Nor do they focus on how well the risks and rewards match.
Your company faced a potential growth initiative that offers both high risk and high reward.
Ask yourself:
1. If you take this high risk and fail, will you lose the ranch?
If yes, you may not want to go ahead. If the risk is not of the bet-the-company type, then ask,
2. If you fail, will it put your company at a severe disadvantage?
Sometimes it is worth betting on a new initiative or idea, but you always want to have a handle on what you are up against. You also want to know how to reduce risk, shape it and manage it.
Convinced the risk is worth taking, you then drill down farther and decide whether the project is too risky, given the other risks in your company's investment portfolio.
Ask again and decide:
3. Would the inclusion of this project push the company over the edge?
If yes, and should you still decide to take the risk ahead, ask,
4. Would sharing the risk by an alliance be an acceptable option?
People often do not properly assess the potential rewards for taking a risk. Nor do they focus on how well the risks and rewards match.
Your company faced a potential growth initiative that offers both high risk and high reward.
Ask yourself:
1. If you take this high risk and fail, will you lose the ranch?
If yes, you may not want to go ahead. If the risk is not of the bet-the-company type, then ask,
2. If you fail, will it put your company at a severe disadvantage?
Sometimes it is worth betting on a new initiative or idea, but you always want to have a handle on what you are up against. You also want to know how to reduce risk, shape it and manage it.
Convinced the risk is worth taking, you then drill down farther and decide whether the project is too risky, given the other risks in your company's investment portfolio.
Ask again and decide:
3. Would the inclusion of this project push the company over the edge?
If yes, and should you still decide to take the risk ahead, ask,
4. Would sharing the risk by an alliance be an acceptable option?
Good growth is profitable, organic, differentiated and sustainable.
Good growth is profitable, organic, differentiated and sustainable.
Profitable
Good growth is profitable.
It is also capital-efficient, that is, it needs to earn a return on its investment greater than what the company could have received by putting its money in something ultra-safe, such as a Treasury bill.
There is growth in revenues and steady improvement in profitability. Gross margin is an important indicator of a company's profitability and often not given the due it deserves.
Increasing gross margin and at the same time growing revenues at a rate better than the overall market is what makes for a great growth company. There is a direct relationship between improved productivity and profitable growth.
The improvement in gross margin also reflects the company's ability to innovate ahead of its competitors.
A company's rapid growth attracts the best managers in the industry - managers who are committed to growth.
Organic
Organic growth is the most efficient way to create revenue growth.
Profitable
Good growth is profitable.
It is also capital-efficient, that is, it needs to earn a return on its investment greater than what the company could have received by putting its money in something ultra-safe, such as a Treasury bill.
There is growth in revenues and steady improvement in profitability. Gross margin is an important indicator of a company's profitability and often not given the due it deserves.
Increasing gross margin and at the same time growing revenues at a rate better than the overall market is what makes for a great growth company. There is a direct relationship between improved productivity and profitable growth.
The improvement in gross margin also reflects the company's ability to innovate ahead of its competitors.
A company's rapid growth attracts the best managers in the industry - managers who are committed to growth.
Organic
Organic growth is the most efficient way to create revenue growth.
When people work with customers in the search for new ideas, translating those ideas into reality requires them to cut across silos and come together to make trade-offs and decisions in launching new products. It also builds the organization's self-confidence. Knowing that it has created a successful growth project makes it easier to tackle the next challenge, and the momentum feeds on itself.
Organic growth can also be based on filling an additional customer need and/or exploiting an organization's existing expertise in products, customer segments, or geographic regions, to capture new markets.
While good growth is PRIMARILY organic, there are times when it makes sense to supplement organic growth with smaller "bolt-on" acquisitions to fill strategic gaps, such as gaining a beachhead in a geographic region, obtaining a new technology, filling an adjacent need, or adding a new distribution channel.
Differentiated
No matter how "commoditized" your business is, good-growth companies find a way to differentiate themselves.
Winners in the quest for profitable growth pay attention to differentiation, however razor-thin.
To do that, they see things through the eyes of their customers and potential customers, detect what these buyers prefer, and hook the customer through products, services, and relationships that are better differentiated than those of the competition.
Dell offers a commodity: personal computers. Yet Dell differentiated its product line by making sure its product are reliable, low-priced, and customizable - that is, customers can design their PCs exactly the way they want.
Lexus truly differentiated itself in the post-purchase experience and in mechanical reliability.
Differentiation can also take place in the service that a manufacturer provides to retailers like Wal-Mart. By helping the customer increase its sales, the manufacturer has differentiated itself from being just another firm that the customer does business with.
Sustainable
Good growth continues over time. It has a sustainable trajectory.
It is not a quick spike upward in revenues, caused by cutting prices or by throwing substantial resources against a one-shot opportunity. The goal is to have the growth continue year after year.
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The only way this growth is going to occur is if everyone in the organization believes in it to be possible. It is up to the organization's leadership to create the right mind-set.
Good Growth
Good Growth
The best companies, those that will thrive over the long run, grow both the top and bottom lines consistently over time, developing a cumulative competitive advantage that creates shareholder value. They may not turn in the best numbers in the industry when measured over any one short-term period, but their cumulative performance is stellar, thanks to the way they approach increasing their revenues.
Their good growth also strengthens the company's DNA by creating new competencies and strengths, thereby building the skills of its people and confidence in the psyche of the organization.
What makes up good growth?
It is profitable, organic, differentiated, and sustainable. (PODS)
The best companies, those that will thrive over the long run, grow both the top and bottom lines consistently over time, developing a cumulative competitive advantage that creates shareholder value. They may not turn in the best numbers in the industry when measured over any one short-term period, but their cumulative performance is stellar, thanks to the way they approach increasing their revenues.
Their good growth also strengthens the company's DNA by creating new competencies and strengths, thereby building the skills of its people and confidence in the psyche of the organization.
What makes up good growth?
It is profitable, organic, differentiated, and sustainable. (PODS)
Bad Growth
Bad Growth
Bad growth is not confined to mergers and acquisitions lacking strategic rationale. Price-cutting to gain market share without a corresponding decrease in costs can also lead to disaster.
Some businesses are capital intensive with high fixed costs and a high breakeven point, for example, the building-materials industry. Cutting prices to gain significant market share maybe successful at least initially. However, the competition had no choice but to respond in kind, since a loss of market share in this high-fixed-cost industry means a loss of both cash flow and profitability. The end result of all that price cutting caused industry revenue and profits to shrink, which obviously, affected every business in the same industry. It may take some time to restore equilibrium to the business.
Cost cutting could have been succesful to gain market share if the company had improved productivity and offered higher-quality products and creating a better cost structure, ahead of the competition. With lower costs and higher-quality products, it would have been possible to cut prices and build market share while maintaining margin. Another approach could have tried to search out the most profitable segments of the market and/or become the industry's innovator.
With no intrinsic competitive advantages, the only result of price cutting was that everyone in the industry suffered, not without its consequences to the managers and management too.
Buying growth through uneconomic price discounting
Gaining market share by giving some customers unusually favourable credit terms - terms that result in your losing money on every sale - is another example of bad growth. It never works long term.
Subsidizing buyers' purchases of your product by charging them little or no interest on the financing options you offer them, or by giving them an extended period until they have to pay you, may spike sales in the short term, but it is never effective as a long-term growth strategy.
In these situations, companies are able to record revenues and profits in accounting terms, and managers get their bonuses for meeting targets, but at the end of the day a cash crisis arises and huge write-offs ensue.
Bad growth is not confined to mergers and acquisitions lacking strategic rationale. Price-cutting to gain market share without a corresponding decrease in costs can also lead to disaster.
Some businesses are capital intensive with high fixed costs and a high breakeven point, for example, the building-materials industry. Cutting prices to gain significant market share maybe successful at least initially. However, the competition had no choice but to respond in kind, since a loss of market share in this high-fixed-cost industry means a loss of both cash flow and profitability. The end result of all that price cutting caused industry revenue and profits to shrink, which obviously, affected every business in the same industry. It may take some time to restore equilibrium to the business.
Cost cutting could have been succesful to gain market share if the company had improved productivity and offered higher-quality products and creating a better cost structure, ahead of the competition. With lower costs and higher-quality products, it would have been possible to cut prices and build market share while maintaining margin. Another approach could have tried to search out the most profitable segments of the market and/or become the industry's innovator.
With no intrinsic competitive advantages, the only result of price cutting was that everyone in the industry suffered, not without its consequences to the managers and management too.
Buying growth through uneconomic price discounting
Gaining market share by giving some customers unusually favourable credit terms - terms that result in your losing money on every sale - is another example of bad growth. It never works long term.
Subsidizing buyers' purchases of your product by charging them little or no interest on the financing options you offer them, or by giving them an extended period until they have to pay you, may spike sales in the short term, but it is never effective as a long-term growth strategy.
In these situations, companies are able to record revenues and profits in accounting terms, and managers get their bonuses for meeting targets, but at the end of the day a cash crisis arises and huge write-offs ensue.
How to Tell Good Growth from Bad Growth
How to Tell Good Growth from Bad Growth
All top-line growth is not created equal. History has shown that most mergers and acquisitions do little to help the long-term health and revenue growth of an organization. Growth that uses capital inefficiently is not the way to go.
How can you tell good growth from bad?
How good growth builds value
Growth of any kind increases revenues. Good growth not only increases revenues but correspondingly improves profits and is sustainable over time. It is primarily organic (internally) generated from the ongoing operations and business of the company and is based on differentiated products and services that meet new or previously unmet consumer needs.
Good growth is thus growth that is profitable, organic, differentiated, and sustainable (PODS). Good growth builds shareholder value over time. In contrast, bad growth destroys shareholder value.
Mergers and acquisitions, a primary example of bad growth, are often based on myopic visions of synergy that have no basis in the reality fo the market place. Instead of 4 plus 4 equaling 10, as promised when the deals are announced, more often than not 4 plus 4 winds up equaling 5 or 6. It is true that a large number of mergers and mega-acquisitions result in one-shot cost synergies - usually cost savings from the elimination of duplication with the merged enterprise - but seldom in an improved rate of revenue growth that is sustainable for the long run.
Compared with growing through a string of major acquisitions, good growth offers better returns over time, is less risky, and saves companies from crippling high debt and cash crises such as those faced by Vivendi and AOL Time Warner.
Vivendi acquired (among other things) Universal Studios, Blizzard Entertainment, and Def Jam. The problem? Vivendi overpaid and used debt to pay for most of those high-priced acquisitions. While the companies it bought were making money, Vivendi as a whole plunged into the red, after taking into account the repayment of interest on the billions of dollars it borrowed. The financial condition of the company became so acute that many wondered if it would survive.
Of course, not all acquisitions are bad. There are times when scale (i.e., your overall size in relation to competitors) matters and it can be impossible to compete against industry giants without it.
Phillips and Conoco were both relatively small fish in the energy market. They were both growing but they were at a huge competitive disadvantage versus ExxonMobil or BP. The Conoco-Phillips merger in 2002 (the new company is called ConocoPhillips) took out costs, and the integration of the two companies has been extremely successful. They have built on each other's strengths.
Similarly, there are times when an industry goes through a consolidation wave. At those moments, you either get bigger or find yourself at a disadvantage.
But, overall, organic growth remains the way to go. It results in a better price-earnings ratio so that when an industry undergoes consolidation, this strength provides a company with the upper hand in making appropriate acquisitions against its competition. The end result is a company with additional scale and scope and greater credibility to go to the next level.
All top-line growth is not created equal. History has shown that most mergers and acquisitions do little to help the long-term health and revenue growth of an organization. Growth that uses capital inefficiently is not the way to go.
How can you tell good growth from bad?
How good growth builds value
Growth of any kind increases revenues. Good growth not only increases revenues but correspondingly improves profits and is sustainable over time. It is primarily organic (internally) generated from the ongoing operations and business of the company and is based on differentiated products and services that meet new or previously unmet consumer needs.
Good growth is thus growth that is profitable, organic, differentiated, and sustainable (PODS). Good growth builds shareholder value over time. In contrast, bad growth destroys shareholder value.
Mergers and acquisitions, a primary example of bad growth, are often based on myopic visions of synergy that have no basis in the reality fo the market place. Instead of 4 plus 4 equaling 10, as promised when the deals are announced, more often than not 4 plus 4 winds up equaling 5 or 6. It is true that a large number of mergers and mega-acquisitions result in one-shot cost synergies - usually cost savings from the elimination of duplication with the merged enterprise - but seldom in an improved rate of revenue growth that is sustainable for the long run.
Compared with growing through a string of major acquisitions, good growth offers better returns over time, is less risky, and saves companies from crippling high debt and cash crises such as those faced by Vivendi and AOL Time Warner.
Vivendi acquired (among other things) Universal Studios, Blizzard Entertainment, and Def Jam. The problem? Vivendi overpaid and used debt to pay for most of those high-priced acquisitions. While the companies it bought were making money, Vivendi as a whole plunged into the red, after taking into account the repayment of interest on the billions of dollars it borrowed. The financial condition of the company became so acute that many wondered if it would survive.
Of course, not all acquisitions are bad. There are times when scale (i.e., your overall size in relation to competitors) matters and it can be impossible to compete against industry giants without it.
Phillips and Conoco were both relatively small fish in the energy market. They were both growing but they were at a huge competitive disadvantage versus ExxonMobil or BP. The Conoco-Phillips merger in 2002 (the new company is called ConocoPhillips) took out costs, and the integration of the two companies has been extremely successful. They have built on each other's strengths.
Similarly, there are times when an industry goes through a consolidation wave. At those moments, you either get bigger or find yourself at a disadvantage.
But, overall, organic growth remains the way to go. It results in a better price-earnings ratio so that when an industry undergoes consolidation, this strength provides a company with the upper hand in making appropriate acquisitions against its competition. The end result is a company with additional scale and scope and greater credibility to go to the next level.
Reading an Annual Report
Reading an Annual Report
Every company must publish an annual report to its shareholders as a matter of corporate law. The primary purpose of this report is to inform shareholders of the company's performance. As a legal requirement, the report usually contains a profit and loss account, a balance sheet, a cash-flow statement, a directors' report, and an auditors' report.
Many companies also provide a lot of other non-statutory information on their affairs, in the interests of general communication. In some cases, this may be little more than gloss, contrived to illustrate the company's wonderful achievement while remaining strangely silent on negative features.
What guarantee is there that an annual reprot is a true picture of a company's performance and not just propaganda put out by directors?
All annual reprots have to include a report from the auditors, independent accountants charged with investigating a company's financial affairs to ensure that the published figures give a true and fair view of performance. Their investigation cannot extend to examining every single transaction (impossible in a company of any size), so they use statistical sampling and other risk-based testing procedures to assess the quality of the company's systems as a basis for producing the annual report. They are not infallible, but they stand between the shareholders and the directors as a way of trying to ensure probity in the running of the company.
Understanding the main contents of an annual report.
Standard sections in annual reports can vary from country to country, but the following is the contents list of a medium-sized UK public company - let's call it X plc.
X world
Chairman's statement
Chief executive's view
Financial review
X in the community
Environment, health, and safety
Board of directors
Directors' report
Board reprot on remuneration
Director's responsibilities
Report of the auditors
Financial statements
Five-year record
Shareholder information.
Financial statements - are the main purpose of the annual report. In the example of X plc, these consist of:
Every company must publish an annual report to its shareholders as a matter of corporate law. The primary purpose of this report is to inform shareholders of the company's performance. As a legal requirement, the report usually contains a profit and loss account, a balance sheet, a cash-flow statement, a directors' report, and an auditors' report.
Many companies also provide a lot of other non-statutory information on their affairs, in the interests of general communication. In some cases, this may be little more than gloss, contrived to illustrate the company's wonderful achievement while remaining strangely silent on negative features.
What guarantee is there that an annual reprot is a true picture of a company's performance and not just propaganda put out by directors?
All annual reprots have to include a report from the auditors, independent accountants charged with investigating a company's financial affairs to ensure that the published figures give a true and fair view of performance. Their investigation cannot extend to examining every single transaction (impossible in a company of any size), so they use statistical sampling and other risk-based testing procedures to assess the quality of the company's systems as a basis for producing the annual report. They are not infallible, but they stand between the shareholders and the directors as a way of trying to ensure probity in the running of the company.
Understanding the main contents of an annual report.
Standard sections in annual reports can vary from country to country, but the following is the contents list of a medium-sized UK public company - let's call it X plc.
X world
Chairman's statement
Chief executive's view
Financial review
X in the community
Environment, health, and safety
Board of directors
Directors' report
Board reprot on remuneration
Director's responsibilities
Report of the auditors
Financial statements
Five-year record
Shareholder information.
Financial statements - are the main purpose of the annual report. In the example of X plc, these consist of:
- Consolidated profit and loss account. The profit and loss account of all the group as one.
- Consolidated and company balance sheets. The former is the group balance sheet and the latter shows the parent company alone.
- Consolidated cash-flow statement. A guide to how the money flowing in and out of the company was utilised.
- Notes to the accounts. These amplify numerous points contained in the figures and are usually critical for anyone wishing to study the accounts in detail.
Five-year record - shows a very abbreviated set of profit and loss and balance sheet figures for the current and previous four years. Some companies provide a ten-year record.
Choosing the right order in which to read the report
1. Start with the auditors' report.
Remember that this thin grey line of accountants is all that stands between the outside shareholder and the directors. To speed up matters, look at the final paragraph, their opinion. Does that statement give a true and fair view? If so, fine. If not, then it is said to be 'qualified'. Qualifications vary in depth from the disastrous, meaning that the company has got something seriously wrong, to perhaps a difference of opinion between the auditors and the board over some accounting matter. Most auditors' reports are unqualified, but, if there is a qualification present, you will have to judge how much the accounts can be relied upon as a measure of the company's performance.
2. Next, turn to the five/ten-year review
This is where you build up a mental picture of the company's financial history. Look at EPS - is it increasing, decreasing, fluctuating wildly? This gives you an idea of how it has been doing over the period. Look at dividend, if any, and consider their patern. Do they follow EPS or, as is likely, are they showing a smoother picture? Look at company debt, if the information is there, and compare it with shareholders' funds. How is it changing over the years?
Generally try to build up a view as to whether the company is doing better, worse, or perhaps has no particular pattern over the period. Depending on your reasons for reading the report, a set of prejudices will have begun to develop from this historical picture. If it shows a declining financial situation, this could be a good thing from some points of view - if you wish to acquire the company, for example. If you are an employee though, it would not be very encouraging. So, reading reports depends to some extent upon which angle you are coming from.
3. Now read the chairman's and directors' comments
These will give a deeper feel for the company's business, over and above the raw numerical data. Try to exercise a degree of scepticism in some areas, because it is natural for directors to attempt to play up the good points and play down the less good ones.
4. Get to the heart of the matter (the financial statements and the huge number of notes that accompany them)
The kernel of the report comprises the financial sttements and the huge number of notes that accompany them. A lot of it is in highly technical accounting terminology, but it gives you the intimate financial detail on the year. Never ignore the notes - they are critical. In fact some investment analysis read the report from the back, because the notes are so important.
Notes have increased dramatically over the years as new legal and accounting standards have been introduced, primarily to enforce standardisation so that accounts are more comparable, but also to avoid 'creative accounting', whereby some companies have tried to conceal (legitimately) financial undesirables.
5. Relax with the glossy stuff
Having absorbed all that really matters, settle back and read the glossy bits that tell you how wonderful the company is. Just remember to exercise a mild degree of cynicism here - this is the least important, though no doubt the most visually attractive, part of the annual reprot. The real picture of the company is the numbers, not the photo of the bloke in the hard hat standing on an oil rig!
COMMON MISTAKES
Paying too much attention to pretty pictures and directors' comments and too little to the accounting data.
This can give a false view of how well, or badly, the company is doing. Understandably, a large number of people have difficulty in comprehending the figures. But if you want to appreciate annual reports properly, then learning to read accounts is essential.
Some cynics among investment analysts have even expressed the view that there is an adverse relationship between the number of glossy pages in an annual report and the company's actual performance. Maybe that's a little harsh but ... there might be something in it.
Also read:
Tuesday 19 May 2009
Yield and price/earnings ratio (P/E)
Yield and price/earnings ratio (P/E)
Yield represents the historical annual dividend income paid by the share as a percentage of its current price. P/E shows how many years of current earnings are represented in the current price. Both of these ratios will therefore fluctuate with the price of the share - P/E in direct proportion and yield in inverse proportion.
These are the two most common ratios used by investors and market commentators in evaluating a share as a potential investment, both on its own merits and as a comparison with other shares. For this reason they are widely quoted in the press and almost every serious newspaper will show these figures alongside the price of each share in the listings.
COMMON MISTAKES
1. Believing that share price alone is an indication of the value fo the share
It seems logical to believe that shares for company A, with a share price of $200, are twice as expensive as those of company B, with a share price of $100. This is completely incorrect. The share price alone tells you almost nothing about the share, which is why P/E is so critically important.
Suppose in the above example, A has a P/E of 12 and B a P/E of 24. Now you can see that in fact B is twice as dear as A, even though it has half the share price. It means that collectively, investors have decided that it is worth paying 24 years' earnings for B but only 12 years' earnings for A. This does not mean that the collective market view is right or wrong, in that a higher P/E is better or worse than a lower one. That is a matter for the individual to decide for him- or herself.
What we are doing when using P/E is relating the price to some other fact about the company, in this case to earnings. Similarly, yield relates the price to the annual dividends paid. There are several other measures that relate the price to something about the share, examples, being assets (P/B) and sales (P/S). It is really only by reference to these that one share can be compared with another to ascertain which is cheaper or dearer.
2. Thinking that the yield will apply in future
In most cases, the yield figures shown in papers are historical. The exact method varies between papers, but generally it is based on taking the last year's dividends paid, dividing by the share price, and expressing the result as a percentage. But it must be borne in mind that no company is obliged to pay dividends at all.
3. Assuming that yield figures will always be sustainable
If you look through the tables, you can occasionally discover shares that appear to give enormous yields like 20% - which, on the face of it, seems to be a fantastic investment. But if you look behind the figures at announcements from the company, you will very likely find that it is going through a bad time and will probably cut, or eliminate, its dividend in the future. The huge historical yield appears only becasue the share price has collapsed following the bad news, and a falling share price drives up the yield in inverse proportion. so do not make the mistake of assuming that the yeild figures are always sustainable in the future, particularly those that appear astronomically high in relation to the rest of the market.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
Yield represents the historical annual dividend income paid by the share as a percentage of its current price. P/E shows how many years of current earnings are represented in the current price. Both of these ratios will therefore fluctuate with the price of the share - P/E in direct proportion and yield in inverse proportion.
These are the two most common ratios used by investors and market commentators in evaluating a share as a potential investment, both on its own merits and as a comparison with other shares. For this reason they are widely quoted in the press and almost every serious newspaper will show these figures alongside the price of each share in the listings.
COMMON MISTAKES
1. Believing that share price alone is an indication of the value fo the share
It seems logical to believe that shares for company A, with a share price of $200, are twice as expensive as those of company B, with a share price of $100. This is completely incorrect. The share price alone tells you almost nothing about the share, which is why P/E is so critically important.
Suppose in the above example, A has a P/E of 12 and B a P/E of 24. Now you can see that in fact B is twice as dear as A, even though it has half the share price. It means that collectively, investors have decided that it is worth paying 24 years' earnings for B but only 12 years' earnings for A. This does not mean that the collective market view is right or wrong, in that a higher P/E is better or worse than a lower one. That is a matter for the individual to decide for him- or herself.
What we are doing when using P/E is relating the price to some other fact about the company, in this case to earnings. Similarly, yield relates the price to the annual dividends paid. There are several other measures that relate the price to something about the share, examples, being assets (P/B) and sales (P/S). It is really only by reference to these that one share can be compared with another to ascertain which is cheaper or dearer.
2. Thinking that the yield will apply in future
In most cases, the yield figures shown in papers are historical. The exact method varies between papers, but generally it is based on taking the last year's dividends paid, dividing by the share price, and expressing the result as a percentage. But it must be borne in mind that no company is obliged to pay dividends at all.
3. Assuming that yield figures will always be sustainable
If you look through the tables, you can occasionally discover shares that appear to give enormous yields like 20% - which, on the face of it, seems to be a fantastic investment. But if you look behind the figures at announcements from the company, you will very likely find that it is going through a bad time and will probably cut, or eliminate, its dividend in the future. The huge historical yield appears only becasue the share price has collapsed following the bad news, and a falling share price drives up the yield in inverse proportion. so do not make the mistake of assuming that the yeild figures are always sustainable in the future, particularly those that appear astronomically high in relation to the rest of the market.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
Reading a Cash-flow Statement
Reading a Cash-flow Statement
The purpose of the cash-flow statement is to explain the movement in cash balances or bank overdrafts held by the business from one accounting period to the next.
What is a cash-flow statement?
Over an accounting period, the money held by a business at the bank (or its overdrafts) will have changed. The purpose of the cash-flow statement is to show the reasons for this change. The cash flow statement is the link between profit and cash balance movements. It takes you down the path from profit to cash. The figures are derived from those published in the annual accounts, and notes will explain how this derivation is arrived at.
What does a cash-flow statement not show?
In the same way that a profit and loss account does not show the cash made by the business, a cash-flow staetement does not show the profit. It is entirely possible for a loss-making business to show an increase in cash, and the other way round too.
Learn to interpret the figures
The cash-flow statement is a 'derived schedule', meaning that the figures are pulled from the profit and loss account and balance sheet statements, linking the two.
Its purpose is to analyse the reasons why the company's cash position changed over an accounting period. For example, a sharp increase in borrowings could have several explanations - such as a high level of capital expenditure, poor trading, an increase in the time taken by debtors to pay, and so on. The cash-flow statement will alert management to the reasons for this, in a way that may not be obvious merely from the profit and loss account and balance sheet.
The generally desirable situation is for the net position before financing to be positive. Even the best-run businesses will sometimes have an outflow in a period (for example in a year of high capital expenditure), but positive is usually good. This become more apparent when comparing figures over a period of time. A repeated outflow of funds over several years is usally an indication of trouble. To cover this, the company must raise new finance and/or sell off assets, which will tend to compound the problem, in the worst cases leading to failure.
Cash is critical to every business, so the management must understand where its cash is coming from and going to. The cash-flow statement gives us this information in an abbreviated form. You could argue that the whole purpose of a business is to start with one sum of money and, by applying some sort of process to it, arrive at another and higher sum, continually repeating this cycle.
COMMON MISTAKES
Confusing 'cash' and 'profit'
As mentioned previously, the most common mistake with cash-flow statements is the potential confusion between profit and cash. They are not the same!
Not understanding the terminology
It is clearly fundamental to an understanding of cash flow statements that the reader is familiar with terms like 'debtors', 'creditors', 'dividends', and so on. But more than appreciating the meaning fo the word 'debtor', it is quite easy to misunderstand the concept that, for example, an increase in debtors is a cash outflow, and equally that an increase in creditors represents an inflow of cash to the business.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
The purpose of the cash-flow statement is to explain the movement in cash balances or bank overdrafts held by the business from one accounting period to the next.
What is a cash-flow statement?
Over an accounting period, the money held by a business at the bank (or its overdrafts) will have changed. The purpose of the cash-flow statement is to show the reasons for this change. The cash flow statement is the link between profit and cash balance movements. It takes you down the path from profit to cash. The figures are derived from those published in the annual accounts, and notes will explain how this derivation is arrived at.
What does a cash-flow statement not show?
In the same way that a profit and loss account does not show the cash made by the business, a cash-flow staetement does not show the profit. It is entirely possible for a loss-making business to show an increase in cash, and the other way round too.
Learn to interpret the figures
The cash-flow statement is a 'derived schedule', meaning that the figures are pulled from the profit and loss account and balance sheet statements, linking the two.
Its purpose is to analyse the reasons why the company's cash position changed over an accounting period. For example, a sharp increase in borrowings could have several explanations - such as a high level of capital expenditure, poor trading, an increase in the time taken by debtors to pay, and so on. The cash-flow statement will alert management to the reasons for this, in a way that may not be obvious merely from the profit and loss account and balance sheet.
The generally desirable situation is for the net position before financing to be positive. Even the best-run businesses will sometimes have an outflow in a period (for example in a year of high capital expenditure), but positive is usually good. This become more apparent when comparing figures over a period of time. A repeated outflow of funds over several years is usally an indication of trouble. To cover this, the company must raise new finance and/or sell off assets, which will tend to compound the problem, in the worst cases leading to failure.
Cash is critical to every business, so the management must understand where its cash is coming from and going to. The cash-flow statement gives us this information in an abbreviated form. You could argue that the whole purpose of a business is to start with one sum of money and, by applying some sort of process to it, arrive at another and higher sum, continually repeating this cycle.
COMMON MISTAKES
Confusing 'cash' and 'profit'
As mentioned previously, the most common mistake with cash-flow statements is the potential confusion between profit and cash. They are not the same!
Not understanding the terminology
It is clearly fundamental to an understanding of cash flow statements that the reader is familiar with terms like 'debtors', 'creditors', 'dividends', and so on. But more than appreciating the meaning fo the word 'debtor', it is quite easy to misunderstand the concept that, for example, an increase in debtors is a cash outflow, and equally that an increase in creditors represents an inflow of cash to the business.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
Reading a Profit and Loss Account
Reading a Profit and Loss Account
A profit and loss (P&L) account is a statement of the income and expenditure of a business over the period stated, drawn up in order to ascertain how much profit the business made. 'Income" and "expenditure' here mean only those amounts directly attributable to earning the profit and thus would exclude capital expenditure, for example.
Importantly, the figures are adjusted to match the income and expenses to the time period in which they were incurred - not necessarily the same as that in which the cash changed hands.
What is a profit and loss account?
A profit and loss account is an accountant's view of the figures that show how much profit or loss a business has made over a period. To arrive at this, it is necessary to allocate the various elements of income and expenditure to the time period concerned, not on the basis of when cash was received or spent, but on when the income was earned or the liability to pay a supplier or employees was incurred. While capital expenditures are excluded, depreciation of property and equipment is included as a non-cash expense.
Thus if you sell goods on credit, you will be paid later but the sale takes place upon the contract to sell them. Equally if you buy goods and services on credit, the purchase takes palce when you contract to buy them, not when you actually settle the invoice.
What does a profit and loss account not show?
Most importantly, a P&L account is not an explanation of the cash coming into and going out of a business.
MAKING IT HAPPEN
The presence of stock and purchases indicates that the business is trading or manufacturing goods of some kind, rather than selling services.
Where a business holds stock, the purchases figure has to be adjusted for the opening and closing values in order to reach the right income and expenditure amounts for that period only. Goods for resale bought in the period may not have been used purely for that period but may be lying in stock at the end of it, ready for sale in the next. Similarly, goods used for resale in this period will consist parly of items already held in stock at the beginning of it. So take the amounts purchased, add the opening stock, and deduct the closing stock. The resulting adjusted purchase figure is known as 'cost of sales'.
In some businesses there may be other direct costs apart from purchases included in cost of sales. For example, a manufacturer may include some wages if they are of a direct nature (wages of employees directly involved in the manufacturing process, as distinct from office staff, say). Or a building contractor would include plant hire in direct costs, as well as purchses of materials.
How to interpret the figures
A lot of accounting analysis is valid only when comparing the figures, usually with similar figures for earlier periods, projected future figures, or other companies in the same business.
On its own, a P&L account tells you only a limited story, though there are some standalone facts that can be derived from it.
However, it is in comparisons that such figures start to have real meaning.
If you then looked at similar margin figures for the preceding accounting period, you would learn something about this business.
Say the gross margin was 45% last year compared with 46% this year - there has been some improvement in the profit made before deducting overheads. But then suppose that the net profit margin of 8.8% this year was 9.8% last year. This would tell you that, despite improvement in profit at the gross level, the overheads have increased disproportionately. You could then check on the ratio of each item of the overheeads to sales to see where this arose and find out why. Advertising spending could have shot up, for example, or perhaps the company moved to new premises, incurring a higher rent. Maybe something could be tightened up.
Another commonly-used ratio
Another ratio often used in business analysis is return on capital employed. Here we combine the profit and loss account with the balance sheet by dividing the net profit (either before or after tax as required) by shareholders' funds. This tells you how much the company is making proportionate to money invested in it by the shareholders - a similar idea to how much you might get in interest on a bank deposit account. It's a useful way of comparing different companies in a particular industry, where the more efficient ones are likely to derive a higher return on capital employed.
COMMON MISTAKES
Assuming that the bottom line represents cash profit from trading
It does not! There are a few examples where this is the case: a simple cash trader might buy something for one price, then sell it for more; his profit then equals the increase in cash. But a business that buys and sells on credit, spends money on items that are held for the longer term, such as property or machinery, has tax to pay at a later date, and so on, will make a profit that is not represented by a mere increase in cash balances held. Indeed, the cash balance could quite easily decrease druing a period when a profit was made.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
A profit and loss (P&L) account is a statement of the income and expenditure of a business over the period stated, drawn up in order to ascertain how much profit the business made. 'Income" and "expenditure' here mean only those amounts directly attributable to earning the profit and thus would exclude capital expenditure, for example.
Importantly, the figures are adjusted to match the income and expenses to the time period in which they were incurred - not necessarily the same as that in which the cash changed hands.
What is a profit and loss account?
A profit and loss account is an accountant's view of the figures that show how much profit or loss a business has made over a period. To arrive at this, it is necessary to allocate the various elements of income and expenditure to the time period concerned, not on the basis of when cash was received or spent, but on when the income was earned or the liability to pay a supplier or employees was incurred. While capital expenditures are excluded, depreciation of property and equipment is included as a non-cash expense.
Thus if you sell goods on credit, you will be paid later but the sale takes place upon the contract to sell them. Equally if you buy goods and services on credit, the purchase takes palce when you contract to buy them, not when you actually settle the invoice.
What does a profit and loss account not show?
Most importantly, a P&L account is not an explanation of the cash coming into and going out of a business.
MAKING IT HAPPEN
The presence of stock and purchases indicates that the business is trading or manufacturing goods of some kind, rather than selling services.
Where a business holds stock, the purchases figure has to be adjusted for the opening and closing values in order to reach the right income and expenditure amounts for that period only. Goods for resale bought in the period may not have been used purely for that period but may be lying in stock at the end of it, ready for sale in the next. Similarly, goods used for resale in this period will consist parly of items already held in stock at the beginning of it. So take the amounts purchased, add the opening stock, and deduct the closing stock. The resulting adjusted purchase figure is known as 'cost of sales'.
In some businesses there may be other direct costs apart from purchases included in cost of sales. For example, a manufacturer may include some wages if they are of a direct nature (wages of employees directly involved in the manufacturing process, as distinct from office staff, say). Or a building contractor would include plant hire in direct costs, as well as purchses of materials.
How to interpret the figures
A lot of accounting analysis is valid only when comparing the figures, usually with similar figures for earlier periods, projected future figures, or other companies in the same business.
On its own, a P&L account tells you only a limited story, though there are some standalone facts that can be derived from it.
- Was this business successful in the period concerned?
- Was it able to make a profit, and not a loss?
- Was it able to pay dividends to shareholders out of that profit?
However, it is in comparisons that such figures start to have real meaning.
- The gross profit margin of X% was an important statistic in measuring business performance.
- The net profit margin before tax was Y%.
- You can calculate the net profit after tax (the bottom line).
- You could take the margin idea further and calculate the net profit after tax ratio to sales.
- Or you could calculate the ratio of any expense to sales. E.g. the wages to sales ratio.
If you then looked at similar margin figures for the preceding accounting period, you would learn something about this business.
Say the gross margin was 45% last year compared with 46% this year - there has been some improvement in the profit made before deducting overheads. But then suppose that the net profit margin of 8.8% this year was 9.8% last year. This would tell you that, despite improvement in profit at the gross level, the overheads have increased disproportionately. You could then check on the ratio of each item of the overheeads to sales to see where this arose and find out why. Advertising spending could have shot up, for example, or perhaps the company moved to new premises, incurring a higher rent. Maybe something could be tightened up.
Another commonly-used ratio
Another ratio often used in business analysis is return on capital employed. Here we combine the profit and loss account with the balance sheet by dividing the net profit (either before or after tax as required) by shareholders' funds. This tells you how much the company is making proportionate to money invested in it by the shareholders - a similar idea to how much you might get in interest on a bank deposit account. It's a useful way of comparing different companies in a particular industry, where the more efficient ones are likely to derive a higher return on capital employed.
COMMON MISTAKES
Assuming that the bottom line represents cash profit from trading
It does not! There are a few examples where this is the case: a simple cash trader might buy something for one price, then sell it for more; his profit then equals the increase in cash. But a business that buys and sells on credit, spends money on items that are held for the longer term, such as property or machinery, has tax to pay at a later date, and so on, will make a profit that is not represented by a mere increase in cash balances held. Indeed, the cash balance could quite easily decrease druing a period when a profit was made.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
Reading a Balance Sheet
Reading a Balance Sheet
A balance sheet will tell us something about the financial strength of a business on the day that the balance sheet is drawn up.
This action list gives an overview of a balance sheet and looks at a brief selection of the more interesting figures that help with interpretation. It is important to remember that a lot of these figures do not tell you that much in isolation; it is in trend analysis or comparisons between businesses that they talk more lucidly.
What is a balance sheet?
A balance sheet is an accountant's view, the book value of the assets and liabilities of a business at a specific date and on that date alone. By balancing the assets and liabilities and showing how the balance lies, it gives us an idea of the financial health of the business.
What does a balance sheet not do?
A balance sheet is not designed to represent market value of the business. For example, property in the balance asset may be worth a lot more than its book value. Plant and machinery is shown at cost less depreciation, but that may well be different from market value. Stock may turn out to be worth less than its balance sheet value, and so on.
Also, there may be hidden assets, such as goodwill or valuable brands, that do not appear on the balance sheet at all. These would all enhance the value of the business in a sale situation, yet are invisible on a normal balance sheet.
Learn to interpret the balance sheet
Note that the balance sheets differ between one industy and another as regards the range and type of assets and liabilities that exist. For example, a retailer will have little in the way of trade debtors because it sells for cash, while a manufacturer is likely to have a far larger investment in plant than a service business like an advertising agency. So the interpretation must be seen in the light of the actual trade of the business.
Reading a balance sheet can be quite subjective - accountancy is an art, not a science and, although the method of producing a balance sheet is standardized, there may be some items in it that are subjective rather than factual. The way people interprete some of the figures will also vary, depending on what they wish to achieve and how they see certain things as being good or bad.
Look first at the net assets/shareholders' funds
Positive or negative? Positive is good.
If it had negative assets (same thing as net liabilities, this might mean that the business is heading for difficulty unless it is being supported by some party such as a parent company, bank, or other investor. When reading a balance sheet with negative assets, consider where the support will be coming from.
Then examine net current assets
Positive or negative? Positive net current assets (NCA) mean that, theoretically, it should not have any trouble settling short-term liabilities because it has more than enough current assets to do so. Negative net current assets suggest that there possibly could be a problem in settling short-term liabilities.
You can also look at NCA as a ratio of current assets/current liabilities. Here, a figure over one is equivalent to the NCA having a positive absolute figure. The ratio version is more useful in analysing trends of balance sheets over successive periods or comparing two businesses.
A cut-down version of NCA considers only (debtors + cash)/(creditors) thus excluding stock (Quick Ratio). The reasoning here is that this looks at the most liquid of the net current asset constituents. Again a figure over one is the most desirable. This is also a ratio that is more meaningful in trends or comparisons.
Understand the significance of trade debtor payments...
Within current assets, we have trade debtors. It can be useful to consider how many days' worth of sales are tied up in debtors - given by (debtors x 365)/annual sales. This provides an idea of how long the company is waiting to get paid. Too long and it might be something requiring investigation. However, this figure can be misleading where sales do not take place evenly throughout the year. A construction company might be an example of such a business: one big debtor incurred near the year end would skew the ratio.
...and trade creditor payments.
Similar to the above, this looks at (trade creditors x 365)/annual purchases, indicating how long the company is taking in general to pay its suppliers. This is not so easy to calculate, because the purchases for this purpose include not only goods for resale but all the overheads as well.
Recognise what debt means
Important to most businesses, this figure is the total of long and short-term loans. Too much debt might indicate that the company would have trouble, in a downturn, in paying the interest. It's difficult to give an optimum level of debt because there are so many different situations, depending on a huge range of circumstances.
Often, instead of an absolute figure, debt is expressed as a percentage of shareholder's funds and known as 'gearing' or 'leverage'. In a public company, gearing of 100% might be considered pretty high, whereas debt of under 30% may be seen as on the low side.
COMMON MISTAKES
Believing that balance sheet figures represent market value
Don't assume that a balance sheet is a valuation of the business. Its primary purpose is that it forms part of the range of accounting reports used for measuring business performance - along with the other common financial reports like profit and loss accounts and cash-flow statements. Management, shareholders, and others such as banks will use the entire range to assess the health of the business.
Forgetting that the balance sheet is valid only for the date at which it is produced
A short while after a balance sheet is produced, things could be quite different. In practice there frequently may not be any radical changes between the date of the balance sheet and the date when it is being read, but it is entirely possible that something could have happended to the business that would not show. For example, a major debtor could have defaulted unexpectedly. So remember that balance sheet figures are valid only as at the date shown, and are not a permanent picture of the business.
Confusion over whether in fact all assets and liabilities are shown in the balance sheet
Some businesses may have hidden assets, as suggested above. This could be the value of certain brands or trademarks, for example, for which money may not have ever been paid. Yet these could be worth a great deal. Conversely, there may be some substantial legal action pending which could cost the company a lot, yet is not shown fully in the balance sheet.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
A balance sheet will tell us something about the financial strength of a business on the day that the balance sheet is drawn up.
This action list gives an overview of a balance sheet and looks at a brief selection of the more interesting figures that help with interpretation. It is important to remember that a lot of these figures do not tell you that much in isolation; it is in trend analysis or comparisons between businesses that they talk more lucidly.
What is a balance sheet?
A balance sheet is an accountant's view, the book value of the assets and liabilities of a business at a specific date and on that date alone. By balancing the assets and liabilities and showing how the balance lies, it gives us an idea of the financial health of the business.
What does a balance sheet not do?
A balance sheet is not designed to represent market value of the business. For example, property in the balance asset may be worth a lot more than its book value. Plant and machinery is shown at cost less depreciation, but that may well be different from market value. Stock may turn out to be worth less than its balance sheet value, and so on.
Also, there may be hidden assets, such as goodwill or valuable brands, that do not appear on the balance sheet at all. These would all enhance the value of the business in a sale situation, yet are invisible on a normal balance sheet.
Learn to interpret the balance sheet
Note that the balance sheets differ between one industy and another as regards the range and type of assets and liabilities that exist. For example, a retailer will have little in the way of trade debtors because it sells for cash, while a manufacturer is likely to have a far larger investment in plant than a service business like an advertising agency. So the interpretation must be seen in the light of the actual trade of the business.
Reading a balance sheet can be quite subjective - accountancy is an art, not a science and, although the method of producing a balance sheet is standardized, there may be some items in it that are subjective rather than factual. The way people interprete some of the figures will also vary, depending on what they wish to achieve and how they see certain things as being good or bad.
Look first at the net assets/shareholders' funds
Positive or negative? Positive is good.
If it had negative assets (same thing as net liabilities, this might mean that the business is heading for difficulty unless it is being supported by some party such as a parent company, bank, or other investor. When reading a balance sheet with negative assets, consider where the support will be coming from.
Then examine net current assets
Positive or negative? Positive net current assets (NCA) mean that, theoretically, it should not have any trouble settling short-term liabilities because it has more than enough current assets to do so. Negative net current assets suggest that there possibly could be a problem in settling short-term liabilities.
You can also look at NCA as a ratio of current assets/current liabilities. Here, a figure over one is equivalent to the NCA having a positive absolute figure. The ratio version is more useful in analysing trends of balance sheets over successive periods or comparing two businesses.
A cut-down version of NCA considers only (debtors + cash)/(creditors) thus excluding stock (Quick Ratio). The reasoning here is that this looks at the most liquid of the net current asset constituents. Again a figure over one is the most desirable. This is also a ratio that is more meaningful in trends or comparisons.
Understand the significance of trade debtor payments...
Within current assets, we have trade debtors. It can be useful to consider how many days' worth of sales are tied up in debtors - given by (debtors x 365)/annual sales. This provides an idea of how long the company is waiting to get paid. Too long and it might be something requiring investigation. However, this figure can be misleading where sales do not take place evenly throughout the year. A construction company might be an example of such a business: one big debtor incurred near the year end would skew the ratio.
...and trade creditor payments.
Similar to the above, this looks at (trade creditors x 365)/annual purchases, indicating how long the company is taking in general to pay its suppliers. This is not so easy to calculate, because the purchases for this purpose include not only goods for resale but all the overheads as well.
Recognise what debt means
Important to most businesses, this figure is the total of long and short-term loans. Too much debt might indicate that the company would have trouble, in a downturn, in paying the interest. It's difficult to give an optimum level of debt because there are so many different situations, depending on a huge range of circumstances.
Often, instead of an absolute figure, debt is expressed as a percentage of shareholder's funds and known as 'gearing' or 'leverage'. In a public company, gearing of 100% might be considered pretty high, whereas debt of under 30% may be seen as on the low side.
COMMON MISTAKES
Believing that balance sheet figures represent market value
Don't assume that a balance sheet is a valuation of the business. Its primary purpose is that it forms part of the range of accounting reports used for measuring business performance - along with the other common financial reports like profit and loss accounts and cash-flow statements. Management, shareholders, and others such as banks will use the entire range to assess the health of the business.
Forgetting that the balance sheet is valid only for the date at which it is produced
A short while after a balance sheet is produced, things could be quite different. In practice there frequently may not be any radical changes between the date of the balance sheet and the date when it is being read, but it is entirely possible that something could have happended to the business that would not show. For example, a major debtor could have defaulted unexpectedly. So remember that balance sheet figures are valid only as at the date shown, and are not a permanent picture of the business.
Confusion over whether in fact all assets and liabilities are shown in the balance sheet
Some businesses may have hidden assets, as suggested above. This could be the value of certain brands or trademarks, for example, for which money may not have ever been paid. Yet these could be worth a great deal. Conversely, there may be some substantial legal action pending which could cost the company a lot, yet is not shown fully in the balance sheet.
Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)
Sunday 17 May 2009
**** Valuation: How much is a share of stock really worth?
How much is a share of stock really worth?
http://www.moneychimp.com/articles/valuation/stockvalue.htm
Not just in terms of analysts' opinions, but logically, based on facts?
In theory, the answer is simple: a company is worth the total amount of cash it will generate over its lifetime, discounted to its present value. (And don't panic if you don't really understand that last sentence, because the next page explains it. You do not need any background to read this article.)
This article presents a simple discounted cash flows calculator, along with some popular variations and shortcuts, to make stock valuation make sense.
Valuation Intro
A Little Theory
DCF Calculator
P/E Ratio
P/S Ratio
PEG Ratio
Graham Formula
Dividend Discount
Buffett Formula (?)
CAPM Calculator
Books & Links
http://www.moneychimp.com/articles/valuation/stockvalue.htm
Not just in terms of analysts' opinions, but logically, based on facts?
In theory, the answer is simple: a company is worth the total amount of cash it will generate over its lifetime, discounted to its present value. (And don't panic if you don't really understand that last sentence, because the next page explains it. You do not need any background to read this article.)
This article presents a simple discounted cash flows calculator, along with some popular variations and shortcuts, to make stock valuation make sense.
Valuation Intro
A Little Theory
DCF Calculator
P/E Ratio
P/S Ratio
PEG Ratio
Graham Formula
Dividend Discount
Buffett Formula (?)
CAPM Calculator
Books & Links
The Importance of Financial Education
3 Types of Education
Academic
Professional
Financial
Financial education is crucial and is seldom emphasized.
To be successful today, we need all 3.
Read:
Robert Kiyosaki
Rich Dad Website
Click the video http://www.richdad.com/
Rich Dad transformation
Knowledge - the new money. Its all about financial education. ESBI.
3 Types of Education
Academic, Professional, and Financial. Our school system does not teach us much about money. The lack of financial education is the reason for the big gap between the rich and the poor. You are responsible for your own financial education. 4 green houses = 1 red hotel = Monopoly game.
The CASHFLOW Quadrant
4 types of people in the world of business or money. E=Employee, S=Small business, Self Employed, B= Big Business or Enterpreneur, I= Investor. "Go to school and get a job." = Employee. "Doctor, specialist, small business person" = Small business or Self employed. You can get rich in all 4 quadrants. Rich Dad aims to teach you to move from the E and S to B and I.
Savers are Losers
More important to be an investor. E.g. invest in oil, gold, rental real estate and learn to be an enterpreneur or an investor.
Assets and Liabilities.
An asset has positive cashflow (Income > Expenses). Liability has negative cashflow and takes money from your pocket. A house can both be an asset or liability depending on the cashflow it generates. Therefore a house may not be an asset. A car is a liability. Don't call a liability an asset. Acquire asset, not liability.
Good Debt vs. Bad Debt
Debt is a 4 letter word. "Get out of debt." Good debt makes you rich and bad debt makes you poor. Mortgage = engage until death. To be rich, improve your financial IQ, engage good debt. Good debt used to acquire assets that generate positive cashflows. Bad debt used to acquire liability with negative cashflows.
Live Above Your Means
Live below your means, your spirit dies, especially if you are poor. Most people has a job and can only work so hard. Our goal is to increase Asset to increase Income or cashflow. The way to get rich is to buy asset first and liability later. Invest in an asset and the money from that investment pays off your liability. After completing this payment, one still has a positive cashflow generating asset.
3 Types of Income
Earned, Portfolio and Passive. Earned income = job. Portfolio income = Capital Gain. Passive income comes in on a regular basis, from interests, dividends, real estates and businesses. Taxes are your highest expense and is highest in earned incomes. Those in the E or I segment have earned income. Portfolio and passive income are taxed less. Work hard for Portfolio and Passive Income. Learn to be a B or I.
Investing Isn't Risky
What is risky is lack of financial intelligence or education (still your best asset). For sophisticated investors (whether fundamental or technical), risk is reduced through using insurance (put, stop, etc.) to counter the risk of volatility. Taking advice from those with no investing knowledge is risky.
Life's 4 Quarters
10 years quarters from age 25 years to 65 years. 1st Quarter = age 25 to 35 years. 2nd Quarter = age 36 to 45 years. Age 45 - half time. 3rd Quarter = age 46 to 55 years. 4th Quarter = age 56 to 65 years. At 65 - Overtime. After that - Out -of- time. Aim to retire in the 2nd Quarter!!!!! At which age will you win the game of money? Some are lucky, they were born rich. Work hard, save money, invest in mutual funds and 401-K may not be enough to retire early. You will have to work hard all your life. Why not retire young and enjoy life? Why retire old and continue to work overtime and out-of-time?
The CASHFLOW Game
2 tracks - the rat race and the fast track. Most people are stuck in the rat race. Get out of the rat race and get onto the fast track. Get the money to work for you. There are 4 levels of investing played in the game: small deals, big deals, fast track and sophisticated investing (or Cash Flow 202). You have to be a rich person to invest in the fast track. To invest in the fast track, one has to be rich and financially educated. The other part of this CASHFLOW Game is a financial statement. A financial statement is very important aspect of your education. Your banker never ask you for your report card, but your financial statement. This game puts investing and accounting together. Have fun, learn from mistakes through the game. Teach other people. The more you teach, the more you learn. Make mistakes, take risk, have fun and get rich. The "poor dad" is poor because he is terrified of making mistakes.
The Cone of Learning
Could the CASHFLOW Game enhance the knowledge of finance and business? Passive learning (reading, lecture) vs Active learning (doing the real thing, just do it, play games). Best way to learn is to do the real thing. 2nd best way is to stimulate the real experience. CASHFLOW Games 101 and 202 fulfill the active learning role. Beware, most financial advisors are sales people. Play the game over and over again before going into the real thing.
IT'S TIME TO GET OUT OF THE RAT RACE
http://www.richdad.com/store/ProductDetail.aspx?id=1
http://cashflow.vo.llnwd.net/o16/cashflow3.swf
CashFlow 101 the E-Game: Intorduction 1
http://www.youtube.com/watch?v=4ug483UeEXs&feature=related
Cashflow Game 101
http://www.youtube.com/watch?v=uqZayPhdUJc&feature=related
Cashflow 202, Introduction
http://www.youtube.com/watch?v=-zGqzbfEvug&feature=related
Robert Kiyosaki : Cashflow Game 202, Overview!
http://www.youtube.com/watch?v=BUbODHeQd1g&feature=related
Cashflow Board Game - Rich Dad Poor Dad Game
http://www.youtube.com/watch?v=X4WcGWhjUS0&feature=related
Cashflow 101 take 1
http://www.youtube.com/watch?v=KresjGfPIW8&feature=related
Cashflow 101 take 2
http://www.youtube.com/watch?v=MHxOSr_jqqg&feature=related
Cashflow 202 take 1
http://www.youtube.com/watch?v=ZnrWo3LDi9E&feature=related
Cashflow 202 take 2
http://www.youtube.com/watch?v=RCFyxC7dQQM&feature=related
Robert Kiyosaki in Israel October 2007
http://www.youtube.com/watch?v=SMLjNjXojmc&feature=related
Academic
Professional
Financial
Financial education is crucial and is seldom emphasized.
To be successful today, we need all 3.
Read:
Robert Kiyosaki
Rich Dad Website
Click the video http://www.richdad.com/
Rich Dad transformation
Knowledge - the new money. Its all about financial education. ESBI.
3 Types of Education
Academic, Professional, and Financial. Our school system does not teach us much about money. The lack of financial education is the reason for the big gap between the rich and the poor. You are responsible for your own financial education. 4 green houses = 1 red hotel = Monopoly game.
The CASHFLOW Quadrant
4 types of people in the world of business or money. E=Employee, S=Small business, Self Employed, B= Big Business or Enterpreneur, I= Investor. "Go to school and get a job." = Employee. "Doctor, specialist, small business person" = Small business or Self employed. You can get rich in all 4 quadrants. Rich Dad aims to teach you to move from the E and S to B and I.
Savers are Losers
More important to be an investor. E.g. invest in oil, gold, rental real estate and learn to be an enterpreneur or an investor.
Assets and Liabilities.
An asset has positive cashflow (Income > Expenses). Liability has negative cashflow and takes money from your pocket. A house can both be an asset or liability depending on the cashflow it generates. Therefore a house may not be an asset. A car is a liability. Don't call a liability an asset. Acquire asset, not liability.
Good Debt vs. Bad Debt
Debt is a 4 letter word. "Get out of debt." Good debt makes you rich and bad debt makes you poor. Mortgage = engage until death. To be rich, improve your financial IQ, engage good debt. Good debt used to acquire assets that generate positive cashflows. Bad debt used to acquire liability with negative cashflows.
Live Above Your Means
Live below your means, your spirit dies, especially if you are poor. Most people has a job and can only work so hard. Our goal is to increase Asset to increase Income or cashflow. The way to get rich is to buy asset first and liability later. Invest in an asset and the money from that investment pays off your liability. After completing this payment, one still has a positive cashflow generating asset.
3 Types of Income
Earned, Portfolio and Passive. Earned income = job. Portfolio income = Capital Gain. Passive income comes in on a regular basis, from interests, dividends, real estates and businesses. Taxes are your highest expense and is highest in earned incomes. Those in the E or I segment have earned income. Portfolio and passive income are taxed less. Work hard for Portfolio and Passive Income. Learn to be a B or I.
Investing Isn't Risky
What is risky is lack of financial intelligence or education (still your best asset). For sophisticated investors (whether fundamental or technical), risk is reduced through using insurance (put, stop, etc.) to counter the risk of volatility. Taking advice from those with no investing knowledge is risky.
Life's 4 Quarters
10 years quarters from age 25 years to 65 years. 1st Quarter = age 25 to 35 years. 2nd Quarter = age 36 to 45 years. Age 45 - half time. 3rd Quarter = age 46 to 55 years. 4th Quarter = age 56 to 65 years. At 65 - Overtime. After that - Out -of- time. Aim to retire in the 2nd Quarter!!!!! At which age will you win the game of money? Some are lucky, they were born rich. Work hard, save money, invest in mutual funds and 401-K may not be enough to retire early. You will have to work hard all your life. Why not retire young and enjoy life? Why retire old and continue to work overtime and out-of-time?
The CASHFLOW Game
2 tracks - the rat race and the fast track. Most people are stuck in the rat race. Get out of the rat race and get onto the fast track. Get the money to work for you. There are 4 levels of investing played in the game: small deals, big deals, fast track and sophisticated investing (or Cash Flow 202). You have to be a rich person to invest in the fast track. To invest in the fast track, one has to be rich and financially educated. The other part of this CASHFLOW Game is a financial statement. A financial statement is very important aspect of your education. Your banker never ask you for your report card, but your financial statement. This game puts investing and accounting together. Have fun, learn from mistakes through the game. Teach other people. The more you teach, the more you learn. Make mistakes, take risk, have fun and get rich. The "poor dad" is poor because he is terrified of making mistakes.
The Cone of Learning
Could the CASHFLOW Game enhance the knowledge of finance and business? Passive learning (reading, lecture) vs Active learning (doing the real thing, just do it, play games). Best way to learn is to do the real thing. 2nd best way is to stimulate the real experience. CASHFLOW Games 101 and 202 fulfill the active learning role. Beware, most financial advisors are sales people. Play the game over and over again before going into the real thing.
IT'S TIME TO GET OUT OF THE RAT RACE
http://www.richdad.com/store/ProductDetail.aspx?id=1
http://cashflow.vo.llnwd.net/o16/cashflow3.swf
CashFlow 101 the E-Game: Intorduction 1
http://www.youtube.com/watch?v=4ug483UeEXs&feature=related
Cashflow Game 101
http://www.youtube.com/watch?v=uqZayPhdUJc&feature=related
Cashflow 202, Introduction
http://www.youtube.com/watch?v=-zGqzbfEvug&feature=related
Robert Kiyosaki : Cashflow Game 202, Overview!
http://www.youtube.com/watch?v=BUbODHeQd1g&feature=related
Cashflow Board Game - Rich Dad Poor Dad Game
http://www.youtube.com/watch?v=X4WcGWhjUS0&feature=related
Cashflow 101 take 1
http://www.youtube.com/watch?v=KresjGfPIW8&feature=related
Cashflow 101 take 2
http://www.youtube.com/watch?v=MHxOSr_jqqg&feature=related
Cashflow 202 take 1
http://www.youtube.com/watch?v=ZnrWo3LDi9E&feature=related
Cashflow 202 take 2
http://www.youtube.com/watch?v=RCFyxC7dQQM&feature=related
Robert Kiyosaki in Israel October 2007
http://www.youtube.com/watch?v=SMLjNjXojmc&feature=related
Saturday 16 May 2009
7 Levels of Investors
7 Levels of Investors according to Kiyosaki
Level 0: Those with nothing to Invest
50% of adult population
Level 1: Borrowers
Pay up to 24% interest
Anything owned of value is financed with debt
Level 2: Savers
Earn 3-5% on savings
Save to consume rather than to invest
Level 3: "Smart" Investors
"Head in Sand"
"Cynics" (fear + ignorance = arrogance)
"Gamblers" (faking it)
Level 4: Long-Term Investors
Earn 8-12% Compounded
Periodic, tax-advantaged, diversified
Level 5: Sophisticated Investors
Earn 25% and up
Focused, not diversified
Level 6: Capitalists
Earn 100% and up
Create investments to sell to the market
From Level 5 to Level 6, the investor assumes more responsibility.
http://www.theinvestorsparadigm.com/invest/Cash-Flow-Investment-Strategies.php?refid=325745514fd2a1b68a99288f9e8d37cc
Level 0: Those with nothing to Invest
50% of adult population
Level 1: Borrowers
Pay up to 24% interest
Anything owned of value is financed with debt
Level 2: Savers
Earn 3-5% on savings
Save to consume rather than to invest
Level 3: "Smart" Investors
"Head in Sand"
"Cynics" (fear + ignorance = arrogance)
"Gamblers" (faking it)
Level 4: Long-Term Investors
Earn 8-12% Compounded
Periodic, tax-advantaged, diversified
Level 5: Sophisticated Investors
Earn 25% and up
Focused, not diversified
Level 6: Capitalists
Earn 100% and up
Create investments to sell to the market
From Level 5 to Level 6, the investor assumes more responsibility.
http://www.theinvestorsparadigm.com/invest/Cash-Flow-Investment-Strategies.php?refid=325745514fd2a1b68a99288f9e8d37cc
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