Blue-Chip Stocks

"Blue chips are companies that pay a dividend and increase it over time."

Blue Chips

Blue chips are the cream of the common stock crop.

They are stocks issued by companies that have a long track record of earning profits and paying dividends.  

Blue-chip stocks are issued by large, well-established firms that have impeccable financial credentials.

These companies are often the leaders in their industries.




Not all blue chips are alike.

Some provide consistently high dividend yields; others are more growth oriented.

While blue-chip stocks are not immune from bear markets, they are less risky than most stocks.

They tend to appeal to investors who are looking for quality, dividend-paying investments with some growth potential.

Blue chips appeal to investors who want to earn higher returns than bonds typically offer without taking a great deal of risk.



Examples:

Good examples of blue chip growth stocks are:

• Nike,
• Procter & Gamble,
• Home Depot,
• Walgreen's,
• Lowe's Companies, and 
• United Parcel Service.

Examples of high-yielding blue chips include such companies as:

• AT&T,
• Chevron,
• Merck,
• Johnson & Johnson,
• McDonald's, and 
• Pfizer.

The Advantages of Stock Ownership

1.  Possibility for substantial returns

One reason stocks are so appealing is the possibility for substantial returns that they offer.

Stocks generally provide relatively high returns over the long haul.

Common stock returns compare very favourably to other investments such as long-term corporate bonds and U.S. Treasury securities.

Over the last century, high-grade corporate bonds earned annual returns that were about half as large as the returns on common stocks.

Although long term bonds outperform stocks in some years, the opposite is true more often than not.

Stocks typically outperform bonds, and usually by a wide margin.

Stocks also provide protection from inflation because over time their returns exceed the inflation rate.

In other words, by purchasing stocks, you gradually increase your purchasing power.



2.  Ease of buying and selling

Stocks are easy to buy and sell, and the costs associated with trading stocks are modest.



3.  Information easily available

Information about stock prices and the stock market is widely disseminated in the news and financial media.



4.  Cost to own stocks is low.

The unit cost of a share of common stock is typically fairly low.    

Unlike bonds, which normally carry minimum denominations of at least $1,000 and some mutual funds that have fairly hefty minimum investments, common stocks don't have such minimums.

Most stocks are priced less than $50 a share and you can buy any number of shares that you want.





Additional notes:

Investors own stocks for all sorts of reasons:
1.  the potential for capital gains,
2.  their current income, or
3.  perhaps the high degree of market liquidity.

The Disadvantages of Stock Ownership

There are some disadvantages of common stock ownership.

1.  Risk

Risk is perhaps the most significant.

Stocks are subject to various types of risk, including:

• business and financial risk,
• purchasing power risk,
• market risk and 
• event risk.

All of these can adversely affect 

• a stock's earnings and dividends, 
• its price appreciation and 
• of course, the rate of return that you earn.

Even the best of stocks possess elements of risk that are difficult to eliminate because company earnings are subject to many factors, including:

• government control and regulation,
• foreign competition and
• the state of the economy.

Because such factors affect sales and profits, they also affect stock prices and (to a lesser degree) dividend payments.

2. Price & Returns Volatility

All of this leads to another disadvantage: stock returns are highly volatile and very hard to predict, so it is difficult to consistently select top performers.

The stock selection process is complex because so many elements affect how a company will perform.

In addition, the price of a company's stock today reflects investors' expectations about how the company will perform.

In other words, identifying a stock that will earn high returns requires that you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) but also that you can spot that opportunity before other investors do and bid up the stock price.

3. Current income

A final disadvantage is that stocks generally distribute less current income than some other investments.

Several types of investments - bond, for instance - pay more current income and do so with much greater certainty.

Comparing the dividend yield on common stocks with the coupon yield on high grade corporate bonds from 1976 to 2012,  shows the degree of sacrifice common stock investors make in terms of current income.

Clearly, even though the yield gap has narrowed a great deal in the past few years, common stocks still have a long way to go before they catch up with the current income levels available from bonds an most other types of fixed-income securities.

Message:  

In other words, identifying a stock that will earn high returns requires that:

• you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) 
• but also that you can spot that opportunity before other investors do and bid up the stock price.

Uses of Common Stocks: as storehouse of value, to accumulate capital and as a source of income

Basically, common stocks can be used as:

1.  a "storehouse" of value,
2.  a way to accumulate capital, and,
3.  a source of income.


Storage of value

Storage of value is important to all investors, as nobody like to lose money.

However, some investors are more concerned about losses than are others.

They rank safety of principal as their most important stock selection criterion.

These investors are more quality-conscious and tend to gravitate toward blue chips and other non-speculative shares.


Accumulation of capital

Accumulation of capital, in contrast, is generally an important goal to those with long-term investment horizons.

These investors use the capital gains and/or dividends that stocks provide to build up their wealth.

Some use growth stocks for this purpose, while others do it with income shares, and still others us a little of both.


Source of income

Finally, some investors use stocks as a source of income.

To them, a dependable flow of dividends is essential.

High-yielding, good-quality income shares are usually their preferred investment vehicle.




Individual investors can use various investment strategies to reach their investment goals.

These include:

1. buy and hold,
2. current income,
3. quality long term growth,
4. aggressive stock management, and 
5. speculation and short term trading.

The first 3 strategies appeal to investors who consider storage of value important.

Depending on the temperament of the investor and the time he or she has to devote to an investment program, any of these strategies might be used to accumulate capital.

In contrast, the current income strategy is the logical choice for those using stocks as a source of income.

Singapore investors lost over S$1 mil to online binary options scams

SINGAPORE (Dec 15): Singapore police has issued a warning over a “sharp rise” in scams involving online trading in binary options.

The Commercial Affairs Department (CAD) has received more than 30 reports from investors who have lost more than S$1 million to unregulated binary options trading platforms, authorities said in a press release on Wednesday.

Police said most victims are local Chinese males aged between 31 and 50, and include finance professionals as well as retirees.

“Binary options trading is attractive, because it sounds simple and the option providers or platforms often promise high, quick and safe returns,” police said in its statement. “In reality, binary options are speculative and risky, and many online platforms offering binary options trading are fraudulent.”


All or nothing

With a binary option, investors try to predict whether the price of the underlying asset will be above or below a specified price at a specified point in time.

That specified point in time is usually very near, ranging from a few minutes to a few months in the future.

Meanwhile, the underlying products can range widely, and include shares, currencies and commodities.

Unlike other types of options, holding a binary option does not give the investor the right to buy or sell the underlying asset. Investors receive a fixed payoff, if their prediction is correct, but lose the entire investment if they are wrong.

“That is why binary options are often also called ‘all or nothing’ options,” police said. “The risk of losing your entire investment is high, because correctly predicting short term price movements is difficult.”

Singapore investors lost over S$1 mil to online binary options scams

An investigation by Money Mail and the Bureau of Investigative Journalism found that the vast majority of binary option traders never make any money from it.

Some eight in 10 customers are reported to end up losing all their cash within five months. At some binary firms, the investigations revealed that just three in 100 customers ever make a profit.

Lured by initial profits and promises of financial advice, more bonuses and attractive rewards, most of the investors found it difficult to stop at one small investment and would put in more money.

In Singapore, these investors either lost all their monies or could not withdraw the balances in their accounts, police said.

Some also had unauthorised withdrawals made in their debit or credit cards after they had handed over their card details for payment.

Authorities said most of the binary options trading platforms encountered were usually unregulated entities based outside Singapore.

When things go wrong, the victims faced difficulties contacting these foreign operators, who commonly claim to be operating from the United Kingdom, Cyprus and Hong Kong.


Beware of scams

Police urged Singaporeans to exercise caution and keep in mind the following when dealing with binary options trading:

a) Even when offered by legitimate sellers, binary options trading is a high risk investment where you can easily lose all that you invested.

b) Investments which promise high returns usually come with high risks. Think carefully before making the investment. When in doubt, seek professional advice before engaging in any investment products.

c) Dealing with unregulated entities mean you may have very little recourse if things go wrong.

To find out which entities are regulated in Singapore, check the list of capital markets services licence holders under Monetary Authority of Singapore (MAS) and the list of licensed commodity brokers under International Enterprise (IE) Singapore.

You may also like to check the MAS Investor Alert List, which provides a listing of unregulated entities which may have been wrongly perceived as being licensed or authorised by MAS.

d) Even if you are dealing with an entity regulated in Singapore, some binary options offered by that regulated entity may not be regulated. This means that you may have minimal recourse if things go wrong. When in doubt, you should check with the regulated entity before investing in any binary option it offers.

e) Be wary of third party reviews, endorsements or success stories of binary option providers. These reviews and endorsements may have been paid for by the binary option providers. They may also attempt to gain your trust by warning you against a particular binary option provider while directing you to another binary option provider connected to them.

f) Be cautious of high pressure sales tactics used by representatives of binary option providers. These tactics include promises of quality financial advice or easy profits.

g) Be careful when sending money to overseas bank accounts via fund transfers, debit or credit card payments, and any other modes of payment. Always ensure that the end recipient is reliable before making any transfers or payments.

Likewise, do not give your personal particulars such as your name, identification number, passport details, bank account or credit and debit card details to others without first verifying whether they are legitimate.

http://www.theedgemarkets.com/my/article/singapore-investors-lost-over-s1-mil-online-binary-options-scams

ROE as a proxy for Competitive Advantage

The DuPont formula

ROE= (Net Profit/ Sales) X (Sales/ Assets) X (Assets/ Equity)

And we are left with:   

ROE = Net Profit/ Equity

The DuPont breakdown goes on to show why ROE is such a critical ratio for analysts and investors alike. 

It basically is combination of three ratios that reflect overall profitability and efficiency of a company. 

This breakdown also shows the bearing of six factors on ROE instead of the usual two that we assume are the beginning and end of it.

ROE as a proxy for Competitive Advantage:

Consistently High RoE figures do indicate that the company has a moat. 

As seen above in the Dupont breakdown of RoE, a company can have a high RoE 

• either because it is able to sell its goods/services at a high margin 
• or because  increase its returns by either selling its products at a high rate. 

Only the third option is undesirable i.e having a high leverage which would mean high indebtedness . 

Remember, we said a consistently high levels of RoE to be construed as an evidence of a moat. 

This is because the denominator of this ratio includes shareholders equity which in turn consists of   share capital plus retained earnings (also called reserves and surplus)

Share holder's equity= Share capital + Retained earnings

Now as the company generates higher returns on equity, the profits are added to the retained earnings. 

So the denominator of ROE keeps increasing and so either the company has to

•  keep showing growth in its profits or 
• find ways to reduce the denominator. 

The company can do that by 

• either paying higher dividends 
• or buying back shares

- both strategies lead to gains for shareholders. 

http://www.investorwhiz.com/concepts/return-on-equity-roe

Working capital management is the main determinant in the liquidity position of a company.

Liquidity or Working Capital Ratios

Cash Conversion cycle is just one part of assessing the working capital position. 

Other is the computation of 

• Current Ratio, 
• Acid-test Ratio and 
• Cash Ratio. 

Current Ratio

Current Ratio is the basic and the most used amongst the list of liquidity ratios. 

It is also known as working capital ratio and is stated as below:

Current Ratio= Current Assets/ Current Liabilities

The resultant figure represents the number of times current assets cover current liabilities. 

Higher the ratio better it is. 

However, this ratio can be higher even if cash is trapped in receivables and inventories.

Acid Test Ratio

Acid test ratio is also known as quick ratio and it considers only “highly” liquid assets in consideration.

Acid Test ratio = (Current Assets- Stock- prepaid expenses)/ Current Liabilities

Acid test ratio doesn't include inventories but does include receivables and so thought a refinement of current ratio may still mislead at times

Cash Ratio

This one is a further refinement of Acid Test ratio and considers only Cash and cash equivalents for the purpose of measuring liquidity. 

Cash Ratio = Cash + Cash equivalents / Current liabilities

The above ratios and Cash Conversion Cycle determine the working capital position of a company. 

However, we always maintain that one aspect of the entire financial position cannot be considered as representative of the total financial health of a company. 

So here are a few cautionary words for cases when you just have working capital figures to contend with.

Factors to consider when assessing working capital position of a Company

1.    Healthy and unhealthy working capital position can be generalized only according to the industry and sector an entity is operating in. Some entities by nature have higher liquidity and some low;

2.    Higher liquidity is not always favourable as it may indicate under-utilisation of resources and money. You will need to further dig in to find if this is the case;

3.    Consider recent sale, purchase, construction of an asset, pre-closure of loan or liquidation of a big liability owing to strategic decisions that affect liquidity tremendously;

4.    Change in trade terms, seasonal nature of goods sold also has a strong bearing on liquidity position.

Working capital management is extremely important for companies. 

It is the main determinant in the liquidity position of a company. 

Profitable companies can go bankrupt due to a paucity of liquidity.  

http://www.investorwhiz.com/concepts/understanding-working-capital

Components of Cash Conversion Cycle

Cash Conversion Cycle (CCC)

Cash Conversion cycle is the time taken by a trading or manufacturing concern to realise cash from its inventory and account receivables after meeting its outflows owing to short term payables including trade creditors. 

It is expressed in terms of number of days and can be defined as follows in form of a formula:-

CCC= Days’ Inventory Outstanding (DIO) + Days’ Sale Outstanding (DSO) – Days’ Purchase Outstanding (DPO)

Components of Cash Conversion Cycle - DIO, DSO and DPO

Days’ Sale Outstanding (DSO)

DSO is the measure to assess the number of days a concern gives credit to its customers. Let us explain it with a formula:
DSO= Average receivables/ daily sale
Where
Average receivables: Opening balance + Closing Balance/2
Daily sales: Total annual sale/365

DSO can be calculated for every month as well. In fact when there is a revamp of credit terms then DSO should be computed for every month to understand the implication and drop or hike in DSO, as the case may be.

Days’ Purchase Outstanding (DPO)

DPO gives average credit term (days of credit) enjoyed by a concern from its trade creditors. In term of formula, it can be stated as follows:
DPO= Average payables/ Daily purchases
Where,
Average payables= Opening balance+ Closing Balance/2
Daily purchases= Total purchases/365
Just like DSO, DPO can also be computed monthly or any period of time as required.

Importance and usage of DSO and DPO

Now that we have discussed the meaning of DSO and DPO, let us understand their implication on a business and cash conversion cycle. 

Ideally, every trading concern must try to have a bigger DPO and smaller DSO, which essentially implies that they recover cash from debtors in shorter duration and pay off their creditors later.

For e.g. ABC Company has a DSO of 30 days and DPO of 40. This gives an advantage of 10 extra days to ABC Company to meet its payables and it enjoys healthy liquidity to meet its other production and day to day expenses as well.

DSO comparisons also help in effective credit control. If without any re-negotiations, a company observes that its DSO has risen then it means that the collection process is not working well. This situation can be rectified in many ways including putting processes like advance reminders and water tight system of invoicing in place for the starters. If a company has indeed renegotiated terms with both debtors and creditors, then the month on month DSO and DPO comparisons would show the result in line with such re-negotiations.

Days’ Inventory Outstanding (DIO)

The third pillar of CCC deals with inventory. DIO is the average days a trading concern takes to convert its inventory into sale and is stated as follows:
DIO= Average Inventory/ Day’s Cost of goods sold
Where,
Average inventory= Opening Balance + Closing Balance/2
Day’s cost of goods Sold (COGS)= Cost of goods sold/365
If the accounting period for which DIO is to be computed is shorter, then day’s COGS will be computed for such other period and 365 days will get replaced accordingly.

An Example

Cash Conversion Cycle (CCC) 

= (DIO + DSO) – DPO 
= (44 + 33) - 61

= 16 days

The above computation shows that the average days of credit granted by XYZ Corp is almost half at 33 days as compared to the credit days lent by it, which is 61 days.

The average days it takes XYZ Corp to sell its stock is 44 days and the number of days in which it converts its inventory and debtors into cash is just 16 days.

These figures picture a very liquid position of XYZ Corp where it is able to meet its able to generate working capital very efficiently.     

Ideally, every trading concern must try to have a bigger DPO and smaller DSO, which essentially implies that they recover cash from debtors in shorter duration and pay off their creditors later.

http://www.investorwhiz.com/concepts/understanding-working-capital

Understanding Working Capital

1. The above figure shows a typical working capital cycle. 
2. Cash is used to purchase raw materials . 
3. The raw materials are then turned into finished goods and sold to customers, usually for a credit period. 
4. Ultimately payment is received in cash from the customer and the cycle repeats. 

Sometimes working Capital can turn negative but before jumping to conclusion about it let us discuss it in length.

What Does Negative Working Capital Mean?

Now the first conclusion about negative working capital would be low efficiency and fact that an entity needs external funding even for day to day operations. 

But having excess of short term liabilities over short-term assets is not always unfavourable. 

• A sudden surge in creditors or dip in debtors can be result of one-off bulk payments and adjustments that make working capital negative but for a short period of time.  

A negative working capital which sustains over extended period is definitely a cause of concern.

• It could be because the finished product is being sold at very low margins or loss. This strategy is sometimes followed by companies who are looking at either increasing their market share or introducing new products. 
• Another instance is sizeble bad debts where debtors have gone bankrupt or refused to pay.  In such a situation the debtors will have a write-off which would result in a dip in current assets. 
• Loss in inventory by accident can also lead to negative working capital. 

But for example- financing a fixed asset by cash will make a hit at current assets position but it is a sign of efficiency where you are able to make investment in fixed assets by using internally generated funds!

• So this is an instance of a favourable negative working capital.

Working capital is a critical factor to consider in assessing the financial health of any business vis. a vis. the efficient use of its resources. 

http://www.investorwhiz.com/concepts/understanding-working-capital

Principles of Portfolio Planning

Investors benefit from holding portfolios of investments rather than single investments.

Without necessarily sacrificing returns, investors who hold portfolios can reduce risk.

Surprisingly, the volatility of a portfolio may be less than the volatilities of the individual assets that make up the portfolio.

When it comes to portfolios and risk, the whole is less than the sum of its parts!



Investment Goals

A portfolio is a collection of investments assembled to meet one or more investment goals.

Different investors have different objectives for their portfolios.

The primary goal of a growth-oriented portfolio is long-term price appreciation.

An income-oriented portfolio is designed to produce regular dividends and interest payments.




Portfolio Objectives

Setting portfolio objectives involves definite tradeoffs, such as the tradeoff

• between risk and return or 
• between potential price appreciation and income.

How you evaluate these tradeoffs will depend on your tax bracket, current income needs, and the ability to bear risk.

The key point is that your portfolio objectives must be established BEFORE you begin to invest.

The ultimate goal of an investor is an efficient portfolio, one that provides the highest return for a given level of risk.

Efficient portfolios are not necessarily easy to identify.

You usually must search out investment alternatives to get the best combinations of risk and return.

An Acceptable Level of Risk

Individuals differ in the amount of risk that they are wiling to bear and the reurn that they require as compensation for bearing that risk.


1.  The risk-indifferent investor requires no change in return for a given increase in risk.

2.  The risk-averse investor requires an increase in return for a given risk increase.

3.  The risk-seeking investor gives up some return for more risk.


The majority of investors are risk averse.

The historical data on the risk and return of different investments from all over the work indicate that riskier investments tend to pay higher returns.

This simply reflects the fact that most investors are risk averse, so riskier investments must offer higher returns to attract buyers.



How much additional return is required to convince an investor to purchase a riskier investment?

The answer to that question varies from one person to another depending on the investor's degree of risk aversion.

A very risk-averse investor requires a great deal of compensation to take on additional risk.

Someone who is less risk averse does not require as much compensation to be persuaded to accept risk.

Determining a Satisfactory Investment

Time value of money techniques can be used to determine whether an investment's return is satisfactory given the investment's cost.

Ignoring risk at this point, a satisfactory investment would be one for which the present value of benefits (discounted at the appropriate discount rate) equals or exceeds its cost.



The three possible cost-benefit relationships and their interpretations follow:

1.  If the present value of the benefits equals the cost, you would earn a rate of return equal to the discount rate.

2.  If the present value of benefits exceeds the cost, you would earn a rate of return greater than the discount rate.

3.  If the present value of benefits is less than the cost, you would earn a rate of return less than the discount rate.



You would prefer only those investments for which the present value of benefits equals or exceeds its cost - situations 1 and 2.

In these cases, the rate of return would be equal to or greater than the discount rate.

Dividend - An Easy Pill to Swallow

On the first trading day of 2016, the stock of a company XYZ, sold for $33.66 per share, just 1.6% higher than its price exactly 1 year earlier ($33.16).

Though it might seem that 2016 was a poor year for company XYZ's shareholders, the stock paid dividends during the year totalling $1.52 and those dividends raised the total return on company XYZ in 2016 to 6.2%.

Why Return is Important

An asset's return is a key variable in the investment decision because it indicates how rapidly an investor can build wealth.

Naturally, because most people prefer to have more wealth rather than less, they prefer investments that offer high returns rather than low returns if all else is equal.

However, the returns on most investments are uncertain, so how do investors distinguish assets that offer high returns from those likely to produce low returns?

One way to make this kind of assessment is to examine the returns that different types of investments have produced in the past.


Historical Performance

Most people recognize that future performance is not guaranteed by past performance, but past data often provide a meaningful basis for future expectations.

A common practice in the investment world is to look closely at the historical record when formulating expectations about the future.

Cash Flow from Financing Activities

This is where the company reports the money that it took in and paid out in order to finance its activities. 

In other words, it calculates how much money the company spent or received from its stocks and bonds. 

This includes 

• any dividend payments that the company made to its shareholders, 
• any money that it made by selling new shares of stock to the public, 
• any money it spent buying back shares of its stock from the public, 
• any money it borrowed, and 
• any money it used to repay money it had previously borrowed.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/

Cash Flows from Investing Activities

This section shows how much money the company has received (or lost) from its investing activities. 

It includes 

• money that the company has made (or lost) by investing its excess cash in different investments (stocks, bonds, etc.), 
• money the company has made (or lost) from buying or selling subsidiaries, and 
• all the money the company has spent on its physical property, such as plants and equipment.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/

Cash Flows from Operating Activities

This is how much money the company received from its actual business operations.

This does not include cash received from other sources, such as investments. 

To calculate the cash flow from operating activities, the company starts with net income (from the income statement), then adds back in any 

• depreciation expenses, 
• deferred taxes, 
• accounts payable and accounts receivables, and 
• one-time charges.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/

Free Cash Flow

While free cash flow doesn't receive as much publicity as earnings do, it is considered by some experts to be a better indicator of a company's bottom line. 

Free cash flow is the amount of cash that a company has left over after it has paid all of its expenses, including investments. 

Whereas earnings reports are subject to a number of different accounting tricks which can artificially boost the bottom line, free cash flow is not. 

It is quite possible, for example, for a company to have positive earnings and negative free cash flow. 

Negative free cash flow is not necessarily an indication of a bad company, however; many young companies tend to put a lot of their cash into investments, which diminishes their free cash flow. 

But if a company is spending so much cash, you should probably be investigating 

• why it is doing so and 
• what sort of returns it is earning on its investments.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/

Current Account Deficit

A current account deficit occurs when a country spends more money on the goods and services it imports than it receives for the goods and services it exports. In other words, more money is leaving the country than flowing into it. The current account consists of money received and paid out for goods, services, investments, salaries, pension payments to foreign workers and money workers send to family members abroad.

When a country has a current account deficit, it must make up for the shortfall. A current account deficit is financed from the capital account and the financial account, which contain the money a country sends out and brings in from buying and selling tangible assets and foreign currency and from foreign direct investment.

Current account deficits are common in highly developed countries and in highly underdeveloped countries. Countries with emerging markets typically have current account surpluses.

Whether a current account deficit is bad or not depends on why it exists and how it is being paid for. A current account deficit might exist because a country is importing the inputs for goods it will export later; it may then create a current account surplus. It can also mean that foreign investors see the country as a desirable place to invest. While the domestic country will pay returns to those foreign investors, the additional capital can help expand the domestic economy.

On the other hand, a country could be overspending on expensive exports when it would be better off increasing domestic production. Also, a longstanding current account deficit could saddle future generations with debt and interest payments. A current account deficit also puts a country at risk of facing financial or political pressure from foreign suppliers.


Read more: Current Account Deficit - Video | Investopedia http://www.investopedia.com/video/play/current-account-deficit/#ixzz4SJbfqOWA
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http://www.investopedia.com/video/play/current-account-deficit/

Current Account Balance in Balance of Payment

Current Account

The current account reflects the difference between a country’s savings and investments.

The three components of the current account are:

• The sum of the balance of trade (goods and services exports, less imports)
• Net income from abroad
• Net current transfers

By looking at a country’s current account, analysts are able to get a good indication of how a country is doing economically.

 If the country’s current account has a surplus balance, it means the country is a net lender as it relates to the rest of the world.

 Conversely, a deficit balance means the country is a net borrower.

But a current account deficit is not always a bad thing. Most often it is the result of temporary economic cycles.

For instance, a country with a surplus balance has been providing more resources to the rest of the world than it has been taking in.

The deficit balance country has been taking in more resources than it has been exporting.

In effect, the surplus balance countries have been financing the economic activities of the deficit countries.

Most likely, the deficit country government has made a decision to invest for future growth.

By taking in outside resources, and thus a deficit balance in its current account, it can use those resources for internal growth and someday become a country with a surplus current account.


Read more: Current Account - Video | Investopedia http://www.investopedia.com/video/play/current-account/#ixzz4SJY4D84B


http://www.investopedia.com/video/play/current-account/

Exploring The Current Account In The Balance Of Payments

The balance of payments (BOP) is the place where countries record their monetary transactions with the rest of the world. Transactions are either marked as a credit or a debit. Within the BOP there are three separate categories under which different transactions are categorized:

• the current account, 
• the capital account and 
• the financial account. 

In the current account, goods, services, income and current transfers are recorded.

In the capital account, physical assets such as a building or a factory are recorded.

And in the financial account, assets pertaining to international monetary flows of, for example, business or portfolio investments, are noted.

In this article, we will focus on analyzing the current account and how it reflects an economy's overall position.


The Current Account

The balance of the current account tells us if a country has a deficit or a surplus.

If there is a deficit, does that mean the economy is weak?

Does a surplus automatically mean that the economy is strong? Not necessarily.

But to understand the significance of this part of the BOP, we should start by looking at the components of the current account:

• goods, 
• services, 
• income and 
• current transfers.

1. Goods - These are movable and physical in nature, and in order for a transaction to be recorded under "goods", a change of ownership from/to a resident (of the local country) to/from a non-resident (in a foreign country) has to take place. Movable goods include general merchandise, goods used for processing other goods, and non-monetary gold. An export is marked as a credit (money coming in) and an import is noted as a debit (money going out).

2. Services - These transactions result from an intangible action such as transportation, business services, tourism, royalties or licensing. If money is being paid for a service it is recorded like an import (a debit), and if money is received it is recorded like an export (credit).

3. Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio investments (in the form of dividends, for example), direct investments or any other type of investment. Together, goods, services and income provide an economy with fuel to function. This means that items under these categories are actual resources that are transferred to and from a country for economic production.

4. Current Transfers - Current transfers are unilateral transfers with nothing received in return. These include workers' remittances, donations, aids and grants, official assistance and pensions. Due to their nature, current transfers are not considered real resources that affect economic production.

Now that we have covered the four basic components, we need to look at the mathematical equation that allows us to determine whether the current account is in deficit or surplus (whether it has more credit or debit). This will help us understand where any discrepancies may stem from, and how resources may be restructured in order to allow for a better functioning economy.


The following variables go into the calculation of the current account balance (CAB):
X = Exports of goods and services
M = Imports of goods and services
NY = Net income abroad
NCT = Net current transfers

The formula is:
CAB = X - M + NY + NCT


What Does It Tell Us?

Theoretically, the balance should be zero, but in the real world this is improbable, so if the current account has a surplus or a deficit, this tells us something about the government and state of the economy in question, both on its own and in comparison to other world markets.

A surplus is indicative of an economy that is a net creditor to the rest of the world. It shows how much a country is saving as opposed to investing. What this means is that the country is providing an abundance of resources to other economies, and is owed money in return. By providing these resources abroad, a country with a CAB surplus gives other economies the chance to increase their productivity while running a deficit. This is referred to as financing a deficit.

A deficit reflects government and an economy that is a net debtor to the rest of the world. It is investing more than it is saving and is using resources from other economies to meet its domestic consumption and investment requirements. For example, let us say an economy decides that it needs to invest for the future (to receive investment income in the long run), so instead of saving, it sends the money abroad into an investment project. This would be marked as a debit in the financial account of the balance of payments at that period of time, but when future returns are made, they would be entered as investment income (a credit) in the current account under the income section.

A current account deficit is usually accompanied by depletion in foreign-exchange assets because those reserves would be used for investment abroad. The deficit could also signify increased foreign investment in the local market, in which case the local economy is liable to pay the foreign economy investment income in the future.

It is important to understand from where a deficit or a surplus is stemming because sometimes looking at the current account as a whole could be misleading.


Analyzing the Current Account

Exports imply demand for a local product while imports point to a need for supplies to meet local production requirements. An export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.

A deficit could also stem from a rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit.

So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the developing stages or under reform: an economy sometimes has to spend money to make money. To run a deficit intentionally, however, an economy must be prepared to finance this deficit through a combination of means that will help reduce external liabilities and increase credits from abroad. For example, a current account deficit that is financed by short-term portfolio investment or borrowing is likely more risky. This is because a sudden failure in an emerging capital market or an unexpected suspension of foreign government assistance, perhaps due to political tensions, will result in an immediate cessation of credit in the current account.

The Bottom Line

The volume of a country's current account is a good sign of economic activity. By scrutinizing the four components of it, we can get a clear picture of the extent of activity of a country's industries, capital market, services and the money entering the country from other governments or through remittances. However, depending on the nation's stage of economic growth, its goals, and of course the implementation of its economic program, the state of the current account is relative to the characteristics of the country in question. But when analyzing a current account deficit or surplus, it is vital to know what is fueling the extra credit or debit and what is being done to counter the effects (a surplus financed by a donation may not be the most prudent way to run an economy). On a separate note, the current account also highlights what is traded with other countries, and it is a good reflection of each nation's comparative advantage in the global economy.


By Reem Heakal

Read more: Exploring The Current Account In The Balance Of Payments | Investopedia http://www.investopedia.com/articles/03/061803.asp#ixzz4SJNYJxla
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The Advantages and Disadvantages of Margin Trading

The Advantages of Margin Trading

1.   A magnified return is the major advantage of margin trading.

The size of the magnified return depends on both the price behaviour of the security and the amount of margin used.

2.   Another more modest benefit of margin trading is that it allows for greater diversification of security holdings because investors can spread their limited capital over a larger number of investments.



The Disadvantages of Margin Trading

1.   The major disadvantages of margin trading, of course, is the potential for magnified losses if the price of the security falls.

2.   Another disadvantage is the cost of the margin loans themselves.  

A margin loan is the official vehicle through which the borrowed funds are made available in a margin transaction.

All margin loans are made at a stated interest rate, which depends on prevailing market rates and the amount of money being borrowed.

This rate is usually 1% to 3% above the prime rate - the interest rate charged to creditworthy business borrowers.

For large accounts, it may be at the prime rate.

The loan cost, which investors pay, will increase daily, reducing the level of profits (or increasing losses) accordingly.




Take home message:

Margin trading can only magnify returns, not produce them.

One of the biggest risks is that the security may not perform as expected.

If the security's return is negative, margin trading magnifies the loss.

Because the security being margined is always the ultimate source of return, choosing the right securities is critical to this trading strategy.

DCF analysis is the most popular valuation methodology today. Growth (or lack of it) is an integral to a valuation exercise.

Discounted Cash Flow analysis to determine Intrinsic Value

The value of a business, a share of stock, or any other productive asset is the present value of its future cash flows.

Discounted cash flow (DCF) analysis (intrinsic value principle of John Burr Williams) is the most popular valuation methodology today.

Its popularity, however, hides the important reality that value is easier to define than to measure (easier said than done).

The tools Graham (margin of safety principle) and Fisher (business franchise principle) developed remain crucial in this exercise.



Value stocks versus Growth stocks:  this distinction has limited difference.

One hazard of undue reliance on DCF analysis is a temptation to classify stocks as either value stocks or growth stocks.  It is a distinction with limited difference.

Value a business (or any productive asset) requires estimating its probable future performance and discounting the results to present value.

The probable future performance includes whatever growth (or shrinkage) is assumed.

So growth (or lack of it) is integral to a valuation exercise.

Investing is the deliberate determination that one pays a price lower than the value being obtained.

Only speculators pay a price hoping that through growth the value rises above it.



Conventional Value Investing = low P/E, low P/BV and high DY companies

Value investing is conventionally defined as buying companies bearing low ratios of price-to-earnings, price-to-book value, or high dividend yields.

But these metrics do not by themselves make a company a value investment.  It is not that simple.

Nor does the absence of such metrics prevent an investment from bearing a sufficient margin of safety and qualitative virtues to justify its inclusion in a value investor's portfolio.




Growth doesn't equate directly with value either.

Growing earnings can mean growing value.

But growing earnings can also mean growing expenses, and sometimes expenses growing faster than revenues.

Growth adds value only when the payoff from growth (revenue) is greater than the cost of growth (expenses).

A company reinvesting a dollar of earnings to grow by 99 cents is not helping its shareholders and is not a value stock, though it may be a growth stock.




Read also:

Value Vs Growth

http://klse.i3investor.com/blogs/kcchongnz/45456.jsp

What drives the return of your stock investment, Growth or Value?

http://klse.i3investor.com/blogs/kcchongnz/81690.jsp

“In our opinion, the two approaches (value and growth) are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive…In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid?”      Warren Buffett Letters to investor, 1992.

The THREE Big Investing Principles

Margin of Safety Principle  -  Benjamin Graham

Intrinsic Value Principle - John Burr Williams

Business Franchise# Principle - Philip A. Fisher


Warren Buffett is the consummate and best known integrator of these three principles.

Buffett practices a comprehensive method of value investing.

He refers to the exercise as investing, viewing the modifier "value" as redundant.



# Franchise = company exhibiting strong long-term prospects.

Are certain parties privy to inside information?

Read more here:

Oops, CIMB releases Vivocom's results premature - M.A. Wind

http://klse.i3investor.com/blogs/kianweiaritcles/110342.jsp


and

MyEG shares jump after juicy government contract (3) - M.A. Wind

http://klse.i3investor.com/blogs/kianweiaritcles/110680.jsp

KYY Investing Guide lines - Koon Yew Yin

KYY Investing Guide lines - Koon Yew Yin

Author: Koon Yew Yin   

Since my retirement as a founder director of IJM Corporation Bhd about 30 years ago, I have been investing in our local and Hong Kong stock markets. I also have read books to learn the methods practiced by legionary experts such as Peter Lynch, Benjamin Graham and many others.   

At the beginning I made some mistakes and I learned from my own mistakes to improve my skill.

Now I am able to write down some simply guide lines to help investors make more money. You do not need a higher tertiary education to make money.

1 KYY golden rule for stock selection:  Before you buy any share, you must make sure that the company can make more profit in the current year than last year by looking at its profit for the last 2 quarters and the projected P/E ratio is less than 10. If it has very good profit growth prospect, you may buy it at higher P/E ratio. 

2 Up and down trend charts:  You don’t have to be an expert in chart. All you need to know is what is up trend and down trend. Never buy down trending stocks even if they are selling below NTA because you don’t know when the price will go higher than your purchase price for you to sell to make money. For example some of the property companies are selling below their NTA. As you know there is an oversupply of properties in every town and city in Malaysia. If you buy property shares, you have to wait a few years before the property market turns around.    

3 Buy up trending stocks provided they have good profit growth prospect and selling at low P/E ratio. The advantage is that after your purchase, you can see the price continues to go up. But you must remember that no share can continue to go up for whatever reason. You must sell to take profit.

4 Cut loss will limit your losses: After you have bought a share and the price did not go up as you expected, you must cut loss when the price drops more than 10% of your purchase price.

5 Control your emotion of fear, greed, ego and over confidence to think logically is the key for successful investing. Most people cannot control their emotion to think logically. If everyone can think logically, all the shares would be fully valued and there would not be any underpriced share for sale. That is not the case. If you can control your emotion you would know when to buy and when to sell to make money.

6 You must develop some business sense. Quite often you can see share prices of really good companies remain flat or keep dropping for no reasons. If have some business sense, you dare to buy.  But if you do not understand business, you would miss the chance to make money. 

7 To maximize profit, you must have patience. Every day you can see how share prices fluctuate. The day’s high and low can be quite a wide difference. If you have patience, you can buy at the lowest price or sell at the highest price of the day.

8 You must own a maximum of 8 stocks so that you can keep track of the companies’ progress. All businesses have different challenges and obstacles at different time to overcome. If you can keep track of them, you know when to buy or sell to make more profit.   

9 You should use margin loan to increase your profit provided you really know all the above guide lines. The current interest rate is 4.8% pa. You can easily make more than the interest rate to increase your profit.

10 Share investing is not an easy venture. If you cannot afford to lose, don’t try. There are more losers than winners in the stock market. If you have not been successful after a few years, you must stop. Otherwise you and your family will suffer.

http://klse.i3investor.com/blogs/koonyewyinblog/110433.jsp