The Risk of Investing in Warrants

A warrant is an investment tool which provides opportunity for investors to diversify their investment. It is popular among retail investors, mainly due to its low cost investment and potential high return characteristics. This makes it even accessible to small investors who are without much additional capital.

However, many investors are investing into warrant without fully understanding the fundamental mechanics of how warrant works and the risk inherent in it. At the end of this article, you will be able to understand the basics of warrants and its implications on your investment decisions.

Types of warrants

A warrant gives you, as the buyer, the right but not the obligation, to buy or sell a specific number of the mother share or underlying shares at a specified price within a specific period. The holder of a warrant or call warrant will not have any voting or dividend rights as that enjoyed by shareholders. One of the main benefits of investing in a warrant is cost leveraging. When you invest in a warrant, you stand to gain from the exposure of the share price movement at only a fraction of its cost.

There are two types of warrants: call warrant and put warrant.

 

A call warrant is one that is most common in our local stock exchange and is almost similar to an option. A warrant is issued by the company of its underlying stock, while an option is a financial instrument of the stock exchange. Warrants are usually issued by companies as part of new issue offering to attract investors into buying the new security. A warrant is also considered a type of equity derivative as it derives its value from its underlying security.

Exercise price (strike price)

The price at which you can buy call warrant is called the exercise price and this is determined at point of issue. The exercise price is the point of reference for you to determine whether your warrant is Out-of-the-Money (OTM), In-the-Money (ITM) or At-the-Money (ATM).

Gearing effect

One of the reasons why warrant attracts investors is mainly because it costs only a fraction of the price of the underlying stock while offering relatively good return, either positive or negative.

Let’s take an example of ABC shares that are currently priced on the market at RM2.00 per share. Investor A puts in RM2,000 to purchase 1,000 shares. Investor B on the other hand, decides to invest the same capital of RM2,000 in warrants that was going for RM0.50 per warrant. With the same amount of investment, Investor B is in possession of 4,000 shares.

If ABC gains RM0.30 per share from RM2.00, to close at RM2.30, the percentage gain would be 15%. However, with a RM0.30 gain in the warrant, from RM0.50 to RM0.80, the percentage gain would be 60%.

This is the leveraging effect of warrant. However, the possibility of huge gain also comes hand in hand with huge loss. During the life time of a warrant, it is also common that the price of warrant moves in parallel with the price of the underlying stock. Due to the leveraging effect, a small decline in the price of the underlying stock will result in a significant drop in the price of its warrant.

Using the example above, assuming the price of the underlying stock reduce from RM2.00 to RM1.80, the percentage drop is 10%, but, with the same amount of RM0.30 reduction in the warrant, it will cause the warrant to drop to RM0.20, which is a 60% drop in value.

Time to maturity

All warrants have a limited life span. In the event that the price of the underlying stock remains below the exercise price at the time the warrant matures, an OTM warrant will be of no value and the investor will lose his investment.

Risk control

Having such a high risk nature, investors who are interested in warrants must fully understand their own risk tolerance level. Too much exposure in warrant may subject their investment portfolio to excessive risk. Many investors tend to purchase warrants that are highly active in the market without much knowledge of what they are buying. As warrants are also popular among short-term speculators, an actively traded warrant may not be suitable for investors who intend to hold the warrant for a longer term. The amount could be provided by short-term traders who are speculating and attempting to earn short-term profit. Therefore, it is important for investors to pay attention to the type of market participants that are interested in the warrant.

Buying ITM warrants may offer less profit but lower risk compared to the OTM warrants. When a warrant is deeply OTM, it is less sensitive to the price movement of its underlying stock, which means even if the price of the stock increases, the price of its warrant may not have significant movement, as what we would expect out of a warrant that is near or in-the-money. Worst still, if the term of warrant is near to its maturity; its time value will decline drastically.

As in any other investment, investors should make sure that they fully understand the characteristics of warrant before they decide to invest in any of it.

© Securities Industry Development Corporation. For more information on wise investing, log on to Malaysian Investor (www.min.com.my)

http://www.min.com.my/en/component/content/article/320-risk-of-investing-in-warrants.html?start=1

CFA Level 1 Course

Table of Contents

 Section 1 to 5

  1. Ethics and Standards

  2. Quantitative Methods

  3. Microeconomics

  4. Macroeconomics

  5. Global Economic Analysis

 Section 6 to 10

 Section 11 to 15

 Section 16 to 17

Read more: http://www.investopedia.com/exam-guide/cfa-level-1/portfolio-management/portfolio-management-theories.asp#ixzz1liMGuwDH

Steps to recovery - 2012 market outlook

Steps to recovery
February 8, 2012

Bulls and bears ... choose wisely.

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Escape the bear … a semblance of reliability in certain stocks at least should become apparent this year. Illustration: Karl Hilzinger

Flow-on effects ... former banker and author Satyajit Das. Photo: Tomasz Machnik

After years of volatility, there are sure signs some stocks are worth investing in, writes John Collett.
It's not surprising that investors are confused - so are the experts. Many called the recovery in Australian shares at the start of last year, only to see markets dip lower. They're reluctant to call it again, even though there has been a good start to the year on world sharemarkets.
The woeful performance of most sharemarkets last year and the trials and tribulations of Europe's debt crisis suggest investors should stick with the capital security of cash.
On the other hand, Australia's economy is growing at close to its trend of a little more than 3 per cent. And economists expect that rate of growth to be maintained, even if there is a recession in Europe this year.

Forecasts of lower global growth by the World Bank and International Monetary Fund should not affect the outlook for Australia, according to most economists.
If anything, the risk is that we talk ourselves into lower growth by focusing too much on the negatives.
The outlook for the world overall is slower growth but not recession, though recession is expected in Europe.

Chinese authorities seem to be engineering a soft landing for the economy, which has slowed to just under 9 per cent, down from about 11 per cent.
Our big miners are certainly showing confidence in China by continuing to make big investments in new mines. And the economic data on the US suggests the country is not about to slip back into a ''double dip'' recession.
The big question for investors, though, is whether we have been through the worst of it.
Is it time to start moving out of cash and into shares? Term deposits have been a rock for worried investors for the past three years but cash is not a long-term solution for wealth accumulation. Interest rates are on their way down. After paying tax on the interest at the investor's marginal income tax rate, term deposits are only just beating inflation.
AUSTRALIAN SHARES
''The improved global economic outlook and reduced risks regarding Europe suggest 2012 should be a better year for shares and other risk assets,'' the chief economist at AMP Capital Investors, Shane Oliver, says. ''This is also supported by the fact that shares are starting the year on sharemarket valuations well below year-ago levels.
''Sharemarket price-to-earnings multiples remain low.''
It's been a good start to the year on world sharemarkets, as it was last year, before markets turned down once again. Australian share prices are almost 6 per cent higher since the start of this year.
US share prices are more than 4 per cent higher and even European shares are more than 5 per cent higher.
The Australian sharemarket underperformed other sharemarkets quite badly last year, with share prices down more than 14 per cent. But the fundamentals of our economy did not justify that, an analyst at Fat Prophets sharemarket research, Greg Fraser, says.
Australian shares could end this year between 15 per cent and 20 per cent higher than they started the year, he says. Fraser favours the diversified miners such as BHP Billiton and Rio Tinto and gold miner Newcrest Mining.
In the energy sector, he likes Woodside Petroleum. Among the industrials, he likes packaging company Amcor, which bought the Alcan packaging assets cheaply.
DEFENSIVE STANCE
The editor of FNArena financial news and analysis service, Rudi Filapek-Vandyck, says long-term investors should continue to have a ''big chunk'' of defensive stocks in their portfolios. But he can see the logic of taking a bit more risk in portfolios as sentiment could turn positive very quickly.
One of the problems for investors is that many of the defensive stocks are, if not overvalued, fully valued. ''People who want to add to the defensive part of their portfolios have to be careful not to pay too much,'' he says. Among the defensive stocks, he likes Blackmores. The food supplements and vitamins maker is a ''dream stock'' to have in a portfolio but is normally too expensive.
''Its share price has come down over the past month, as the market has been selling out of stocks like Blackmores and buying miners and biotechs,'' Filapek-Vandyck says. He also likes Fleetwood Corporation. Its original business is making caravans but it also builds and operates mobile accommodation for the mining industry. Its shares are on a fully franked dividend yield of 7 per cent.
For investors with an appetite for risk, he likes iron-ore miner Fortescue Metals Group. ''If sentiment turns positive and world growth this year, including China, surprises on the upside, then Fortescue is definitely among the stocks you want to have.''
For those who can take on more risks, substantial rewards could be on offer from international shares.
INTERNATIONAL SHARES
The US is still home to many of the most profitable companies in the world.
''Corporate balance sheets are arguably in the best shape we have ever seen, with very low levels of debt and mountains of cash,'' says Jonathan Pain, a former fund manager and author of the investment newsletter The Pain Report.
He says in his latest report: ''Apple has $US97.6 billion of cash, enough to cover Greece's debt payments due in the next two years.'' During 2011, Apple's sales rose to $US127.8 billion, ''bigger than the size of the New Zealand economy'', while more iPhones were sold each day in the final three months of last year than babies were born in the world, according to data compiled by Bloomberg and the United Nations.
Greg Fraser says of the overseas sharemarkets, the US could do best given the emerging economic recovery there.
Fraser regards European shares as a ''no-go zone'', as there are just too many unknowns. Pain says the world's most populous nations will continue to produce the lion's share of global growth.
He regards Indonesia, the world's fourth-most populous nation, as ''one of the most exciting prospects on planet Earth''. India should grow about 7 per cent and China should should slow to about 7 per cent, Pain says. Japan will ''bumble more than muddle along'', he says. ''Their demographics are truly horrifying, as soon more adult diapers will be sold than those for children.''
For most investors, the best way to own shares listed on overseas sharemarkets is to invest through a fund manager. Andrew Clifford, the deputy chief investment officer at fund manager Platinum Asset Management, says the manager owns many strong and growing businesses trading at attractive prices.
BMW, Microsoft, Samsung Electronics, China Mobile and Royal Dutch Shell are trading on low price-to-earnings multiples of between eight and 11 times. ''Each of these businesses will face challenges in the current economic environment but our assessment is that they are well-placed to grow their businesses over the next five years or so,'' Clifford says.
The fund manager also has investments in companies on ''distressed'' valuations such as Bank of America and Allianz Insurance. ''On any given company, we will clearly make errors but with a portfolio of companies on starting valuations such as these, it is difficult to see how they will not provide investors with good returns over the next three to five years,'' Clifford says.
WHAT TO DO?
Investors have to think about capital preservation first, then income and, last, about the opportunities for capital gains, says Satyajit Das, a former banker and author of Extreme Money: The Masters of the Universe and the Cult of Risk. It is the reserve order of how investors have thought about investing for the past 20 years.
In Das's opinion, there is almost a bubble in high-dividend stocks and a bubble in high-yield corporate debt, including non-investment grade debt.
''You want a core portfolio that is throwing off income and is capital-secure but you want to capture some growth,'' he says. Investors need to be mindful of the elevated risks - there will be bubbles and busts and the recovery could be a very long one.
''People forget it took 25 years for US stocks to recover to the level of 1929,'' Das says. ''People also forget that even if Australian share prices rose by 10 per cent, prices would still be 30 per cent below their high.''
Pain continues to favour global companies, regardless of their domicile, that have the reach and scale to benefit from the emergence of the Asian middle class.
He also favours a core exposure to energy-related assets and an exposure to gold, as it should provide some security against some of the more nasty risks. The chief geo-political risk, as Pain sees it, is conflict in the Persian Gulf over Iran's nuclear ambitions.
Three reasons to be cautious
Satyajit Das says there are still significant risks for investors: ''Europe is going to be trapped in, at best, a long period of low growth and at worst, a deep recession.''
He identifies at least three channels of possible contagion of the ''train wreck'' in Europe to Australia.
Slowing European demand for Chinese exports and imbalances in the Chinese economy could lead to China's growth rates falling from less than 9 per cent now to between 5 per cent and 7 per cent - and it could happen quite quickly, Das says.
And, with all the new mines opening there could be an oversupply of some commodities at the same time as demand weakens.
That would have a big impact on the profitability of Australian mining companies.
There is another way the woes in Europe could affect Australia. Its current account deficit has to be funded from overseas markets, including Europe. Das says Australian banks might have to start rationing credit if their costs of borrowing from overseas increase.
He says a third danger is the emerging ''currency wars''. Europe, the US and Japan are trying to devalue their currencies to increase the competitiveness of their exports.
The problem with that is the Australian dollar could be pushed higher, reducing Australia's competitiveness with exports.


Read more: http://www.smh.com.au/money/investing/steps-to-recovery-20120207-1r2ah.html#ixzz1lgc4hMVr

Good dividends key to recovery

John Collett
February 8, 2012

Are the days of cash as the first-choice investment of many risk-adverse investors numbered? With interest rates on their way down, you would think the cash yields on the big banks and stocks such as Telstra, at 7 per cent or 8 per cent fully franked, would beat the 5.5 per cent on term deposits - hands down.

Two years ago, term deposits paid almost 7 per cent as the banks sought domestic depositors due to the rising cost of overseas funding. The amount in term deposits is at record highs and the banks have decreased their reliance on overseas short-term funding.

Rates on term deposits are set to go lower but not as much as the cuts in interest rates. They still need to attract depositors and because term deposits are simple products, the banks compete only on the interest rates they pay.

Cash certainly makes a lot of sense, especially when the money is invested for a relatively short period or is earmarked for a specific purpose and when fear makes capital certainty king.

But a term-deposit return of 5.5 per cent taxed at the investor's marginal income-tax rate - unless inside the low-tax superannuation environment - does not leave much left after inflation. Cash has never been a solution for wealth creation.

At some stage, investors saving for long-term goals will have to re-embrace risk. Markets will turn the corner and begin the long-awaited recovery.

The head of investment research at Perpetual, Matthew Sherwood, says corporate earnings are in pretty good shape. It is negative investor sentiment, driven by Europe's debt crisis and lower global growth, that's the main obstacle to a sustained recovery.

But there are signs the crisis in Europe has stabilised, buying European governments more time to make lasting reforms. While global economic growth is weak, China is still growing at about 9 per cent, though it could slow further.

But the recovery in sharemarkets, when it comes, is unlikely to return to the double-digit gains common before the GFC.

Sherwood says income from investing, rather than capital growth, will play a bigger role for investors than it has during the past 30 years.

The head of Australian equities at Fidelity Worldwide Investment, Paul Taylor, says bad news is now priced into sharemarkets. ''Equity markets have their bear hat on, expectations are low and everyone is very well aware of the very negative macroeconomic global environment,'' he says.

With the hurdle set so low, all that needs to happen is for the bad news to get less bad and we could be in for better returns this year, he says.

In a lower-growth environment, you would expect those shares on good dividend yields that can deliver modest growth to do well. But there will be no bell to signal the beginning of the recovery.



Read more: http://www.smh.com.au/money/investing/good-dividends-key-to-recovery-20120207-1r2ac.html#ixzz1lgYLPouG

Taking Financial Inventory

Taking Financial Inventory
by Michele Cagan, CPA

Creating a personal financial inventory worksheet is the first step toward creating a unique guide on which you'll base all of your financial decisions. Although this initial inventory will be frozen in time, you'll revisit and reconstruct it regularly to chart the changes. At first, you'll probably need to revise it every three to six months; later, an annual revision will usually suffice. Even more important than looking at your personal balance sheet, it is vital that you understand what goes into it. This knowledge will carry you toward setting (and meeting) achievable financial goals.

Your net worth equals the difference between what you have (assets) and what you owe (liabilities). Your assets include things like bank accounts, investment portfolios, retirement accounts, the value of whole life insurance policies, the market value of real estate and vehicles, and any other property, such as jewelry. Liabilities encompass everything you owe, typically separated into short-term debt and long-term obligations. Short-term debt includes your regular monthly bills, credit card balances, income taxes, and anything else you might have to pay within the next twelve months. Long-term debts include mortgages and any other installment loans, such as those for your car. In taking stock of your assets, use current market value for things like real estate and vehicles.

Good news! In addition to your savings and other accounts, you can also count money that is owed to you by other people as an asset. As long as this money is coming your way in the foreseeable future, it can be regarded as part of your financial inventory.

While getting a formal appraisal may give you the most accurate assessment, it's not necessarily the most efficient way to proceed. To get approximate market values for your house, you can check out your state's property tax assessment website. For your car, try the Kelley Blue Book (online at www.kbb.com). For smaller items, you can determine which may have significant resale value. Again, you can get a professional appraiser, or you can try looking up similar items on a website like eBay to get approximate market values. Once you've ascertained reasonable values for your belongings, add them to your cash and investment accounts for a total asset figure.

Once you've figured out your assets, it's time to take an honest look at your liabilities. For now, we'll just add in your true debt and leave out your regular monthly bills. In this section of your worksheet, include the outstanding balance of your mortgage and other installment loans, everything you owe on credit cards, and any unpaid personal loans. Total these and you have an accurate picture of your current debt load.

To calculate your net worth, subtract your total liabilities from your total assets. The result shows what you'd have left if you sold or cashed in all your assets and paid off all your liabilities. Here are some steps you can follow to calculate your net worth:

List all of your liquid (cash-like) assets: bank accounts, CDs, stocks, bonds, mutual funds, etc.


List your retirement accounts: every IRA, 401(k) plan, ESOP, etc.


List all of your physical assets at current market value, starting with your home, other real estate you own, vehicles, and any valuable smaller items (like jewelry) that you choose.


Add the value of all these items to get your total assets.

List all of your outstanding debts, and add those to get your total liabilities.

Subtract your total liabilities (step 5) from your total assets (step 4) to get your personal net worth.

Revisit your worksheet every three to six months at first, then at least once a year going forward, to adjust for any changes.

If the number you came up with as your net worth is greater than zero, you have a positive net worth, meaning you'd still have assets left if you settled all outstanding debts. If your bottom line is less than zero, you have a negative net worth, meaning you would still owe money even if you liquidated all your assets and put that cash toward your debts. Regardless of your personal bottom line, you now have a solid base to work from and will be able to make your financial plan accordingly.

http://www.netplaces.com/investing/planning-for-success/taking-financial-inventory.htm

Before you can conquer the markets and lie back to count your millions, you must have a clear picture of where your finances stand right now. Once you've taken that crucial first step toward your eventual wealth, you'll be ready to set your goals, analyze your style, and put together a real plan — one that will get you exactly where you want to go. The path to wealth comes with countless setbacks, many roadblocks, and dozens of disappointments. A solid plan will help you get through those impediments.

Planning for Success

• Top 10 Things to Do Before You Invest $1
• Laying the Foundation
• Taking Financial Inventory
• Building a Budget

• Do-It-Yourself Filing System
• Knock Out Your Debt
• Easy Ways to Cut Spending
• Set Your Investing Goals

Top 10 Things to Do Before You Invest

Top 10 Things to Do Before You Invest
by Michele Cagan, CPA

1. Pay off every penny of credit card debt. You'll earn sky-high (18 to 22 percent!) returns just by paying your credit card balance in full rather than making the minimum monthly interest-laden payments.

2. Build yourself an emergency fund. Start a separate bank account for this purpose alone. It should have enough money to cover at least three to six months of living expenses.

3. Set up and follow a household budget. Keep track of where your money comes from and (even more important) where it's going.

4. Set clear financial goals. Whether you want to save for a new car this year or retirement twenty years from now, you need to know why you're investing.

5. Determine your time frame. How long your money will be working for you plays a key role in designing the best portfolio.

6. Know your risk tolerance. Investing can bring about as many downs as ups, and you have to know just how much uncertainty you can comfortably stand.

7. Figure out your asset allocation mix. Before you start investing, know what proportion of your portfolio will be dedicated to each asset class (like stocks, bonds, and cash, for example).

8. Improve your understanding of the markets. That includes learning about the big picture, such as the global political and economic forces that drive the markets and affect asset prices.

9. Set up your brokerage account. Whether you decide to start out with a financial advisor or take a more do-it-yourself approach, you'll need to have an open brokerage account before you can make your first trade.

10. Analyze every investment before you buy it. Buy only investments that you have researched and fully understand; never risk your money on an unknown.

http://www.netplaces.com/investing/planning-for-success/top-ten-things-to-do-before-you-invest-1.htm

Learn Accounting

Accounting Sections

• Accounting Is More Than Numbers
• The Basic Accounts
• Keeping Track of Transactions
• Setting Up a System
• The Accounting Equation
• Recording Your Revenues
• The Inventory-Cost Connection
• Standard Operating Expenses
• Managing the Payroll
• Always Know Your Cash
• Handling Customer Credit
• Controlling Purchase Costs
• The End of Period Cleanup
• Preparing Financial Statements
• Different Entities Mean Different Equity
• The Income Tax Impact
• The Best Use of Your Financial Statements
• More Ways Accounting Helps Your Business
• Unique Issues for Specific Businesses
• Retirement Plans
• Common Small-Business Tax Snafus
• Accounting Glossary
• Small-Business Resources on the Internet

Graham's Valuation Formula

Investing is a multidimensional activity.

To cope with this complexity, investors have resorted to increasingly powerful computers that purport to capture the inter-relatedness of many variables.  But this approach tends to lose the most valuable input of all:  human intuition.

A far better solution for the investment process would be to "freeze" some variables so that analyses could focus on a reasonable number of factors.

Benjamin Graham's valuation formula provided all stock market investors with a critically important tool that freezes one of the key variables of the investment process to simplify the purchase decision.  By using Graham's formula, investors are freed to consider other important factors when evaluating a public company.


GRAHAM'S SIMPLE FORMULA
To calculate intrinsic value, multiply the earnings growth rate by 2 and add 8.5 to the total, then multiply that by the current earnings per share.

[8.5 + (2 x growth) ] x EPS = Intrinsic Value per share

1.  A no-growth company.   The company would have a P/E ratio of 8.5 (and an earnings yield of 12%), which is a fairly typical P/E for a mature company.

2.  An average-growing company.  Most analysts use a P/E range of 15 to 20 times earnings for the S&P 500.  This would translate into the average growth stock in the S&P 500 growing between the ranges of 3.25% to 5.75% (mean 4.5%).


3.  A faster-growing company.  A faster-growing stock growing at 10% will have a P/E ratio of 28.5.  This is fairly typical for the faster-growing companies in the S&P 500.


Two flaws in the valuation models.  All valuation models have flaws.

1.  Models such as Graham's value a company based solely on its earnings.  This leaves out the possible positive effects of non-operating assets or negative effects of non-operating liabilities..  That's why investors need to look beyond earnings and examine company balance sheets prior to purchase to look for non-operating assets and liabilities.

2.  A second flaw has to do with the potential competition from high interest rates.  Should the P/E ratio of stocks be immune to high interest rates?  Of course not.  Graham himself addressed this issue when he suggested that P/E ratios should be adjusted downward if long-term interest rates on AAA corporate bonds
exceeded 4.4%.  The revised Graham formula factors in the current yield to maturity on AAA corporate bonds in the calculation of a company's intrinsic value:

REVISED GRAHAM FORMULA
Intrinsic value per share = EPS x (8.5 + 2g) x 4.4 / y

where,
g = growth rate
y = yield on AAA corporate bonds


If the yields on AAA corporate bonds were to remain at 4.4%, then the original Graham model would remain intact.

If the yields on AAA corporate bonds increased to 6.6%, the P/E ratios would be reduced by 1/3 (4.4/6.6 = 2/3).

If the yields on AAA corporate bonds increased to 8.8%, the P/E ratios would be cut by 1/2.  Thus, the future value of all companies would be reduced by 50%, all things being equal.

For those who want to use Graham's amended model, some caution is warranted.  The model requires that the user forecast interest rates well into the future.  For an investor to rely on recent interest rates as an input to the model could be misleading.

The Intrinsic Value Formula of Benjamin Graham

Intrinsic Value = E (2r + 8.5 ) x 4.4 / Y

E = Earnings
r =  Expected Earnings Growth rate
Y = Current yield on AAA corporate bonds.
8.5 = Graham believed this to be the correct P/E multiple for a company with no growth.

Therefore, Intrinsic Value will rise proportionately to

• rising earnings, 
• rising earnings growth rate and 
• falling yields of AAA corporate bonds.

P/E ratios have risen in recent years, perhaps making 15 to 20 a more appropriate number for a company with no growth, but a conservative investor will continue to use a low multiplier.

Before accepting this formula too enthusiastically, you might reflect on Warren Buffett's response when asked about it.  "I never use formulas like that.  I never thought Ben was at his best when he worked with formulas either," he said with a chuckle.

Corporate Taxes

Back in the 1940s Graham suggested that to ensure that management is honest about earnings, corporations should make income tax statements available to investors upon request.

• If the company paid taxes on income, then it is genuine income.
• If the company didn't, there must be a logical reason, such as a tax write-off or the use of some type of tax credit.  

Corporate taxes have become progressively complex over the years, and only the most dedicated investors - and ones with a lot of time to kill - would care to pore over corporate tax statements.

Fortunately, many corporations now include summary tax information in their annual reports to shareholders.

Many investor information services also supply simplified income tax information in their stock reports.

Reporting of earnings on an after-tax basis is standard practice and to most people, the "real bottom line" is the profits after tax.


Comment:
When the company reported an effective tax rate that is lower than the normal, you may wish to know the reasons for this.  Perhaps, the company has a tax write-off or tax credit that year.

One simple criterion to base stock purchases - FOCUS ON EARNINGS

Toward the end of his life, Benjamin Graham spent many hours looking for one simple criterion on which to base stock purchases.  His focus turned to EARNINGS.

"My research indicates that the best results come from simple earnings criterions."

His multiple criteria for selecting investment-quality stocks have remained the most reliable.  What makes an "investment-quality stock"?

• Financial condition is conservative and working capital position is strong. (Check the Balance Sheet).
• Earnings are reasonably stable, allowing for business conditions that fluctuate over a 10-year period. (Check the Income Statement).
• Average earnings bear a satisfactory ratio to market price. (Check the Valuation).

As investors become more familiar with these guidelines, they follow them easily and automatically, or so it seems.

Buffett and his partner, Charlie Munger, say they don't sweat over formal rules or procedures when trying to determine if a stock has growth potential.

For those of us with less talent and experience than Buffett and Munger, however, it is acceptable to work out a portfolio plan and run a checklist tally of a stock's pluses and minuses.


REMEMBER:

• Quantitative data are useful only to the extent that they are supported by a qualitative survey of the enterprise.
• The companies with the best investment potential are consistently profitable.
• The P/E ratio should be low compared with those of other companies in the same industry.
• The P/E ratio establishes the upper share price limit on intrinsic value.
• Earnings and other estimates should err on the side of understatement.  That, in itself, makes for a margin of safety.

Also read:
Ben Graham's checklist for finding undervalued stocks
https://docs.google.com/spreadsheet/ccc?key=0AuRRzs61sKqRdFpHTldITEQyZDJuVGdDY3hTS3lvQ0E&hl=en#gid=0

Be careful with companies in formation - Wait For Earnings

Without Earnings, Nothing To Measure

Graham was suspicious of 'hot' or fast-growth stocks because their promise relies on the prediction of ever-increasing future earnings with little historical evidence that the company can consistently produce ever-rising future earnings.

He warned the growth stock investor to seek two things:

• Assurance that growth will continue
• Assurance that the investor isn't paying too high a price for future growth.

Peter Lynch warns investors to be especially careful with companies in formation.  "Wait for earnings," he cautions.

• Though Lynch has done very well with some initial public offerings in particular (he was an original investor in Federal Express, "I'd say three out of four have been long-term disappointments."

Venture capital operations

Many high-tech, bio-tech or other emerging technology companies operate more like venture capital operations.

Venture capitalists demand guarantees of high returns because the risk is high that earnings will be slow in arriving, or will never materialize at all.

The venture capitalist is betting on a technology and the talent to put that technology into use.

Venture capital investment is best practiced by those who know a particular industry extremely well.