Wednesday, December 21, 2011

Short vs Long-Term Stock Trading Strategies

While there are numerous stock trading strategies, when it comes to buying and selling stocks, investors have two main stock trading paths to choose from: short and long-term.  Those involved in short-term trading are referred to as traders, while those buying and selling for the long-term are called buy-and-hold investors.  Both traders and buy-and-hold investors can be successful, but must follow different strategies in order to achieve success. Below is information about both short and long-term stock trading strategies.

Short-Term Stock Trading Strategies
The world of a short-term trader requires them to keep on top of current and historical stock prices. Their stock trading strategy includes maneuvering between the opening and closing prices and knowing the precise moment to enter or close a stock position. Short-term trading can be very lucrative, but it is also risky.
Traders can enter and exit a stock position over the course of one or a few days. Experienced traders evaluate the technical indicators of a stock and make judgments on whether the stock will be an immediate gain or loss. Short-term traders watch the moving averages, understand investing patterns and know the stock market trends in order to make profitable trades.

Long-Term Stock Trading Strategies
Long-term investors demonstrate more patience than short-term traders. Buy-and-hold investors enter a stock position for the long-term and are not preoccupied with short-term market volatility. These investors outlook on the stocks is rooted in the belief that the stock market will provide a good rate of return over the long-haul.

There are benefits and drawbacks to both short and long-term trading strategies.  Investors and traders must use different strategies and analyze stocks in various ways.  Yet both will need market knowledge and the ability to understand trading strategies to be successful and make the appropriate stock picks.
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Tuesday, December 20, 2011

Investing for Dummies

It is no secret that the world of investing can be quite scary to people who have little to no experience when it comes to serious money matters, but that is no reason to avoid investing since investing is what turns money into wealth. It is extremely important that you learn as much as you can about investing before you start so that you make the best decisions possible with your money. A good saying to remember as you get started is, "Don't invest any money you can't afford to lose."
Before you contact a stock broker or open your own online trading account, you must have an understanding of the risk involved with investing. While it is a crude comparison to say that investing is like gambling, there is always the chance with any investment that it could go south, and you could end up losing your shirt. An investment is more like an educated gamble that you take significant time in researching before you act on. While there is no way to really research what numbers will hit on the roulette wheel next, there is a systematic way one can research stocks, bonds and mutual funds to try to figure out which investments will perform well and which ones won't. There are even people you can contact who will not only do all of this research for you, but they will also help you make some big financial decisions.
A stock broker is the best friend of every new investor. It is your broker's job to stay on top of all of the latest investment news and help steer you in the right direction when it comes to making big investment decisions. Your broker will take a complete look at your current financial picture and help you decide what investments to make to meet your short term and long term investment goals. While it has become fashionable lately to use sites like E*Trade that don't require a broker, those sites are only recommended for people who have an encyclopedic knowledge of investing and not for folks who are just getting started. If an inexperienced investor were to try to use one of those sites, it could end very badly since you would literally be gambling with your life savings. If you're new to the investment game, use a broker until you know the ropes.
Before you show up at your broker's front door with a smile and a check, there are a few major decisions you need to make before hand. First, you need to set some investing goals. Your broker will look at your current financial situation, your age and the reasons why you are investing to decide exactly what kind of investments are right for you. If you are in your 50's and you don't have much saved in the way of retirement, your investments will need to be somewhat risky since you will need to make a significant amount of money over a relatively short period of time so that you can retire at 60 or 65. On the other hand, if you are still in your 20's and the main reason you are investing is for retirement, your investment strategy can be conservative since you have decades to go until your final goal is reached.
Your broker will take all of this and more into consideration when you invest for the first time. You will also have a series of short term goals that you can plan out on the way to your long term goal, that way, you'll always know whether you are on the right track.
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Understanding Book Value

Why is Book Value Important For Investors?
The ratio of the Price to Book Value can help investors understand if they are getting good value in buying a share. On its own it often  indicates little or nothing. But it can back up an opinion about a stock arrived at in another way such as the Price / Earnings ("P/E") ratio. In combination with the P/E ratio and other analysis the Price to Book Value Ratio can help identify bargains and help investors avoid over-priced stocks. All serious investors should understand the Price to book Value Ratio and its implications.

How is Book Value Calculated?
Book Value means the value of the equity that is owned by shareholders according to the financial statements. Book Value is calculated from the Balance Sheet. Book Value is usually shown directly on the Balance Sheet as the total equity value. Usually the total equity (Book Value) is a subtotal that adds up the value of the original common share dollars invested in the company at the IPO and any secondary offerings including amounts received for warrants and options plus retained earnings. (Often there are a few other smaller items added in, such as gains or losses on foreign exchange rates).  Alternatively, Book Value can also be calculated as the total Asset value minus all items on the liability side of the balance sheet that are not part of common equity.
Book Value is also referred to as the net asset value since it is the value of assets net of (after subtracting) all debts and liabilities of all kinds. However in recent years net asset value has also been used to mean net market value of assets rather than the accounting book value.
Some companies use preferred shares. These should not be included in the calculation of Book Value. Some companies (legally but rather annoyingly) show these preferred shares in the same subtotal as common equity and in that case they have to subtracted out.

How is Book Value per Share Calculated?
Unless you are Warren Buffett you are not likely going to buy the whole company. Therefore, you are interested in Book Value per share. To calculate Book Value per share divide Book Value by the current diluted number of common shares outstanding. Often the number of shares is shown directly on the income statement. The diluted number of shares can also be calculated by dividing the latest quarter net income by the diluted earnings per share in the latest quarter. (If there has been a share issue in the quarter this will not be completely accurate but it is usually close enough). Additionally you can find the number of shares in the notes to the financial statements, under "common shares". Ideally you should use the diluted number of shares but you can use the actual number of shares at the quarter end if the diluted number is not provided.
Book Value per share is also known as the net asset value per share since it is the book value of assets per share net of (after subtracting) all liabilities per share.

What is the Price to Book Value Ratio?
The Price to Book Value ratio is calculated by dividing the market price of the shares by the Book Value per Share calculated above.
Most companies trade above Book Value and therefore the Price to Book Value Ratio is typically greater than 1.

Is the Book Value Per Share the "true" value of the Assets Per Share?
Absolutely not! You may see Book Value described this way but it is not true. Book Value per share is the accounting value per share. There is absolutely no guarantee that the assets could be sold for the accounting value in the event of a liquidation of the company. In almost all cases where a company is liquidated and sold off as assets, it is a distress sale situation. In that kind of situation the market value of the assets would usually be much less than the accounting value.
Conversely, the assets could have a market value that far exceeds the accounting value. This could occur, for example, with a company that has land on its balance sheet that has appreciated in value over the years.
Only in rare cases does Book Value tend to approximate the true market value of assets. Most corporations are valued for the earnings that the assets produce and not  for the assets as such.

Can Book Value Per Share be Trusted to mean anything?
In many cases no, but it can give a directional signal and can be a red flag to indicate when a stock may be over or under priced. It would seldom ever be a reliable indicator on its own, but can be a secondary indicator.

Does Leverage Impact the Reliability of Book Value?
Leverage means the amount of liabilities on the balance sheet in relation to the common shareholder's equity. In an extreme case if there is no debt or other liabilities, then all of the assets belong to shareholders. In this case Book Value is relatively more reliable. For example if the assets were sold at 95% of accounting value then the shareholders would receive 95% of Book Value.
At the other extreme, if liabilities amount to 95% of assets and the common equity amounts to only 5% of assets, then Book Value (also called net asset value) is almost completely unreliable. In this highly leveraged case if the assets are sold at 95% of the accounting value then there is nothing left for the shareholders. It is important to remember that in liquidation the common shareholders get paid last, only after all other liabilities are paid.
If the assets are very liquid in nature (easily converted to cash), then the Book Value may be relatively reliable even with a high debt ratio. Conversely, a combination of assets that are not easily converted to cash and a high debt ratio would mean that the common shareholder could not count on getting anything in the event of liquidation, so the Book Value would be meaningless in that case.

Why Do Most Shares Trade Above Book Value?
The goal of a corporation is to make a high return on invested common equity.
It makes perfect sense that if an established company is earning a high return, they are not going to sell you a part of it at Book Value, they will want some premium.
If an existing corporation is making a sustained 20% return on equity, then this is an excellent, highly profitable company. An existing shareholder is not going to sell you his shares at Book Value. If the shares are making a 20% return on Book Value, then the share price will usually rise. The existing shareholder might be willing to sell you a share for twice Book Value. In this case you should expect to make 10% on your investment. Since you paid twice Book Value. The company is earning 20% and you paid twice Book Value, so you would expect 20% / 2 = 10%. And as earnings are retained, if the company keeps on making 20%, you will expect to earn 10% on your original investment but 20% on the reinvested retained earnings.
Another reason that companies trade above the accounting Book Value is that the accounting figure is designed to be conservative. For example, land typically appreciates in value due to inflation but this is not recorded in the accounting figures. Also when a company is first starting it typically loses money due to spending on start-up costs or even research costs. These costs are meant to be an investment for the longer term but in the interest of being conservative, these costs are expensed rather than recorded as investments.

Why Would Some Companies Trade Below Book Value?
This can easily happen with unprofitable companies. Imagine a company that has invested heavily in assets which turn out not to be capable of generating a profit. If the assets consist of mostly equipment and processes it may not be worth much as salvage. So logically the company may not be worth much.
In 2003, examples of companies trading below Book Value were Nortel and JDS Uniphase. These companies purchased assets and paid prices that were "over the moon" for mostly intangible assets that turned out to be worth only a few pennies on the dollar. In this case much of the assets were recorded as goodwill or intangible and in fact turned out to close to worthless. Prior to writing off billions in goodwill, these companies did trade below Book Value.
A mining company is sometimes allowed to capitalize its costs to search for minerals. But if none are found, then the so called asset can be worthless.

Are "Hard Assets" more valuable than intangible assets?
No, not necessarily. Hard assets like, cash, accounts receivable, inventory to some degree, and residential and commercial real estate are likely to have significant value even in the event of a liquidation situation. Often we might not expect 100 cents on the dollar but at least there should be some significant return. (However, a large discount to 100 cents would mean the equity owners might get nothing if the debt leverage is high).
Intangible assets like goodwill and patents may have no value if if the company can't generate earnings. On the other hand goodwill and intangibles can be extremely valuable in many cases. These assets prove their worth by producing earnings. But unlike cash and hard assets, they may have zero value if they can't produce earnings.
Some hard assets can also be of very little value. Specialized equipment may have little or no salvage value.
In general, assets are valued for their earnings power. If the earnings power is not there, it is rare that the assets will return full Book Value. And since the debts must be paid first, it is even more rare that assets really offer that much protection to shareholders in the event of liquidation.

Does Cash Per Share Matter?
You sometimes hear analysts say that a certain company has so many dollars per share of cash. That in itself tells you little. It is rare indeed that there would be net cash left after subtracting debts. But it can happen with research companies that have raised a pile of money and have little or no debt. But in those cases the company is very intent on spending that cash (they actually refer to it as the burn rate - an analogy that is often frighteningly accurate) so the cash as such has little to do with valuation.

How Does Book Value Relate to Dilution?
When a company issues shares they almost always do so at a price above Book Value. This increases the Book Value per share and tends to help put a valuation floor under the shares. Buyers of the newly issued shares suffer dilution in that for every $1.00 paid, they usually get less than a dollar in Book Value. The existing shareholders benefit from an accretion in Book Value per share.
This is confusing because the existing shareholders will often claim that they are suffering a dilution. In fact they usually are suffering a dilution of earnings per share, at least initially, but they usually are getting an accretion in Book Value per share.
A share prospectus may tell investors the amount of dilution they are suffering. It should make you nervous when the dilution is more than about 25%, particularly for an Initial Public Offering. High dilutions can be justified by proven high earnings. But if you are being asked to suffer a large dilution to buy into a forecast of expected (rather than proven) earnings then you are obviously into a higher risk situation. Buyers in the stock market, who are interested, can calculate their own Book Value dilution figure which is calculated as 1 minus (1 divided by the Price to Book Value Ratio).

How Does Book Value Relate To Return On Equity and Return On Market Value?
A company that is expected to earn a 20% return on equity ("ROE") would be a great investment - if you could buy it at book value. Investors should be interested in the return on their investment. The inverse of the P/E ratio tells you the initial earnings yield on your investment. For example a P/E of 20 is an earnings yield of 1/20 = 5%. The Earnings yield or return on market value can also be calculated as return on equity divided by the price to book value ratio.
A stock with an ROE of 20% and a price to book value of 1, has an earnings yield of 0.20 / 1 = 0.2 or 20%. The inverse of this is the P/E ratio and is an attractive 1/0.2 = 5. This looks like a bargain stock. However if the price to book value is 4 then the the earnings yield in 20% /4 = 5%, the P/E is 1/0.05 = 20. Now it is does not look so attractive.
The ROE tells you how attractive and profitable the underlying business is. You can then divide that figure by the price to book value to see the initial return yield on your investment.
A mathematical relationship between P/B and ROE and P/E is as follows:
P/B = ROE times P/E
(Technically in the above formula use Return on Ending Equity rather than the more common Return on mid-year equity, but the result will usually not be much different).
This formula directly illustrates why some companies have a high P/B ratio. A company with a high ORE and a modest or high P/E is going to have a high P/B ratio.
A value investor basically cannot insist on both a high ROE and a low P/B. That can only happen if the P/E is very low which is probably unrealistic, given a high ROE. In screening for stocks you cannot screen for more than two of the variable in the equation. Otherwise you are "over-constraining" the problem.

How Can Investors Use the Price to Book Value Ratio?
If a share is trading at twice Book Value, then this means that you are paying double the accounting value for your share of equity when you buy the share.
Companies trading below Book Value absolutely are not necessarily bargains, in fact they could be worthless. Only in very rare cases could you be confident that buying assets at less than book value would guarantee a good return. For example, if you were very sure that the assets had a reliable market value that was higher than the price you were paying, then that would likely be a good investment. Even in that case you would have to be sure that management would be willing to liquidate the assets and disburse the cash to you. In most cases a company trading below book value has a very poor or negative ROE. It is usually a mediocre company and in most cases the assets are not liquid enough to be sold for more than pennies on the dollar. Still, exceptions do exist and it is worth investigating companies that trade below book value despite having a reasonable ROE based on book value.
A share trading at more than at most 3 to 4 times Book Value is often (but not always) a danger sign. A company that has found the mother of all gold deposits or has found a cure for cancer could, in theory, be worth a huge multiple of Book Value. But the higher the Price to Book Value ratio then the more of that potential value is already being priced-in by the seller of the shares, leaving less up-side potential for today's investor. If an existing company is making a sustained 20% return on book equity and they want to sell me a share at twice Book Value, then I am okay with that. But if they want to sell me a share at 10 times Book Value, then I get extremely nervous. That would imply they are going to make huge returns on book equity such as 50% or 100% in order to give me an initial return of 5% to 10% on my market value. I'm probably not going to take that bet.
The Book Values of mining and research oriented companies are almost completely meaningless. A cancer vaccine company could easily be worth anywhere between 0 times and 100 times (or more) Book Value. In this case Book Value is of almost no relevance. Book Values of companies that have made major acquisitions are also unreliable since we can't be sure if they paid too much for the acquisitions.
Book Value is of most guidance when the company is a mature company that has earnings. Your main valuation decision should be based on earnings and cash flow and growth per share outlook. However, a Price to Book Value ratio that is within a reasonable range can add a fair amount of comfort to your decision. Book Value is also of more relevance when the company is not extremely leveraged. If the equity represents 30% or less of the assets, then the Book Value becomes increasingly unreliable.
The ideal scenario is to find a company that appears to be under-valued on a P/E basis, where the ROE is high, where earnings growth is sustainable and predictable, and which is also (of mathematical necessity, given the low P/E) selling at an attractive Book Value ratio, say less that 2.0, and where the net-asset value after liabilities seems reliable. The higher the price to book value then the higher the ROE and or growth in earnings per share is needed to insure your investment makes sense. 
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Tuesday, December 13, 2011

Top 10 Bear Stock Market Investing Tips

1. Find Undervalued Stocks - Stock market investing in a bear market can be tricky because the entire market seems to be on the decline. Look for undervalued stocks which have a price lower than the anticipated stock value in the near future. If the company is solid and shows promise but has a very low stock price it may be a good choice, especially in a bear market.
2. Engage In Short Selling - This investment method involves a complicated process which utilizes the loaning of stock shares. The investor borrows the shares with an agreement to deliver the exact same number of shares at a later date. The shares are sold by the investor and then repurchased when the price of the stock drops. This short sale means a profit because the investor sold at a higher price than the stock is repurchased at.
3. Watch For Signs of A Bull Market Approaching - Both bull and bear markets are cyclical, and eventually a bear market will turn bullish. Smart investors watch the market carefully so that the first signs of the market turning can be detected and acted on quickly.
4. Invest For The Long Term - Successful stock market investing will usually look at the long-term prospects of a stock, and this is true in a bear market as well as a bull market.
5. Avoid Margin Positions - A bear market is not usually the best time to take margin positions because of the expected market decline. Most professionals and experienced investors advise that margin positions should be closed and avoided until the market conditions turn more favorable.
6. Be Cautious with Ratings Systems - Many investors use ratings systems to help pick ideal stocks to invest in. A bear market can cause these systems to be unreliable, and may result in large losses instead of better stock picks for an investor.
7. Be Alert For Any Market Trends - Successful stock market investing when the market is bearish means noticing market trends right away. Roughly 75% of stocks on the market will follow any trends that occur. Detecting any trends early can make the difference between success and failure.
8. Don't Hold a Losing Position Out of False Hope - Some investors refuse to sell even when the losses continue to pile up, either from emotions like fear or out of false hope that the market may turn around soon. Be realistic about the stock prospects, and sell if this step seems like the best choice.
9. Don't Panic and Start Selling Everything - A big mistake made by many investors is to start selling stocks indiscriminately when a bear market hits. This is done in an effort to minimize the investment losses, but eventually the market will turn around and most stocks on the market will rebound.
10. Only Choose Stocks from Solid Companies - Successful stock market investing means performing extensive research on each stock considered. Only including quality stocks from solid companies in the investment portfolio will help protect the investment value over time regardless of any short-term market changes.

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Tuesday, December 6, 2011

6 Basic Financial Ratios And What They Reveal

Ratio - the term is enough to curl one's hair, conjuring up those complex problems we encountered in high school math that left many of us babbling and frustrated. But when it comes to investing, that need not be the case. In fact, there are ratios that, properly understood and applied, can help make you a more informed investor. Find out how this method can be applied strategically to increase profit. Check out Fundamental Analysis For Traders.

1. Working Capital Ratio 

Assessing the health of a company in which you want to invest involves understanding its liquidity - how easily that company can turn assets into cash to pay short-term obligations. The working capital ratio is calculated by dividing current assets by current liabilities.

So, if XYZ Corp. has current assets of $8 million, and current liabilities of $4 million, that's a 2:1 ratio - pretty sound. But if two similar companies each had 2:1 ratios, but one had more cash among its current assets, that firm would be better able to pay off its debts quicker than the other.

2. Quick Ratio

Also called the acid test, this ratio subtracts inventories from current assets, before dividing that figure into liabilities. The idea is to show how well current liabilities are covered by cash and by items with a ready cash value. Inventory, on the other hand, takes time to sell and convert into liquid assets. If XYZ has $8 million in current assets minus $2 million in inventories over $4 million in current liabilities, that's a 1.5:1 ratio. Companies like to have at least a 1:1 ratio here, but firms with less than that may be okay because it means they turn their inventories over quickly.

3. Earnings per Share

When buying a stock, you participate in the future earnings (or risk of loss) of the company. Earnings per share (EPS) measures net income earned on each share of a company's common stock. The company's analysts divide its net income by the weighted average number of common shares outstanding during the year.

4. Price-Earnings Ratio

Called P/E for short, this ratio reflects investors' assessments of those future earnings. You determine the share price of the company's stock and divide it by EPS to obtain the P/E ratio.

If, for example, a company closed trading at $46.51 a share and EPS for the past 12 months averaged $4.90, then the P/E ratio would be 9.49. Investors would pay $9.49 for every generated dollar of annual earnings.

Even so, investors have been willing to pay more than 20 times the EPS for certain stocks if hunch that future growth in earnings will give them an adequate return on their investment.   

5. Debt-Equity Ratio 

What if your prospective investment target is borrowing too much? This can reduce the safety margins behind what it owes, jack up its fixed charges, reduce earnings available for dividends for folks like you and even cause a financial crisis. 

The debt-to-equity is calculated by adding outstanding long and short-term debt, and dividing it by the book value of shareholders' equity. Let's say XYZ has about $3.1 million worth of loans and had shareholders' equity of $13.3 million. That works out to to a modest ratio of 0.23, which is acceptable under most circumstances. However, like all other ratios, the metric has to be analyzed in terms of industry norms and company specific requirements.

6. Return on Equity 

Common shareholders want to know how profitable their capital is in the businesses they invest it in. Return on equity is calculated by taking the firm's net earnings (after taxes), subtracting preferred dividends, and dividing the result by common equity dollars in the company.

Let's say net earnings are $1.3 million and preferred dividends are $300,000. Take that and divide it by the $8 million in common equity. That gives a ROE of 12.5%. The higher the ROE, the better the company is at generating profits.

The Bottom Line

Applying formulae to the investment game may take some of the romance out of the process of getting rich slowly. But the above ratios could help you pick the best stocks for your portfolio, build your wealth and even have fun doing it. 

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