To be
checked
·
First thing to do before starting, take copy
of financial newspaper ( wall street journal) turn to money and investing and
take a look on NYSE and NASDAQ to find daily stock list that have hit new lows.
·
PAGE 225
·
Pay proper attention on companies footnotes. ‘
·
Prospectus’which also
includes information regarding the size of the issue, the currentstatus of the
company, its equity capital, its current and past performance,promoters, the
project, cost of the project, means of financing, productand capacity etc. It
also contains lot of mandatory information regarding
underwriting and statutory compliances.
·
Try to find extraordinary and non-recurring
items.
·
A great company is not a great investment if
you pay too much for stock.
·
An average of more than two acquisitions a
year is not a good sign.
·
Checking cash flow from financing. If it is
high than also it’s not a good sign, as company is not growing instead is using
OPM.
·
More than by financial calculations for gain
or loss some method should be adopted for varying proportion of bonds and
stocks. As market advances he will make time to time sales of common stock,
putting the proceeds into bonds and vice versa.
·
Long Term Investor is the only way to earn
good profits. Holding stocks for few hours is a type of suicide. You may sell
stock, if stock price increase by 10 - 15 cents but there are other invisible
fees (Buy and Sell transactions) also that you have to pay. And those take out
all your profit and even investment. Speculator lies in anticipating and
profiting from price movements and investors interest lies in acquiring and
holding suitable securities at suitable price. So, trader needs to gain at
least 10% just to break even. More you trade less you keep.
·
Selling in bear market makes sense only if it
provides tax bracket.
·
More the stocks in Portfolio more the risk try
to keep minimum of 25% and maximum of 75% and rest on Bonds (Defensive investor
Strategy).
·
Investing 10% in TIPS is good move.
·
Never buy a stock immediately after
substantial rise and never sell immediately with substantial drop.
·
Conservative investor in common stocks should
not pay more than 1/3 of companies tangible assets in addition satisfactory
earning to Price ratio, good financial condition so that earnings can be
maintained.
·
Not excessive diversification. Minimum of 10
different issues and maximum of 30.
·
Defensive Investor Recommendation- Not to buy
Foreign Bonds, Ordinary Preferred Stock and secondary common stock at all. Aggressive investors to buy but not at
full price. Prices not more than 2/3 of appraisal value.
·
Buying the stocks of unpopular company is a
good move if you are paying less than price shown.
·
Secondary Company- Company that is not a
leader in a fairly important industry. Substantial profits by chasing these
companies can be made. Difficult to find a lot of companies are in Border
area. Buying stock of this gives
favorable returns only if bought on bargain basis. As-
§ Dividend returns
are high.
§ Reinvestment earnings
are substantial in level of price.
§ A Bull market is
relatively good to low priced issues. In turn raises typical bargain issues.
§ In bear market
also secondary issues that are undervalued may rise to normal level.
§ Disappointing
record of earnings may be corrected by advent of new conditions.
Acquisition of company’s increases there
price.
·
Never buy into a lawsuit.
·
Bond Analysis –
o
Chief criteria used for corporate bonds is the
number of times that total interest charge have been covered- interest coverage
ratio
Getting
historical data of interest coverage ratio = EBIT / Interest Expense.
Or lower, its ability to meet
interest expenses may be questionable
o
Debt / Equity Ratio.
o
Asset value shown in BS is important earning
power is considered more important.
o
Bond holders can lay claim on company’s assets
if company is not performing good.
Chief
Elements of Performance for Defensive Investor to select Stock-
A. Profitability-
Should,
have satisfactory figure of Rate of Return.
For
manufacturing companies, profit figure per dollar of sales is usually an
indicator-
Use
Operating Profit Margin – Operating Profit / Sales.
B. To compare the
liquidity of two companies one should use Cash Conversion Cycle. Cash
conversion cycle tells us time taken between acquisition of goods and final
cash realization in turn liquidity.
Operating
Cycle= Inventory Days held + Accounts Receivable in Days – Days Payable
C. Adequate size of
the company:
Annual Sales > $100 million for Industrial
Company.
Annual Sales > $50 million for Public
Utility.
D. Financial
Condition:
Quick and Current Ratio > 1
Debt / Equity < 1
E. Dividends
Best record if dividends are not suspended in
last 10 yrs.
F. Earning Growth
A minimum increase of at least one-third in
EPS in the past 10yrs using 3 yrs. average at the beginning and end.
G. Price
·
Price should not be more than 20 times the
average EPS of last 3yrs.
H. P/E ratio * P/B
ratio < 22.5.
I. Net Current Asset
Value > Current Stock Price.
{(Current Assets – Current Liabilities) /
Total Shares Outstanding} > Current
Stock Price.
J. ROIC (Return on
Invested Capital) = Owner Earnings /
Invested Capital
Should be at least 10%and even 6% or 7% is
good if company has good brand names.
Where:
Owner Earning = Operating Profit +
Depreciation + Amortization of Goodwill – Federal Income Tax – Cost of Stock
Options – Capital Expenditure – Income generated on unsustainable rates of
return on pension funds.
Invested Capital = Total Assets – Cash + Past
Accounting Charges that reduced invested capital.
Calculations
·
Should set limit for the price of the stock to
buy. In general not more than 20 times those of last 12 months EPS. And not
more than 25 times for average 13 yrs. EPS.
·
Book value of Common Stock = (Total
Shareholder’s Equity – Preferred stock) / Total Shares Outstanding.
Suggested
standard- Industrial company finances are not conservative unless the company’s
common stock (at Book Value) represents at least half of the total
capitalization including all bank debt. For Railroad or public utility at least
30 %.
·
Owner Earning = Net Income + Depreciation or
Amortization – capital Expenditure – Any extraordinary charges- any income in
company pension fund.
If Owner earning
had grown at steady rate of 6 to 7% in past 10 years, than company prospects
for growth is good.
Use average earnings in conjunction with
ratings for growth and stability of earnings.
Stability:
Not good if maximum decline in EPS in any of
the past 10 years is against the average EPS of last 3 years.
Compare 10 yrs. average growth rate of company
with last 3yrs.
·
Value Stock –
A stock that tends to
trade at a lower price relative to its fundamentals and thus considered
undervalued by a value investor.
Value Formula = (Most Value) / (Price to Book
Ratio)
Most
Value = Retained Earning Percentage (Divide the retained earnings per share by
the total earnings per share - Dividend Yield.
If Value Formula is > 10 buy the stock.
·
Calculating stock value for aggressive
investors-
NWC = CA – CL.
NNC = NWC – Long term Liabilities.
Advised price to buy stock = 66% of NNC /
Total shares Outstanding.
·
Calculate Z score
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Companies with Z-Scores above 3.1 are
generally considered to be stable and healthy with low probability of
bankruptcy. Scores that fall between 1.8 and 3.1 lie in a so-called 'grey area'
with scores of less than 1 indicating the high probability of distress.
Unintelligent
Speculation
o
Speculating when
you think you are investing.
o
When you lack in
knowledge and skill.
o
Risking more
money in speculation than you afford.
o
Recommendation- If
one wants to than put maximum 10% of money for speculation.
·
Margin trading – High risk strategy when executed properly
than good.
o
Aggressive Investor –
o
Trading in the Market – Buying when market is in advance and selling
them when market is about toturn downward. Stock selected should be those
behaving better than the market average.
o
Short Term Selectivity – buying stocks of companies that are expected
or reporting increased earnings.
o
Long Term Selectivity – Excellent record in past growth.
Two things to be under consideration
o
Nature of
competition. Stemming from human fallibility.
o
Buy stock when intrinsic value is high than current and
vice versa.
o
Calculating net working capital per share.
Inflation
and Investor
Measure of inflation through Consumer
Price Index.
A real return
is the rate of return you receive after the impact of inflation. Take Real interest rate under consideration
while calculating stock values and expected returns from investment. Than make
your strategy according to your investment constraints.
Nominal is rate of return generated
before taxes or for future calculations expected return you expect. (1 + Real)
= (1 + Nominal)/(1+ Risk Free)
·
Strategies one can use-
o
Real Estate Companies- Companies that own and collect rent from
commercial and residential properties.
o
TIPS – Treasury Inflation- Protected Securities. Guarantees that value
of investment will not be eroded by inflation. Can be bought directly from US
Government www.publicdebt.treas.gov/of/ofinflin.htm.
Investing
10% in TIPS is good move.
The
interest rate on TIPs is set at issuance and fixed until maturity.
However, the principal amount of the bond is adjusted for inflation.
Ex
- Assume a five-year inflation-protected bond with initial face amount of
$1,000 has an interest rate set at auction of 2.0%.
If
the inflation rate is zero for the first six months, then the first semi-annual
interest payment would be $10.00 ($1,000 X 2.0% ÷ 2).
If the CPI for the second six months rises 2.5%
(or at roughly a 5% annual rate), then $25.00 would be added to the principal
amount of the bond and the second semi-annual interest payment would be $10.25
($1,025 X 2.0% ÷ 2).
If inflation stays fixed at 5% for five-years,
then the inflation-adjusted principal balance would grow to $1,245 and along
the way, the bondholder would collect semi-annual interest payments equal to
1.00% of the inflation-adjusted balance.
General
Portfolio Theory
·
Keep stock
component to 25% up to the time DJIA dividend yield two-third of the bond yield
before establishing 50-50 division.
·
All bonds are
subject to Federal Income Tax except Municipal Bond (Not safe depends on the
ratings given by Rating Agencies). Unless one is in low tax bracket one should
buy Municipal Bonds otherwise Bond income goes to IRS. Only place of Taxable
Income is in 401(K)
·
Some securities
have indirect involvement of US government. Backed by them, yield is relatively
little more than Treasury. This
indirection is because of the debt limit imposed on government borrowing.
·
Preferred Stock- has a dividend
that must be paid out before dividends to common stockholders. Lacks both legal
claim on bondholders and also the profit possibilities of a common shareholder.
Should
be bought on bargain basis.
·
Bond Funds-
o
Bond funds invest
in bonds and other debt securities.
o
If you invest in a bond fund you'll receive
monthly dividends from the fund that include interest payments on the fund's
underlying securities plus any capital appreciation in the prices of the
portfolio's bonds.
o
Bond funds have a
net asset value {NAV=(Total Shares Value – Liabilities)/ Total Shares} that is
the dollar value of one share in the fund; this is the price that investors pay or
receive when they buy or sell shares in the fund. Calculated as market closes.
o
Provides Income
and diversification. Bond funds tend to pay higher dividends than money market
( Short term investment) and savings accounts
o
Bond funds are
not risk-free investments -- they are still subject to the same credit and
interest rate risks as regular bonds. Low Risk because of Diversification.
o
Types-
o
US bond Funds- Backed by US government.
o
Municipal – Tax
free, debt securities issued by state and local governments to pay for local
public projects. Buy on the base of ratings.
o
Corporate-Corporate
bond funds are comprised of bonds issued by corporations. Typically much
greater than that paid by municipal or U.S. government bond funds.
Investment-grade corporate bond funds invest only in the most creditworthy of companies;
they are considered to be the safest of all corporate bond funds.
The Defensive Investor & Common Stock
·
Rules for common
stock component-
o
Suggested
standard-
Industrial company finances are not conservative unless the company’s common stock (at Book Value)
represents at least half of the total capitalization including all bank debt.
For Railroad or public utility at least 30 %.
Book value of
Common Stock = (Total Shareholder’s Equity – Preferred stock) / Total Shares
Outstanding.
o
Not excessive diversification. Minimum of 10
different issues and maximum of 30.
o
Purchase of the
shares of well-established investment funds as an alternative to create own
common stock portfolio.
o
Diversifying
investment in high grade common stock and high grade bonds (including options)
where holding in common stock 25% minimum to 75% maximum.
o
Company selected should be large enough and
conservatively financed.
o
Company should have a long record of
continuous dividend payments.
o
Investor should buy undervalued stock. Intrinsic
Value > Current Price.
o
Should set limit for the price. In general not
more than 20 times those of last 12 months EPS. And not more than 25 times for
average 13 yrs. EPS.
o
Growth stock (popular stock) as a whole is too
uncertain and risky. There prices and dividends rises at fast rate but decrease
even at very fast rate. For defensive investor large companies that are
relatively unpopular and obtainable at reasonable earnings often offers good
returns.
o
One should do proper investigation on IPO as
they are offered when market conditions are good and also backed by special
salesmanship.
·
Dollar Averaging
Formula-Investing
same amount of money every month in the selected stocks. Average of increase
and decrease of price will give subsequent returns. Works good under depression
also. Ideal way is into a portfolio of index funds-
o
Index Fund- A type of
mutual fund with a portfolio
constructed to match or track the components of a market index, such as the
Standard & Poor's 500, low expense like management fees, low risk in turn
low return helps in predicting where market is going and which particular stock
is performing best. Learn at
Recommendation- Not to buy Foreign Bonds,
Ordinary Preferred Stock and secondary common stock at all.
Aggressive or Enterprising Investors
·
In common Stock –
o
Buying in low
markets and selling in high markets.
o
Buying carefully
chosen “Growth stock”- Stock that showed growth in the past and
expected to show in future. Risky as at some point growth curve flattens.
o
Buying Bargain
issues of various types – Should be done by doing two tests.
1)
Estimating future earnings and then
multiplying it by a factor as per the issue. If result is above market price
and if investor is confident. He can tag to bargain.
2)
By estimating Realizable Value of the assets -
Calculating Net Working Capital.
NWC
= CA – CL.
NNC
= NWC – Long term Liabilities.
Advised
price to buy stock = 66% of NNC / Total shares Outstanding.
3) Under this one
has to ignore current disappointing results and unpopularity of company.
Company should have sufficient size and financial strength to meet possible setbacks,
reasonable stability in past and no year earning deficit.
4) Secondary Company- Company that is
not a leader in a fairly important industry. Substantial profits by chasing
these companies can be made. Difficult to find a lot of companies are in Border
area. Buying stock of this gives
favorable returns only if bought on bargain basis. As-
§ Dividend returns
are high.
§ Reinvestment
earnings are substantial in level of price.
§ A Bull market is
relatively good to low priced issues. In turn raises typical bargain issues.
§ In bear market
also secondary issues that are undervalued may rise to normal level.
§ Disappointing
record of earnings may be corrected by advent of new conditions.
§ Acquisition of company’s
increases there price.
o
Buying into
special situations.
When company acquires small companies and you
own shares of the company to be acquired, you can offer substantially good
price over current price.
·
Recommended
Approaches-
o
Relatively
Unpopular large Company – Might be the company is not in good condition.
But, they have resources capital and brain to carry them through and if market
is likely to respond there growth will be at reasonable speed. But selection
should be made by proper research. Should start with low PE multiplier (P/E ratio),
but also add other quantitative and qualitative requirements thereto in making
portfolio.
o
Never buy into a
lawsuit.
Investor
and Market Fluctuations
·
Dow Theory- works as MACD line works. Good to go
with this but not the only way to judge.
·
Secondary line companies fluctuates more than
the major ones, but doesn’t mean they will make poor performance.
·
Professional Investor should not think about
day to day or month to month but should work on long term basis.
·
More than by financial calculations for gain
or loss some method should be adopted for varying proportion of bonds and
stocks. As market advances he will make time to time sales of common stock,
putting the proceeds into bonds and vice versa.
·
Conservative investor in common stocks should
not pay more than 1/3 of companies tangible assets in addition satisfactory earning
to Price ratio, good financial condition so that earnings can be maintained.
·
Speculator lies
in anticipating and profiting from price movements and investors interest lies
in acquiring and holding suitable securities at suitable price.
·
Never buy a stock immediately after
substantial rise and never sell immediately with substantial drop.
·
All mutual funds are open end funds can be
redeemed anytime by investor at Net Asset Value.
·
Open end vs.
close end Funds – Let A buy open end at 109 paying 9% premium
on asset value of 100 and B buys close end at discount of 85. Say both earn
30%. Returns for A is
= 30 – 9 =21 or
(130 – 109)/109 = 19%. B can analyze the same return by a discount of 27% that
is at 73. As such close end can suffer widening of 12 points.
Security
Analysis for the lay Investor
·
Bond Analysis –
o
Chief criteria used for corporate bonds is the
number of times that total interest charge have been covered-interest coverage ratio
Getting
historical data of interest coverage ratio = EBIT / Interest Expense.
1.5 Or lower, its ability to
meet interest expenses may be questionable
o
Debt
/ Equity Ratio.
o
Asset
value shown in BS is important earning power is considered more important.
o
Bond
holders can lay claim on company’s assets if company is not performing good.
·
Common Stock Analysis Tests-
General
Long term Prospect-
o
Estimating future earnings and then
discounting back to present value. Good but difficult
to be efficient in this approach as calculation are done on the basis of past
data.
o
An average of
more than two acquisitions a year is not a good sign.
o
Checking cash
flow from financing. If it is high than also it’s not a good sign, as company
is not growing is using OPM.
o
Company relying
on only one customer is not good.
o
If a company has
not gained any competitive advantage. Economics of scale, any uniqueness etc.
is also negative.
o
Company should
grow at steady rate.
Management-
o
Directly
proportional.
o
Company is not
spending money to develop his new business or Research & Development.
o
Research on the
promises done by managers of the company in past and whether those are
fulfilled or not.
o
Keep an eye on
firm employees buying or selling options.
o
Financial
Strength and capital structure –
o
Stock
of a company with lot of surplus cash is good purchase.
o
Generating
more cash than it consumes.
o
See
cash flow from operations, if had grown than calculate
Owner Earning = Net Income + Depreciation or
Amortization – capital Expenditure – Any extraordinary charges- any income in
company pension fund.
If Owner earning had grown at steady rate of 6 to 7% in past
10 years, than company prospects for growth is good.
o
Long
term debt should be under 50% of total capital.
o
Dividend
Record-
o
A
continuous dividend payment from last 10 to 15 years is a plus.
o
Company
doing stock splits frequently is not
a good sign.
o
Dividend
Yield.
Things to
Consider About Per Share Earnings
·
Don’t take single years earning seriously.
If
paid attention to short term earning, look for traps in the per share earnings
figures.
·
Use average earnings in conjunction with
ratings for growth and stability of earnings.
·
Compare 10 yrs. average growth rate of company
with last 3yrs.
·
Chief Elements of Performance for Defensive
Investor to select Stock-
K.
Profitability-
Should,
have satisfactory figure of Rate of Return.
For
manufacturing companies, profit figure per dollar of sales is usually an
indicator-
Use
Operating Profit Margin – Operating Profit / Sales.
L.
Stability:
Not good if maximum decline in EPS in any of
the past 10 years is against the average EPS of last 3 years.
M. Adequate size of
the company:
Annual Sales > $100 million forIndustrial
Company.
Annual Sales > $50 million for Public
Utility.
N.
Financial Condition:
Quick and Current Ratio > 1
Debt / Equity < 1
O.
Dividends
Best record if dividends are not suspended in
last 10 yrs.
P.
Earning Growth
A minimum increase of at least one-third in
EPS in the past 10yrs using 3 yrs. average at the beginning and end.
Q.
Price-
Price should not be more than 20 times the
average EPS of last 3yrs.
R.
P/E ratio * P/B ratio < 22.5.
S.
Net Current Asset Value > Current Stock
Price.
{(Current Assets – Current Liabilities) /
Total Shares Outstanding} > Current
Stock Price.
T.
ROIC (Return on
Invested Capital) =
Owner Earnings / Invested Capital
Should be at least 10%and even 6% or 7% is
good if company has good brand names.
Where:
Owner Earning = Operating
Profit + Depreciation + Amortization of Goodwill – Federal Income Tax – Cost of
Stock Options –Capital Expenditure – Income generated on unsustainable rates of
return on pension funds.
Invested Capital
= Total
Assets –Cash + Past Accounting Charges that reduced invested capital.
Public Utility and Industrial Companies-
·
In the criteria mentioned above exclude
Current, Quick and Debt/Equity Ratio selection element.
·
If P/E ratio of Industrial as well as Utility companies had changed drastically
places during last decade, for defensive investor also better to sell and pay
tax then to hold.
·
Management talking more about stock price than
about the business is not a good sign.
·
As per book, defensive investor never deals
with convertibles, Option and warrants.
Websites Can be
used for Buying Stocks-
All quarterly, annual report from companies
website or from EDGAR database at- Data Bases
Factiva, ProQuest or LexisNexis
Company and
Industry Ratios Quick way to look companies that might pass
graham’s NWC Test-
One should keep
track of all transactions to overcome tax problems
·
These charge less
for transactions
Buying Direct
from Companies-
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