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Don't miss out on DGGXF:
Cryptocurrency is here to stay,
And DGGXF is a great buy. Here’s why:
Please visit our board. There is a lot of DD posted there. We invite yo to ask questions about DigitalX. We well do our best to answer them.
Bitcoin is simply the beginning of a blockchain currency revolution that is embryonic and will ultimately evolve into a new trusted world currency. And companies like DigitalX will be the ones who are facilitating and will continuer to facilitate the changes along the way.
https://www.marketwatch.com/story/a-trusted-digital-currency-is-coming-but-its-not-bitcoin-says-starbucks-howard-schultz-2018-01-26
I believe cryptocurrency is going to EVENTUALLY replace all conventional currency. I know right now this sounds like a bit of a stretch. But the potential is there. Companies like DigitalX (DGGXF) understand this and are prepared to facilitate the market needs of this new emerging industry.
Right now bitcoin leads the industry. Bitcoin has been so successful that now there are numberless blockchian currencies out there and some of them are catching up to bitcoin. And rich people who want to be richer are investing. I want to be rich too. But I cant afford the currency so the next best thing is a company like DigitalX.
I believe this industry terrifies big banks and government. For now, that makes cryptocurrency volatile. Because the big banks and big governments simply like things the way they are. That's why this industry seems to be under attack lately. Because cryto has become a threat to what has become an antiquated financial system. The current conventional currency ignorant rich are threatened. The smart one who understands tech and money and how its evolves are the ones investing in cryptocurrrency.
I picked DGGXF as my stock because the company appears to be solid with a great executive team and because the stock is very affordable.
I also believe that this penny stock will soon be a mid cap and eventually even a large cap stock.
Crypto currency will replace all other currencies the way netflix replaced blockbuster.
DigitalX (DGGXF) is to crypto what intel is to microsoft or Mac OS
Also, most of this stock is traded on the Australian stock market:
https://finance.yahoo.com/quote/DCC.AX/DGGXF
This is only my opinion. Please do your own DD. I am not a pump and dump poster. I am a guy who has simply been searching for a way to realize his financial dreams. Good luck to all.
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http://www.barchart.com/technicals/stocks/TRKG
How To Avoid Investing Too Conservatively
If you dont do anything, you cant lose money. That might be true with slot machines, horse racing and the lottery, but its not true with investing . Skilled investors know that the price of doing nothing or not enough can result in losses; not the lost value of stocks or mutual funds, but other losses not plainly visible to the eye of a new investor. Heres what you need to know about how these losses can affect you.
Beware of Inflation
If you have a few decades behind you, you probably remember the days of being a kid, where you could hop on your bike with a quarter, take it to a local store and buy a piece of candy. As you got older, you remember buying gasoline for less than a dollar per gallon.
Your money had more buying power back in those days, but today a quarter has to be combined with other quarters to have much buying power and a gallon of gas is close to $4. For an investor, inflation is fundamentally important; just as inflation has contributed to changes in the price of gas over the years, it can have a surprising affect on your investments, if youre not prepared for it.
Dont Hold Cash
Holding onto cash for long periods of time, waiting for the market to bottom, reduces the value of your money. You might be able to earn 1% from a savings account right now but if the current rate of inflation is 2.3%, inflation is causing an annual loss of 1.3%.
Holding cash for short periods of time is a wise investment choice, but over the long term youre silently losing purchasing power, and purchasing power is the only reason we hold currency. How do you combat inflation? Put that money to work but only in investments that earn a rate of return higher than the rate of inflation.
Junk Bonds
Because interest rates are so low, getting gains that beat inflation from government or investment grade bonds is sometimes difficult. Junk bonds, also known as high-yield bonds in the form of a low-fee mutual fund or exchange-traded funds (ETFs), can pay yields of more than 7%, in some cases. The downside is the increased level of risk, but for many investors the level of risk is appropriate. Bonds have been in a bull market for the past few years and theres no guarantee that the bull market will continue. Always have an exit strategy in place.
International Funds
Many investors have heard that investing in big companies in developed countries may not provide the growth necessary to outpace inflation; however, investing in the eurozone, China or many other countries has proven to be too risky. Investing too conservatively can harm your portfolio, but taking on too much risk can cause even worse results. To account for world events, make conservative asset allocations changes to your portfolio, instead of an all or nothing approach.
Own Real Estate
Many current and former homeowners may still be recovering from the housing crisis, and theres no guarantee that the market is now in recovery or will recover in the near future. For those with a long-term investment objective, owning a home will keep pace with inflation and even beat it. Some investors are putting the cash to work by purchasing distressed properties and renting in this red hot rental market.
Consider Gold
For years, gold held the distinction of being a shiny way to battle inflation but theres no guarantee that, going forward, gold will provide that protection. Still, CNBCs Jim Cramer advises owning gold for just that purpose. Gold in its physical form is better than gold ETFs or other stock market products, but owning large amounts of gold and protecting it from theft or loss is difficult.
The Bottom Line
Investing too conservatively usually means not taking on enough risk to beat the effects of inflation. The key for each investor is to take on enough risk to beat inflation without moving outside of his or her risk tolerance. The best way to strike the perfect balance is to find a trusted financial adviser to evaluate each individual situation.
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Should You Buy Stock Or An ETF?
After completing a thorough research of an attractive sector, you may like a couple of stocks and an exchange-traded fund (ETF) that fit your criteria. Now you need to decide, do I buy the stocks or the ETF? Investors encounter this question every day. Many are under the impression that if you buy an ETF, you are stuck with receiving the average return in the sector. This is not necessarily true, depending on the characteristics of the sector.
SEE: Building An All-ETF Portfolio
Making this choice is no different from any other investment decision. As always, you want to look for ways to reduce your risk. Of course, you want to generate a return that beats the market (create alpha.) Reducing the volatility of an investment is the general method of mitigating risk. Most rational investors give up some upside potential to prevent a potentially catastrophic loss. An investment that offers diversification across an industry group should reduce the portfolio volatility an investor is exposed to. This is one way that diversification through ETFs works in your favor.
Alpha is the ability of an investment to outperform its benchmark. Any time you can fashion a more stable alpha, you will be able to experience a higher return on your investment. There is a general belief that you must own stocks, rather than an ETF, to beat the market. This notion is not always correct. Being in the right sector can lead to achieving alpha, as well.
When Stock Picking Might Work
Industries or situations where there is a wide dispersion of returns, or instances in which ratios and other forms of fundamental analysis could be used to spot mispricing, offer stock-pickers an opportunity to exceed.
Maybe you have a good legal insight on how well a company is performing, based on your research and experience. This insight gives you an advantage that you can use to lower your risk and achieve a better return. Good research can create value added investment opportunities, rewarding the stock investor .
The retail industry is one group in which stock picking might offer better opportunities than buying an ETF that covers the sector. Companies in the sector tend to have a wide dispersion of returns based on the particular products that they carry, creating an opportunity for the astute stock picker to do well.
SEE: Analyzing Retail Stocks
For example, recently you have noticed that your daughter and her friends prefer a particular retailer. Upon further investigation, you find that the company has upgraded its stores and hired new product management people. This led to the very recent roll out of new products that have caught the eye of your daughters age group. So far, the market has not noticed. This type of perspective (and your research) might give you an edge in picking the stock over buying a retail ETF.
Company insight through a legal or sociological perspective may provide investment opportunities that are not immediately captured in market prices. When such an environment is determined for a particular sector, where there is much return dispersion, single stock investments can provide a higher return than a diversified approach.
When an ETF Might Be the Best Choice
Sectors that do have a narrow dispersion of returns from the mean do not offer stock pickers an advantage when trying to generate market-beating returns. The performance of all companies in these sectors tends to be similar. For these sectors, the overall performance is fairly similar to the performance of any one stock. The utilities and consumer staples industries fall into this category. In this case, investors need to decide how much of their portfolio to allocate to the sector overall, rather than pick specific stocks. Since the dispersion of returns from utilities and consumer staples tends to be narrow; picking a stock does not offer sufficiently higher return for the risk that is inherent in owning individual securities. Since ETFs pass through the dividends that are paid by the stocks in the sector, investors receive that benefit as well.
Often, the stocks in a particular sector are subject to disperse returns, yet investors are unable to select those securities which are likely to continue over-performing. Therefore, they cannot find a way to lower risk and enhance their potential returns by picking one or more stocks in the sector.
SEE: How To Pick The Best ETF
If the drivers of the performance of the company are more difficult to understand, you might consider the ETF. These companies may possess more difficult to evaluate technology or processes that cause them to underperform or do well. Perhaps their performance depends on the successful development and sale of a new unproven technology. The dispersion of returns is wide, and the odds of finding a winner can be quite low. The biotechnology industry is a good example, as many of these companies depend on the successful development and sale of a new drug. If the development of the new drug does not meet expectations in the series of trials, or the FDA does not approve the drug application, the company faces a bleak future. On the other hand, if the FDA approves the drug, investors in the company can be highly rewarded.
The semiconductors, certain commodities and specialty technology groups fit the category where ETFs may be the preferred alternative. For example, if you believe that now is a good time to invest in the mining sector, you may want to gain specific industry exposure. However, you are concerned that some stocks might encounter political problems harming their production. In this case, it is prudent to buy into the sector rather than a specific stock, since it reduces your risk. You can still benefit from growth in the overall sector, especially if it outperforms the overall market.
When deciding whether to pick stocks or select an ETF, look at the risk and the potential return that can be achieved. Stock-picking offers an advantage over ETFs, when there is a wide dispersion of returns from the mean. And you can gain an advantage using your knowledge of the industry or the stock.
ETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, and regardless of return dispersions, an ETF is your best choice
SEE: 5 ETFs Flaws You Shouldnt Overlook
The Bottom Line
Whether picking stocks or an ETF, you need to stay up to date on the sector or the stock in order to understand the underlying investment fundamentals. You do not want to see all of your good work go down the drain as time passes.
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APR and APY: Why Your Bank Hopes You Cant Tell The Difference
It is often purported that Albert Einstein referred to compound interest as the greatest force on earth. Strong words from one of the smartest men to ever live. Although this articles intention is not to ponder Einsteins most compelling views, we do intend to demonstrate the importance of understanding the difference between annual percentage rate (APR) and annual percentage yield (APY). For most people, these terms are applied to loans and investment products, but they are not created equal and they significantly affect how much you earn or must pay in these transactions.
What Is Compounding?
At its most basic, compounding refers to earning interest on previous interest. All investors want to maximize compounding on their investments , while at the same time minimize it on their loans. (For more detail on this subject, see Investing 101: The Phenomenal Concept Of Compounding.)
Compounding is especially important in our APR vs. APY discussion because many financial institutions have a sneaky way of quoting interest rates that use compounding principles to their advantage. Being financially literate in this area will help you spot which interest rate you are really getting.
Defining APR and APY
APR is the annual rate of interest without taking into account the compounding of interest within that year. Alternatively, APY does take into account the effects of intra-year compounding. This seemingly subtle difference can have important implications for investors and borrowers. Here is a look at the formulas for each method:
For example, a credit card company might charge 1% interest each month; therefore, the APR would equal 12% (1% x 12 months = 12%). This differs from APY, which takes into account compound interest. The APY for a 1% rate of interest compounded monthly would be 12.68% [(1 0.01)^12 – 1= 12.68%] a year. If you only carry a balance on your credit card for one months period you will be charged the equivalent yearly rate of 12%. However, if you carry that balance for the year, your effective interest rate becomes 12.68% as a result of compounding each month.
The Borrowers Perspective
As a borrower, you are always searching for the lowest possible rate. When looking at the difference between APR and APY, you need to be worried about how a loan might be disguised as having a lower rate .
For example, when looking for a mortgage you are likely to choose a lender that offers the lowest rate. Although the quoted rates appear low, you could end up paying more for a loan than you originally anticipated.
This is because banks will often quote you the annual percentage rate (APR). As we learned earlier, this figure does not take into account any intra-year compounding either semi-annual (every six months), quarterly (every three months), or monthly (12 times per year) compounding of the loan. The APR is simply the periodic rate of interest multiplied by the number of periods in the year. This may be a little confusing at first, so lets look at an example to solidify the concept:
As you can see, even though a bank may have quoted you a rate of 5%, 7%, or 9% depending on the frequency of compounding (this may differ depending on the bank, state, country, etc), you could actually pay a much higher rate. In the case of a bank quoting an APR of 9%, this does not consider the effects of compounding. However, if you were to consider the effects of monthly compounding, as APY does, you will pay 0.38% more on your loan each year - a significant amount when you are amortizing your loan over a 25- or 30-year period.
This example should illustrate the importance of asking your potential lender what rate he or she is quoting when seeking a loan. It is also important when comparing borrowing prospects to compare apples to apples so to speak (comparing the same figures), so that you can make the most informed decision.
The Lenders Perspective
Now as you may have already guessed, it is not hard to see how standing on the other side of the lending tree can affect your results in an equally significant fashion, and how banks and other institutions will often entice individuals by quoting APY. Just as individuals who are seeking loans want to pay the lowest possible rate of interest, the same individual wants to receive the highest rate of interest when they themselves are the lender.
For example, suppose that you are shopping around for a bank to open a savings account with; obviously, you are seeking the highest rate of interest. It is in the banks best interest to quote you the APY, as opposed to the APR. They want to quote the highest possible rate they can to entice you with to their bank. They are much less likely to quote you the APR because this rate is lower than the APY given that there is some compounding during the year.
Again, it is important for the individual to acknowledge the distinction between these two rates, because they can significantly affect that amount of interest that can be accumulated in a savings account.
It should be noted that different countries have different rules and regulations in place to combat some of the unscrupulous activity surrounding quoting rates that has arisen in the past; however, there is no better insulator against these ruses than knowledge.
Summary
Whether you are shopping for a loan or seeking the highest rate of return on a savings account, be mindful of the different rates that a bank or institution quotes. Depending on which side of the lending tree you stand on, banks and institutions have different motives for quoting different rates. Always ensure you understand which rates they are quoting and then compare the equivalent rates between alternatives.
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Diversifying Your Portfolio With Real Estate And Infrastructure
Real estate is undoubtedly a significant element of asset allocation, and should form a component of any institutional or personal investment portfolio. Also increasing in importance is infrastructure, which has similar advantages to real estate. Based on research at the University of Regensburg in Germany, this article will consider some of the main asset allocation issues in this context.
Both real estate and infrastructure constitute attractive investments for risk-averse investors, especially during bear markets. There are similarities and differences between the two, and you can construct a truly optimal portfolio by fully exploiting them. (For more on optimizing portfolios, see Achieving Optimal Asset Allocation.)
Diversification Through Real Estate and Infrastructure
The diversification benefits of direct and indirect real estate investments are well known, and diversifications role in institutional portfolios has been investigated extensively. The different correlations to those of stocks and bonds are extremely helpful for avoiding portfolio volatility.
In the U.S., there is a huge need to invest in and improve the infrastructure in many respects, so there is plenty of potential in the market. Pretty much all investors should take advantage of this potential to diversify more effectively than ever and in an extremely promising sector.
In the past, infrastructure has received relatively less attention, along with other alternative assets such as commodities and private equity. There has been a move away from the old-school conventional portfolios comprising equities, bonds, cash and real estate.
The allocation to real estate in particular could be affected if alternative investments significantly diversify returns from conventional investments. In fact, infrastructure has become a focus of attention and found its way into institutional portfolios, and to a lesser extent, private ones. (For more on asset allocation, see Five Things To Know About Asset Allocation.)
What makes infrastructure so appealing is that it seems quite similar to direct real estate in terms of big lot sizes and illiquidity, but also offers general stability and stable cash flows. The research on infrastructure lags behind that of real estate, and Tobias Dechant and Konrad Finkenzeller from Regensberg have attempted to bridge this gap.
Portfolio Optimization with Real Estate and Infrastructure
This research project, and earlier work in the field, demonstrates that direct infrastructure is an important element of portfolio diversification, and that firms tend to overallocate to real estate if they do not also invest in infrastructure. This is an important finding given that infrastructure is really helpful for risk-averse investors - especially in equity market downturns.
There is considerable variation in the recommended, relative amounts that should be invested in these two asset classes, The range extends from zero to as high as 70% (mainly in real estate), depending on the time frame, state of the markets and the methods used to derive the optimum.
The maximum total amount usually recommended for real estate and infrastructure allocations is about 25%, which is considerably higher than actual institutional allocations. It is important to note that efficient allocations in practice depend on numerous factors and parameters, and no specific mix proves to consistently superior. (For related reading, see Asset Allocation: The First Step Towards Profit.)
The blend of real estate and infrastructure is also controversial, but one study by Terhaar et al. (2003), for instance, suggests an even split. Some experts believe that about 5% is sufficient for each. In crisis periods, this can be three or even four times higher.
Another important finding is that real estate and infrastructure may be more useful in terms of diversification than through actual returns. Given the controversy on effective asset allocation and the turbulence in real estate markets, this is a major issue. The latter highlights the benefits of using not only real estate, but also infrastructure.
Also significant is the revelation that the targeted rate of return impacts on the appropriate level of real estate. Investors with higher portfolio return targets (who wish to earn more, but with more risk), may wish to devote less to real estate and infrastructure. This depends a lot on the state of these markets in relation to the equity markets in terms of whether the latter is in an upward or downward phase. (Asset allocation takes care of nearly 94% of your portfolios investment profile. For more, see Asset Allocation: One Decision To Rule Them All.)
The exact allocations to real estate and infrastructure depend on various parameters. Apart from the expected rate of portfolio return mentioned above, there is also the issue of how risk is defined. Other relevant factors include attitudes towards infrastructure in general, and how this relates to other alternative investments. In practice, these allocation decisions are complex, and higher or lower optima are therefore possible for different investors at different times.
Conclusions
If there is one thing that remains the top priority for all investors its having a well diversified portfolio. There is simply no substitute for this, but there is a lot of untapped potential in the market. Real estate investment, but also infrastructure, can play a vital role in optimizing portfolios. This mainly pertains to institutions, but also for private investors. Private investors can generally benefit from more diversification.
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Are You A Disciplined Investor?
In the late 1990s, many investors enjoyed the fruits of positive double-digit returns with their equity investments. Then, during the period of January 1, 2000, through December 31, 2002, the S
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An Inside Look At ETF Construction
Some people are happy to simply use a range of devices like wrist watches and computers and trust that things will work out. Others want to know the inner workings of the technology they use, and understand how it was built. If you fall into the latter category and as an investor have an interest in the benefits that exchange-traded funds (ETFs) offer, youll definitely be interested in the story behind their construction.
How an ETF Is Created
The creation and redemption process for ETF shares is almost the exact opposite of that of mutual fund shares. When investing in mutual funds, investors send cash to the fund company, which then uses that cash to purchase securities and in turn issue additional shares of the fund. When investors wish to redeem their mutual fund shares, the shares are returned to the mutual fund company in exchange for cash. The creation of an ETF, however, does not involve cash.
The process begins when a prospective ETF manager (known as a sponsor) files a plan with the SEC to create an ETF. Once the plan is approved, the sponsor forms an agreement with an authorized participant, generally a market maker, specialist or large institutional investor, who is empowered to create or redeem ETF shares. (In some cases, the authorized participant and the sponsor are the same).
The authorized participant borrows shares of stock, often from a pension fund, places those shares in a trust, and uses them to form creation units of the ETF. Creation units are bundles of stock varying from 10,000 to 600,000 shares, but 50,000 shares is whats commonly designated as one creation unit of a given ETF. Then, the trust provides shares of the ETF - which are legal claims on the shares held in the trust (the ETFs represent tiny slivers of the creation units) - to the authorized participant. Because this transaction is an in-kind trade - that is, securities are traded for securities - there are no tax implications. Once the authorized participant receives the ETF shares, they are then sold to the public on the open market just like shares of stock.
When ETF shares are bought and sold on the open market, the underlying securities that were borrowed to form the creation units remain in the trust account. The trust generally has little activity beyond paying dividends from the stock held in the trust to the ETF owners and providing administrative oversight because the creation units are not impacted by the transactions that take place on the market when ETF shares are bought and sold.
Redeeming an ETF
When investors want to sell their ETF holdings, they can do so by one of two methods. The first is to sell the shares on the open market. This is generally the option chosen by most individual investors. The second option is to gather enough shares of the ETF to form a creation unit and then exchange the creation unit for the underlying securities. This option is generally only available to institutional investors due to the large number of shares required to form a creation unit. When these investors redeem their shares, the creation unit is destroyed and the securities are turned over to the redeemer. The beauty of this option is in its tax implications for the portfolio.
We can see these tax implications best by comparing the ETF redemption to that of a mutual fund redemption. When mutual fund investors redeem shares from a fund, all shareholders in the fund are affected by the tax burden. This is because to redeem the shares, the mutual fund may have to sell the securities it holds, realizing the capital gain, which is subject to tax. Also, all mutual funds are required to pay out all dividends and capital gains on a yearly basis. Therefore, even if the portfolio has lost value that is unrealized, there is still a tax liability on the capital gains that had to be realized because of the requirement to pay out dividends and capital gains.
ETFs minimize this scenario by paying large redemptions with shares of stock. When such redemptions are made, the shares with the lowest cost basis in the trust are given to the redeemer. This increases the cost basis of the ETFs overall holdings, minimizing its capital gains. It doesnt matter to the redeemer that the shares it receives have the lowest cost basis because the redeemers tax liability is based on the purchase price it paid for the ETF shares, not the funds cost basis. When the redeemer sells the shares of stock on the open market, any gain or loss incurred has no impact on the ETF. In this manner, investors with smaller portfolios are protected from the tax implications of trades made by investors with large portfolios.
The Role of Arbitrage
Critics of ETFs often cite the potential for ETFs to trade at a share price that is not aligned with the value of the underlying securities. To help us understand this concern, a simple representative example best tells the story.
Assume an ETF is made up of only two underlying securities:
• Security A, which is worth $1 per share
• Security B, which is also worth $1 per share
In this example, most investors would expect one share of the ETF to trade at $2 per share (the equivalent worth of Security A and Security B). While this is a reasonable expectation, it is not always the case. It is possible for the ETF to trade at $2.02 per share or $1.98 per share or some other value.
If the ETF is trading at $2.02, investors buying shares of the ETF are paying more for the shares than the underlying securities are worth. This would seem to be a dangerous scenario for the average investor, but in reality, it isnt a major problem because of arbitrage trading.
Heres how arbitrage sets the ETF back into equilibrium. The trading price of an ETF is established at the close of business each day, just like any other mutual fund. ETF sponsors also announce the value of the underlying shares on a daily basis. When the price of the ETF deviates from the value of the underlying shares, the arbitragers spring into action. If the underlying securities are trading at a lower price than the ETF shares, arbitragers buy the underlying securities, redeem them for creation units, and then sell the ETF shares on the open market for a profit. If underlying securities are trading at higher values than the ETF shares, arbitragers buy ETF shares on the open market, form creations units, redeem the creation units in order to get the underlying securities, and then sell the securities on the open market for a profit. The actions of the arbitrageurs set the supply and demand of the ETFs back into equilibrium to match the value of the underlying shares.
Because ETFs were used by institutional investors long before they were discovered by the investing public, active arbitrage among institutional investors has served to keep ETF shares trading at a range that is close to the value of the underlying securities.
The Bottom Line
In a sense, ETFs have a lot in common with wrist watches. Everybody wants their watch to tell the correct time, but they dont need to know how the watch was built in order to benefit from it. With ETFs, investors can enjoy the benefits associated with this unique and attractive investment product, without even being aware of the complicated series of events that make it work. But, of course, knowing how those events work makes you a more educated investor, which is the key to being a better investor.
Interest Rates And Your Bond Investments
Most investors care about future interest rates , but none more than bondholders. If you are considering a bond or bond fund investment, you must ask yourself whether you think interest rates will rise in the future. If the answer is yes then you probably want to avoid long-term maturity bonds or at least shorten the average duration of your bond holdings; or plan to weather the ensuing price decline by holding your bonds and collecting the par value at maturity. (For a review of the relationships between prevailing interest rates and yield, duration, and other bond aspects, please see the tutorial Advanced Bonds Concepts.)
The Treasury Yield Curve
In the United States, the Treasury yield curve (or term structure) is the first mover of all domestic interest rates and an influential factor in setting global rates. Interest rates on all other domestic bond categories rise and fall with Treasuries, which are the debt securities issued by the U.S. government. To attract investors, any bond or debt security that contains greater risk than that of a similar Treasury bond must offer a higher yield. For example, the 30-year mortgage rate historically runs 1% to 2% above the yield on 30-year Treasury bonds.
Below is a graph of the actual Treasury yield curve as of December 5, 2003. It is considered normal because it slopes upward with a concave shape:
Consider three elements of this curve. First, it shows nominal interest rates. Inflation will erode the value of future coupon dollars and principal repayments; the real interest rate is the return after deducting inflation. The curve therefore combines anticipated inflation and real interest rates. Second, the Federal Reserve directly manipulates only the short-term interest rate at the very start of the curve. The Fed has three policy tools, but its biggest hammer is the federal funds rate, which is only a one-day, overnight rate. Third, the rest of the curve is determined bysupply and demand in an auction process.
Sophisticated institutional buyers have their yield requirements which, along with their appetite for government bonds, determine how these institutional buyers bid for government bonds. Because these buyers have informed opinions on inflation and interest rates, many consider the yield curve to be a crystal ball that already offers the best available prediction of future interest rates. If you believe that, you also assume that only unanticipated events (for example, an unanticipated increase in inflation) will shift the yield curve up or down.
Long Rates Tend to Follow Short Rates
Technically, the Treasury yield curve can change in various ways: it can move up or down (a parallel shift), become flatter or steeper (a shift in slope), or become more or less humped in the middle (a change in curvature).
The following chart compares the 10-year Treasury yield (red line) to the one-year Treasury yield (green line) from June 1976 to December 2003. The spread between the two rates (blue line) is a simple measure of steepness:
Consider two observations. First, the two rates move up and down somewhat together (the correlation for the period above is about 88%). Therefore, parallel shifts are common. Second, although long rates directionally follow short rates, they tend to lag in magnitude. Specifically, when short rates rise, the spread between 10-year and one-year yields tends to narrow (curve of the spread flattens) and when short rates fall, the spread widens (curve becomes steeper). In particular, the increase in rates from 1977 to 1981 was accompanied by a flattening and inversion of the curve (negative spread); the drop in rates from 1990 to 1993 created a steeper curve in the spread, and the marked drop in rates from March 2000 to the end of 2003 produced a very steep curve by historical standards.
Supply-Demand Phenomenon
So what moves the yield curve up or down? Well, lets admit we cant do justice to the complex dynamics of capital flows that interact to produce market interest rates. But we can keep in mind that the Treasury yield curve reflects the cost of U.S. government debt and is therefore ultimately a supply-demand phenomenon. (For a refresher on how increases and decreases in the supply and demand of credit affect interest rates, see the article Forces Behind Interest Rates.)
Supply-Related Factors
Monetary Policy
If the Fed wants to increase the fed funds rate, it supplies more short-term securities in open market operations. The increase in the supply of short-term securities restricts the money in circulation since borrowers give money to the Fed. In turn, this decrease in the money supply increases the short-term interest rate because there is less money in circulation (credit) available for borrowers. By increasing the supply of short-term securities, the Fed is yanking up the very left end of the curve, and the nearby short-term yields will snap quickly in lockstep.
Can we predict future short-term rates? Well, the expectations theory says that long-term rates embed a prediction of future short-term rates. But consider the actual December yield curve illustrated above, which is normal but very steep. The one-year yield is 1.38% and the two-year yield is 2.06%. If you were going to invest with a two-year time horizon and if interest rates were going to hold steady, you would, of course, do much better to go straight into buying the two-year bond (which has a much higher yield) instead of buying the one-year bond and rolling it over into another one-year bond. Expectations theory, however, says the market is predicting an increase in the short rate. Therefore, at the end of the year you will be able to roll over into a more favorable one-year rate and be kept whole relative to the two-year bond, more or less. In other words, expectations theory says that a steep yield curve predicts higher future short-term rates.
Unfortunately, the pure form of the theory has not performed well: interest rates often remain flat during a normal (upward sloping) yield curve. Probably the best explanation for this is that, because a longer bond requires you to endure greater interest rate uncertainty, there is extra yield contained in the two-year bond. If we look at the yield curve from this point of view, the two-year yield contains two elements: a prediction of the future short-term rate plus extra yield (i.e., a risk premium) for the uncertainty. So we could say that, while a steeply sloping yield curve portends an increase in the short-term rate, a gently upward sloping curve, on the other hand, portends no change in the short-term rate - the upward slope is due only to the extra yield awarded for the uncertainty associated with longer term bonds.
Because Fed watching is a professional sport, it is not enough to wait for an actual change in the fed funds rate, as only surprises count. It is important for you, as a bond investor , to try to stay one step ahead of the rate, anticipating rather than observing its changes. Market participants around the globe carefully scrutinize the wording of each Fed announcement (and the Fed governors speeches) in a vigorous attempt to discern future intentions.
Fiscal Policy
When the U.S. government runs a deficit, it borrows money by issuing longer term Treasury bonds to institutional lenders. The more the government borrows, the more supply of debt it issues. At some point, as the borrowing increases, the U.S. government must increase the interest rate to induce further lending. However, foreign lenders will always be happy to hold bonds in the U.S. government: Treasuries are highly liquid and the U.S. has never defaulted (it actually came close to a default in late 1995, but Robert Rubin, the Treasury secretary at the time, staved off the threat and has called a Treasury default unthinkable - something akin to nuclear war). Still, foreign lenders can easily look to alternatives like eurobonds and, therefore, they are able to demand a higher interest rate if the U.S. tries to supply too much of its debt.
Demand-Related Factors
Inflation
If we assume that borrowers of U.S. debt expect a given real return, then an increase in expected inflation will increase the nominal interest rate (the nominal yield = real yield inflation). Inflation also explains why short-term rates move more rapidly than long-term rates: when the Fed raises short-term rates, long-term rates increase to reflect the expectation of higher future short-term rates; however, this increase is mitigated by lower inflation expectations as higher short-term rates also suggest lower inflation (as the Fed sells/supplies more short-term Treasuries, it collects money and tightens the money supply):
An increase in feds funds (short-term) tends to flatten the curve because the yield curve reflects nominal interest rates: higher nominal = higher real interest rate lower inflation.
Fundamental Economics
The factors that create demand for Treasuries include economic growth, competitive currencies and hedging opportunities. Just remember: anything that increases the demand for long-term Treasury bonds puts downward pressure on interest rates (higher demand = higher price = lower yield or interest rates) and less demand for bonds tends to put upward pressure on interest rates. A stronger U.S. economy tends to make corporate (private) debt more attractive than government debt, decreasing demand for U.S. debt and raising rates. A weaker economy, on the other hand, promotes a flight to quality, increasing the demand for Treasuries, which creates lower yields. It is sometimes assumed that a strong economy will automatically prompt the Fed to raise short-term rates, but not necessarily. Only when growth translates or overheats into higher prices is the Fed likely to raise rates.
In the global economy, Treasury bonds compete with other nationss debt. On the global stage, Treasuries represent an investment in both the U.S. real interest rates and the dollar. The euro is a particularly important alternative: for most of 2003, the European Central Bank pegged its short-term rate at 2%, a more attractive rate than the fed funds rate of 1%.
Finally, Treasuries play a huge role in the hedging activities of market participants. In environments of falling interest rates, many holders of mortgage-backed securities, for instance, have been hedging their prepayment risk by purchasing long-term Treasuries. These hedging purchases can play a big role in demand, helping to keep rates low, but the concern is that they may contribute to instability.
Conclusion
We have covered some of the key traditional factors associated with interest rate movements. On the supply side, monetary policy determines how much government debt and money are supplied into the economy. On the demand side, inflation expectations are the key factor. However, we have also discussed other important influences on interest rates, including: fiscal policy (that is, how much does the government need to borrow?) and other demand-related factors such as economic growth and competitive currencies.
Here is a summary chart of the different factors influencing interest rates:
For thou convenience $SDRG BarChart Technical Analysis NITE-LYNX
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Dissecting Declarations, Ex-Dividends And Record Dates
Have the workings of dividends and dividend distributions mystified you too? Chances are its not the concept of dividends that confuses you; the ex-dividend date and date of record are the tricky factors. In this article well sort through the dividend payment process and explain on what date the buyer of the stock gets to keep the dividend.
Before we explain how it all works, lets go over some of the basics to ensure we have the proper foundation to understand the more complex issues. Some investment terms are thrown around more often than Frisbees on a hot summer day, so its important that we define exactly what were talking about.
Different Types of Dividends
The decision to distribute a dividend is made by a companys board of directors. There is nothing requiring a company to pay a dividend, even if the company has paid dividends in the past. However, many investors view a steady dividend history as an important indicator of a good investment, so most companies are reluctant to reduce or stop their dividend payments. (For more information on buying dividend paying stocks , see the articles How Dividends Work for Investors and The Importance of Dividends.
Dividends can be paid in various different forms, but there are two major categories: cash and stock. The most popular are cash dividends. This is money paid to stockholders , normally out of the corporations current earnings or accumulated profits.
For example, suppose you own 100 shares of Corys Brewing Company (ticker: CBC). Cory has made record sales this year thanks to an unusually high demand for his unique peach flavored beer. The company therefore decides to share some of this good fortune with the stockholders and declares a dividend of $0.10 per share. This means that you will receive a check from Corys Brewing Company for $10.00 ($0.10*100). In practice, companies that pay dividends usually do so on a regular basis of four times a year. A one-time dividend such as the one we just described is referred to as an extra dividend.
The stock dividend, the second most common dividend paying method, pays additional shares rather than cash. Suppose that Corys Brewing Company wishes to issue a dividend but doesnt have the necessary cash available to pay everyone. He does, however, have enough Treasury stock to meet the requirements of the dividend payout. So instead of paying cash, Cory decides to issue a dividend of 0.05 new shares of CBC for every existing one. This means that you will receive five shares of CBC for every 100 shares that you own. If any fractional shares are left over, the dividend is paid as cash (because stocks cant trade fractionally).
Another type of dividend is the property dividend, but it is used rarely. This type of allocation is a physical transfer of a tangible asset from the company to the investors. For instance, if Corys Brewing Company was still insistent on paying out dividends but didnt have enough Treasury stock or enough money to pay out all investors, the company could look for something physical (property) to distribute. In this case, Cory might decide that his unique peach beer would be the best substitute, so he could distribute a couple of six-packs to all the shareholders.
The Important Dates of a Dividend
There are four major dates in the process of a company paying dividends:
• Declaration date - This is the date on which the board of directors announces to shareholders and the market as a whole that the company will pay a dividend.
• Ex-date or Ex-dividend date - On (or after) this date the security trades without its dividend. If you buy a dividend paying stock one day before the ex-dividend you will still get the dividend, but if you buy on the ex-dividend date, you wont get the dividend. Conversely, if you want to sell a stock and still receive a dividend that has been declared you need to sell on (or after) the ex-dividend day. The ex-date is the second business day before the date of record.
• Date of record - This is the date on which the company looks at its records to see who the shareholders of the company are. An investor must be listed as a holder of record to ensure the right of a dividend payout.
• Date of payment (payable date) - This is the date the company mails out the dividend to the holder of record. This date is generally a week or more after the date of record so that the company has sufficient time to ensure that it accurately pays all those who are entitled.
Why All These Dates?
Ex-dividend dates are used to make sure dividend checks go to the right people. In todays market, settlement of stocks is a T 3 process, which means that when you buy a stock , it takes three days from the transaction date (T) for the change to be entered into the companys record books.
As mentioned, if you are not in the companys record books on the date of record, you wont receive the dividend payment. To ensure that you are in the record books, you need to buy the stock at least three business days before the date of record, which also happens to be the day before the ex-dividend date.
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As you can see by the diagram above, if you buy on the ex-dividend date (Tuesday), which is only two business days before the date of record, you will not receive the dividend because your name will not appear in the companys record books until Friday. If you want to buy the stock and receive the dividend, you need to buy it on Monday. (When the stock is trading with the dividend the term cum dividend is used). But, if you want to sell the stock and still receive the dividend, you need to sell on or after Tuesday the 6th.
*Note: Different rules apply if the dividend is 25% or greater of the value of the security. In this case, the Financial Industry Regulatory Authority (FINRA) indicates that the ex-date is the first business day following the payable date. For further details on dividend issues, search FINRAs website.
A Money Machine?
Now that we understand that a dividend can be received by purchasing the stock before the ex-date, can we make more money? Nope, its not that easy. Remember, everybody knows when the dividend is going to be paid, and the market sees the dividend payout as a time when the company is giving out a part of its profits (reducing its cash). So the price of the stock will drop approximately by the amount of the dividend on the ex-dividend date. The word approximately is crucial here. Due to tax considerations and other happenings in the market, the actual drop in price may be slightly different. In any case, the point is that you cant make free profits on the ex-dividend date.
Conclusion
The reasons for and effects of all these dates are by no means easy to grasp. Its important to clear up any confusion between ex-dividend and record dates. But always keep in mind that when youre investing in a dividend paying stock, its more crucial to consider the quality of the company than the date on which you buy in.
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Financial Statement Manipulation An Ever-Present Problem For Investors
Financial statement manipulation is an ongoing problem in corporate America. Although the Securities and Exchange Commission (SEC) has taken many steps to mitigate this type of corporate malfeasance, the structure of management incentives, the enormous latitude afforded by theGenerally Accepted Accounting Principles (GAAP) and the ever-present conflict of interest between the independent auditor and the corporate client continues to provide the perfect environment for such activity. Due to these factors, investors who purchase individual stocks or bonds must be aware of the issues, warning signs and the tools that are at their disposal in order to mitigate the adverse implications of these problems.
Factors That Contribute to Financial Statement Manipulation
There are three primary reasons why management manipulates financial statements. First, in many cases the compensation of corporate executives is directly tied to the financial performance of the company. As a result, management has a direct incentive to paint a rosy picture of the companys financial condition in order to meet established performance expectations and bolster their personal compensation.
Second, it is relatively easy to manipulate corporate financial statements because the Financial Accounting Standards Board (FASB), which sets the GAAP standards, provides a significant amount of latitude in the accounting provisions that are available to be used by corporate management. For better or worse, these GAAP standards afford a significant amount of flexibility, making it very easy for corporate management to paint a favorable picture of the financial condition of the company.
Third, it is unlikely that financial manipulation will be detected by investors due to the relationship between the independent auditor and the corporate client. In the U.S., the Big Four accounting firms and a host of smaller regional accounting firms dominate the corporate auditing environment. While these entities are touted as independent auditors, the firms have a direct conflict of interest because they are compensated by the very companies that they audit. As a result, the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep their client happy. Moreover, auditors typically receive a significant amount of money from the companies that they audit. Therefore, there is implicit pressure to certify the financial statements of the company in order to retain their business.
How Financial Statements Are Manipulated
There are two general approaches to manipulating financial statements. The first approach is to inflate current period earnings on the income statement by artificially inflating revenue and gains, or by deflating current period expenses. This approach makes the financial condition of the company look better than it actually is in order to meet established expectations.
The second approach to financial statement manipulation requires the exact opposite tactic, which is to deflate current period earnings on the income statement by deflating revenue or by inflating current period expenses. The reason behind this approach may not be as obvious as in the previous example because it may seem counterintuitive to make the financial condition of a company look worse than it actually is. However, there are many reasons to engage in such activity, such as making a company look bad in order to dissuade potential acquirers, pulling all of the bad financial information surrounding the company into one period so that the company will look stronger going forward, pulling all of the bad financial information into the current period when the poor performance can be attributed to the current macroeconomic environment or to postpone good financial information to a future period when it is more likely to be recognized.
According to Dr. Howard Schilit, in his famous book Financial Shenanigans (2002), there are seven primary ways in which corporate management manipulates the financial statements of a company. Lets look at these seven general categories of financial statement manipulation and the typical accounting processes that facilitate the manipulation.
1. Recording Revenue Prematurely or of Questionable Quality
o Recording revenue prior to completing all services
o Recording revenue prior to product shipment
o Recording revenue for products that are not required to be purchased
2. Recording Fictitious Revenue
o Recording revenue for sales that did not take place
o Recording investment income as revenue
o Recording proceeds received through a loan as revenue
3. Increasing Income with One-Time Gains
o Increasing profits by selling assets and recording the proceeds as revenue
o Increasing profits by classifying investment income or gains as revenue
4. Shifting Current Expenses to an Earlier or Later Period
o Amortizing costs too slowly
o Changing accounting standards to foster manipulation
o Capitalizing normal operating costs in order to reduce expenses by moving them from the income statement to the balance sheet
o Failing to write down or write off impaired assets
5. Failing to Record or Improperly Reducing Liabilities
o Failing to record expenses and liabilities when future services remain
o Changing accounting assumptions to foster manipulation
6. Shifting Current Revenue to a Later Period
o Creating a rainy day reserve as a revenue source to bolster future performance
o Holding back revenue
7. Shifting Future Expenses to the Current Period as a Special Charge
o Accelerating expenses into the current period
o Changing accounting standards to foster manipulation, particularly through provisions for depreciation, amortization and depletion
Investors should understand that there are a host of techniques that are at managements disposal. However, what investors also need to understand is that while most of these techniques pertain to the manipulation of the income statement, there are also many techniques available to manipulate the balance sheet, as well as the statement of cash flows . Moreover, even the semantics of the management discussion and analysis section of the financials can be manipulated by softening the action language used by corporate executives from will to might, probably to possibly, and therefore to maybe. Taken collectively, investors should understand these issues and nuances and remain on guard when assessing a companys financial condition.
Financial Manipulation via Corporate Merger or Acquisition
Another form of financial manipulation can be found during the merger or acquisition process. A classic approach to this type of manipulation occurs when management tries to persuade all parties involved in the decision-making process to support a merger or acquisition based primarily on the improvement in the estimated earnings per share of the combined companies. Lets look at the table below in order to understand how this type of manipulation takes place.
Proposed Corporate Acquisition Acquiring Company Target Company Combined Financials
Common Stock Price
$100.00
$40.00
-
Shares Outstanding
100,000
50,000
120,000
Book Value of Equity
$10,000,000
$2,000,000
$12,000,000
Company Earnings
$500,000
$200,000
$700,000
Earnings Per Share $5.00 $4.00 $5.83
Based on the data in the table above, the proposed acquisition of the target company appears to make good financial sense because the earnings per share of the acquiring company will be materially increased from $5 per share to $5.83 per share. However, the earnings per share of the acquiring company will increase by a material amount for only two reasons, and neither reason has any long-term implications.
Following the acquisition, the acquiring company will experience an increase of $200,000 in company earnings due to the addition of the income from the target company. Moreover, given the high market value of the acquiring companys common stock, and the low book value of the target company, the acquiring company will only have to issue an additional 20,000 shares in order to make the $2 million acquisition. Taken collectively, the significant increase in company earnings and the modest increase of 20,000 common shares outstanding will lead to a more attractiveearning per share amount. Unfortunately, a financial decision based primarily on this type of analysis is inappropriate and misleading, because the future financial impact of such an acquisition may be positive, immaterial or even negative.
How to Guard Against Financial Statement Manipulation
There are a host of factors that may affect the quality and accuracy of the data at an investors disposal. As a result, investors must have a working knowledge of financial statement analysis, including a strong command of the use of internal liquidity solvency analysis ratios, externalliquidity marketability analysis ratios, growth and corporate profitability ratios, financial risk ratios and business risk ratios. Investors should also have a strong understanding of how to use market multiple analysis, including the use of price/earnings ratios, price/book value ratios, price/sales ratios and price/cash flow ratios in order to gauge the reasonableness of the financial data .
Finally, investors should keep in mind that the independent auditors responsible for providing the audited financial data may very well have a material conflict of interest that is distorting the true financial picture of the company and that the information provided to them by corporate management may be disingenuous, and therefore should be taken with a grain of salt.
The Bottom Line
The known prevalence and magnitude of the material issues associated with the compilation of corporate financial statements should remind investors to use extreme caution in their use and interpretation. There are many cases of financial manipulation that date back over the centuries, and recent examples such as Enron, Worldcom, Tyco International, Adelphia, Global Crossing, Cendant, Freddie Mac and AIG should remind investors of the potential land mines that they may encounter. Investors should also remember the corporate malfeasance recently conducted by the now defunct auditing firm Arthur Anderson, as well as the disingenuous information provided to the general public by the corporate executives of 360 Networks, Lehman Brothers and General Motors leading up to their bankruptcies. Extreme caution should be used while conducting financial statement analysis.
Finally, given the prevalence and magnitude of the material issues surrounding financial statement manipulation in corporate America, a strong case can be made that most investors should stick to investing in low-cost, diversified, actively-managed mutual funds in order to mitigate the likelihood of investing in companies that suffer from such corporate financial malfeasance. Simply put, financial statement analysis should be left to investment management teams that have the knowledge, background and experience to thoroughly analyze a companys financial picture before making an investment decision. Unfortunately, very few investors have the necessary time, skills and resources to engage in such activity, and therefore the purchase of individual securities by most investors is probably not a wise decision.
BarChart Technical Analysis NITE-LYNX $LTCH
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Peter Lynch On Playing The Market
Even though the reality of investing is often extremely disappointing or worse, the literature in the field can be outstanding. There is no shortage of excellent books, or of journalistic and academic writing. In this article, well take a look at Peter Lynchs One Up on Wall Street and get an overview of the kind of timeless advice that he provides. (For more, see Pick Stocks Like Peter Lynch.)
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Market Timing and Daring to be Different
Lynch sums up issues on market timing beautifully. His basic idea is that, not only is it difficult to predict the markets, but small investors can be both pessimistic and optimistic at all the wrong times. Basically, it can be self-defeating to try to invest in good markets and get out of bad ones. Thats not to imply that the small investor doesnt know what theyre doing, but rather that accurate market timing, especially in the short run, is unlikely. The critical point is that you dont have to be able to predict the stock market to make money with it.
Some of the best and most successful professional traders have an uncanny ability to sniff out really good stocks, before they become trendy and overpriced. According to Lynch, this is because the risks of the stock market can be reduced by proper play, just like the risks of stud poker.
Overheated Markets
What Lynch makes clear is that there are bad times to buy. This is not market timing, it is simply true that sometimes the market is dangerously high and at other times, way too low; for buyers, this can be appealingly low. Although, according to him, there is no absolute division between safe and rash places to invest, experts, or just ordinary, sensible people who take the trouble to find out, can find reliable signs of where they should be investing. When people are getting greedy, excessively risk-friendly, and are taking too many chances, the market should be avoided, or exposure to it at least reduced. (To learn more, see our Market Crashes Tutorial.)
Nothing, says Lynch, is more dangerous than extremely overpriced stocks, and it is possible to know when this is the case. There is nothing intrinsically wrong with the stocks of good companies; what is wrong is the way people invest. This can apply just as much to so-called professionals, as to the investor on the street. Likewise, for people who just do not have the time horizon for stocks, even buying blue chips would be too risky. Lynch stresses that it is important to remember that the market, like individual stocks, can move in the opposite direction of the fundamentals. If stocks, or more likely, too much of your money in them, are unsuitable for your needs and appetite for risk, dont even think about it. Diversification is the essence of sensible investing. (To learn more, see The Importance Of Diversification.)
What Most Brokers Really Do and Dont
If you are a small investor, dont expect too much attention from the industry. Lynch warns that theres an unwritten rule in the industry that, the bigger the client, the more talking the portfolio manager has to do to please him. If you are a small fish, he may not bother much at all, just leaving the money at the mercy of the market.
Its an ugly reality that most brokers just do not have the guts to buy into unknown companies. Believe it or not, the average Wall Street professional isnt looking for reasons to buy exciting stocks, and when these companies rocket up, the broker will have all manner of excuses for not having bought.
How to Do It
Lynch explains that the next investment is never like the last one and yet we cant help readying ourselves for it anyway. The economy and markets evolve in a mixture of the unpredictable and the predictable. We cannot know how the future will unfold, but we can still invest prudently and make money. The significance of this simple fact cannot be overemphasized. The trick is to buy great companies, especially those that are undervalued and/or underappreciated. Alternatively, if you pick the right stock the market will take care of itself.
There are some common characteristics of companies that should be avoided like the plague. By using such methods as cash, debt, price to earnings ratios, profit margins, book value and dividends, you can get a pretty good idea about whether a company is worth buying into.
Its also a good idea to keep checking; after all, sooner or later every popular, fast-growing industry becomes a slow-growing industry. There is a tendency to think things will never change, and while you may always want to keep some stalwarts in your portfolio, these, too, need to be monitored. (For more, see Fundamental Analysis For Traders.)
Other Classic Blunders and Seriously Dangerous Delusions
Apart from all the above, Lynch teaches that there are many disastrous things that many people think, and do, again and again, but which can easily be avoided. You dont need to time the market to believe that if its gone down so much already, it cant get much lower. By the same token, people who think they can always tell when a stock has hit the bottom, are themselves going to get hit.
In the same vein, do not believe that stocks always come back or that conservative stocks dont fluctuate much. Similarly, believing that when the stock goes up youre right, or when its down, youre wrong, can cost you a lot of money.
The Bottom Line
Lynch summarizes his book with some succinct advice: It is inevitable that there will be sharp declines in the market that present buying opportunities. To come out ahead, you dont have to be right all the time. Nevertheless, trying to predict the market in the short term is impossible. Companies dont grow without good reason and fast growers wont stay that way forever. If you dont think you can beat the market, for whatever reason, buy a mutual fund and save both the work and the money; dont count on the industry to do a great job, on your behalf.
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Digging Deeper Into Bull And Bear Markets
Almost every day in the investing world, you will hear the terms bull and bear to describe market conditions. As common as these terms are, however, defining and understanding what they mean is not so easy. Because the direction of the market is a major force affecting your portfolio, its important you know exactly what the terms bull and bear market actually signify, how they are characterized and how each affects you.
What Are Bear and Bull Markets?
Used to describe how stock markets are doing in general - that is, whether they are appreciating or depreciating in value - these two terms are constantly buzzing around the investing world. At the same time, because the market is determined by investors attitudes, these terms also denote how investors feel about the market and the ensuing trend.
Simply put, a bull market refers to a market that is on the rise. It is typified by a sustained increase in market share prices. In such times, investors have faith that the uptrend will continue in the long term. Typically, the countrys economy is strong and employment levels are high.
On the other hand, a bear market is one that is in decline. Share prices are continuously dropping, resulting in a downward trend that investors believe will continue in the long run, which, in turn, perpetuates the spiral. During a bear market, the economy will typically slow down and unemployment will rise as companies begin laying off workers.
Where Did the Terms Come From?
The origins of the terms bull and bear are unclear, but here are two of the most common explanations:
1. The bear and bull markets are named after the way in which each animal attacks its victims. It is characteristic of the bull to drive its horns up into the air, while a bear, on the other hand, like the market that bears its name, will swipe its paws downward upon its unfortunate prey. Furthermore, bears and bulls were literally once fierce opponents when it was popular to put bulls and bears into the arena for a fight match. Matches using bulls and bears (whether together or gains other animals) took place in the Elizabethan era in London and were also a popular spectator sport in ancient Rome.
2. Historically, the middlemen who were involved in the sale of bearskins would sell skins that they had not yet received and, as such, these middlemen were the first short sellers. After promising their customers to deliver the paid-for bearskins, these middlemen would hope that the near-future purchase price of the skins from the trappers would decrease from the current market price. If the decrease occurred, the middlemen would make a personal profit from the spread between the price for which they had sold the skins and the price at which they later bought the skins from the trappers. These middlemen became known as bears, short for bearskin jobbers, and the term stuck for describing a person who expects or hopes for a decrease in the market.
Characteristics of a Bull and Bear Market
Although we know that a bull or bear market condition is marked by the direction of stock prices, there are some accompanying characteristics of the bull and bear markets that investors should be aware of. The following list describes some of the factors that generally are affected by the current market type, but do keep in mind that these are not steadfast or absolute rules for typifying either bull or bear markets:
• Supply and Demand for Securities - In a bull market, we see strong demand and weak supply for securities. In other words, many investors are wishing to buy securities while few are willing to sell. As a result, share prices will rise as investors compete to obtain available equity. In a bear market, the opposite is true as more people are looking to sell than buy. The demand is significantly lower than supply and, as a result, share prices drop. (For more on this, read Economics Basics: Demad and Supply.)
• Investor Psychology - Because the markets behavior is impacted and determined by how individuals perceive that behavior, investor psychology and sentiment are fundamental to whether the market will rise or fall. Stock market performance and investor psychology are mutually dependent. In a bull market, most everyone is interested in the market, willingly participating in the hope of obtaining a profit. During a bear market, on the other hand, market sentiment is negative as investors are beginning to move their money out of equities and into fixed-income securities until there is a positive move. In sum, the decline in stock market prices shakes investor confidence, which causes investors to keep their money out of the market - which, in turn, causes the decline in the stock market. (For related reading, see Taking A Chance On Behavioral Finance.)
• Change in Economic Activity - Because the businesses whose stocks are trading on the exchanges are the participants of the greater economy, the stock market and the economy are strongly connected. A bear market is associated with a weak economy as most businesses are unable to record huge profits because consumers are not spending nearly enough. This decline in profits, of course, directly affects the way the market values stocks. In a bull market, the reverse occurs as people have more money to spend and are willing to spend it, which, in turn, drives and strengthens the economy.
How to Gauge Market Changes
The key determinant of whether the market is bull or bear is the long-term trend, not just the markets knee-jerk reaction to a particular event. Small movements only represent a short-term trend or a market correction. Of course, the length of the time period that you are viewing will determine whether you see a bull or bear market.
For instance, the last two weeks could have shown the market to be bullish while the last two years may have displayed a bearish tendency. Thus, most agree that a decided reversal in the market should be ascertained by the degree of the change: if multiple indexes have changed by at least 15-20%, investors can be quite certain the market has taken a different direction. If the new trend does continue, it is because investors are perceiving a changes in both market and economic conditions and are thus making decisions accordingly.
Not all long movements in the market can be characterized as bull or bear. Sometimes a market may go through a period of stagnation as it tries to find direction. In this case, a series of up and downward movements would actually cancel-out gains and losses resulting in a flat market trend.
What To Do?
In a bull market, the ideal thing for an investor to do is take advantage of rising prices by buying early in the trend and then selling them when they have reached their peak. (Of course, determining exactly when the bottom and the peak will occur is impossible.) On the whole, when investors have a tendency to believe that the market will rise (thus being bullish), they are more likely to make profits in a bull market. As prices are on the rise, any losses should be minor and temporary. During the bull market, an investor can actively and confidently invest in more equity with a higher probability of making a return.
In a bear market, however, the chance of losses is greater because prices are continually losing value and the end is not often in sight. Even if you do decide to invest with the hope of an upturn, you are likely to take a loss before any turnaround occurs. Thus, most of the profitability will be found in short selling or safer investments such as fixed-income securities. An investor may also turn to defensive stocks, whose performances are only minimally affected by changing trends in the market and are therefore stable in both economic gloom and boom. These are industries such as utilities, which are often owned by the government and are necessities that people buy regardless of the economic condition.
Conclusion
There is no sure way to predict market trends, so investors should invest their money based on the quality of the investments. At the same time, however, you should have an understanding of long-term market trends from a historical perspective. Because both bear and bull markets will have a large influence over your investments, do take the time to determine what the market is doing when you are making an investment decision. Remember though, in the long term, the market has posted a positive return.
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Testing 3 Types Of Analysts
There are several types of analysts on Wall Street, and they produce different kinds of reports because they have different kinds of clients. Lets take a look at the different responsibilities required for each analyst, so that you can do your own litmus test to see which ones you need to pay attention to.
Sell-Side Analysts
These are the analysts that are dominating todays headlines. They are employed by brokerage houses to analyze companies and write in-depth research reports, conducting what is sometimes called primary research. These reports are used to sell an idea to individuals and institutional clients. Individual investors gain access to these reports mainly by having accounts with the brokerage firm. For example, to get free research from Merrill Lynch, you need to have an account with a Merrill Lynch broker. Sometimes the reports can be purchased through a third party such as Multex.com. Institutional clients (i.e. mutual fund managers) get research from the brokerages institutional brokers. (Keep reading about fund managers in Should You Follow Your Fund Manager? and Choose A Fund With A Winning Manager.
A good sell-side research report contains a detailed analysis of a companys competitive advantages and provides information on managements expertise and how the companys operating and stock valuation compares to a peer group and its industry. The typical report also contains an earnings model and clearly states the assumptions that are used to create the forecast.
Writing this type of report is a time consuming process. Information is obtained by reading the companys filings for the Securities
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The Value Investors Handbook
Value investing, and any type of investing for that matter, varies in execution with each person. There are, however, some general principles that are shared by all value investors. These principles have been spelled out by famed investors like Peter Lynch, Kenneth Fisher, Warren Buffet,John Templeton and many others. In this article, we will look at these principles in the form of a value investors handbook.
Buy Businesses
If there is one thing that all value investors can agree on, its that investors should buy businesses, not stocks. This means ignoring trends in stock prices and other market noise. Instead, investors should look at the fundamentals of the company that the stock represents. Investors can make money following trending stocks, but it involves a lot more activity than value investing. Searching for good businesses selling at a good price based on probable future performance requires a larger time commitment for research, but the payoffs include less time spent buying and selling and fewer commission payments. (False signals can drown out underlying trends. Find out how to tone them down and tune them out in Trading Without Noise.)
Love the Business You Buy
You wouldnt pick a spouse based solely on his or her shoes, and you shouldnt pick a stock based on cursory research. You have to love the business you are buying, and that means being passionate about knowing everything about that company. You need to strip the attractive covering from a companys financials and get down to the naked truth. Many companies look far better when you judge them on basic price to earnings (P/E), price to book (P/B) and earnings per share (EPS) ratios than they do when you look into the quality of the numbers that make up those figures.
If you keep your standards high and make sure the companys financials look as good naked as they do dressed up, youre much more likely to keep it in your portfolio for a long time. If things change, youll notice it early. If you like the business you buy, paying attention to its ongoing trials and successes becomes more of a hobby than a chore.
Simple Is Best
If you dont understand what a company does or how, then you probably shouldnt be buying shares. Critics of value investing like to focus on this main limitation. You are stuck looking for businesses that you can easily understand because you have to be able to make an educated guess about the future earnings of the business. The more complex a business is, the more uncertain your projections will necessarily be. This moves the emphasis from educated to guess.
You can buy businesses you like but dont completely understand, but you have to factor in uncertainty as added risk. Any time a value investor has to factor in more risk, he has to look for a larger margin of safety - that is, more of adiscount from the calculated true value of the company. There can be no margin of safety if the company is already trading at many multiples of its earnings, which is a strong sign that, however exciting and new the idea is, the business is not a value play. Simple businesses also have an advantage, as its harder for incompetent management to hurt the company. (For a complete guide to reading the financial reports, check out our Financial Statements Tutorial.)
Look for Owners, Not Managers
Management can make a huge difference in a company. Good management adds value beyond a companys hard assets. Bad management can destroy even the most solid financials. There have been investors who have based their entire investing strategies on finding managers that are honest and able. To quote Buffett, look for three qualities: integrity, intelligence, and energy. And if they dont have the first, the other two will kill you. You can get a sense of managements honesty through reading several years worth of financials. How well did they deliver on past promises? If they failed, did they take responsibility, or gloss it over? (Find out more about Buffetts investing in Warren Buffett: How He Does It.)
Value investors want managers who act like owners. The best managers ignore the market value of the company and focus on growing the business, thus creating long-term shareholder value. Managers who act like employees often focus on short-term earnings in order to secure a bonus or other performance perk, sometimes to the long-term detriment of the company. Again, there are many ways to judge this, but the size and reporting of compensation is often a dead give away. If youre thinking like an owner, you pay yourself a reasonable wage and depend on gains in your stock holdings for a bonus. At the very least, you want a company that expenses its stock options. (Still wondering how to investigate the top brass? Check out Evaluating A Companys Management.)
When You Find a Good Thing, Buy a Lot
One of the areas where value investing runs contrary to commonly accepted investing principles is on the issue of diversification. There are long stretches where a value investor will be idle. This is because of the exacting standards of value investing as well as overall market forces. Toward the end of a bull market, everything gets expensive, even the dogs, so a value investor may have to sit on the sidelines waiting for the inevitable correction. Time, an important factor in compounding, is lost while waiting, so when you do find undervalued stocks, you should buy as much as you can. Be warned, this will lead to a portfolio that is high-risk according to traditional measures like beta. Investors are encouraged to avoid concentrating on only a few stocks, but value investors generally feel that they can only keep proper track of a few stocks at a time.
One obvious exception is Peter Lynch, who kept almost all of his funds in stocks at all times. Lynch broke stocks into categories and then cycled his funds through companies in each category. He also spent upwards of 12 hours every day checking and rechecking the many stocks held by his fund. As an individual value investor with a different day job, however, its better to go with a few stocks for which youve done the homework and feel good about holding long term. (Learn the basic tenets that helped this famous investor earn his fortune in Pick Stocks Like Peter Lynch.)
Measure Against Your Best Investment
Anytime you have more investment capital, your aim for investing should not be diversity, but finding an investment that is better than the ones you already own. If the opportunities dont beat what you already have in your portfolio, you may as well buy more of the companies you know and love, or simply wait for better times. During idle times, a value investor can identify the stocks he or she wants and the price at which theyll be worth buying. By keeping a wish list like this, youll be able to make decisions quickly in a correction.
Ignore the Market 99% of the Time
The market only matters when you enter or exit a position; the rest of the time, it should be ignored. If you approach buying stocks like buying a business, youll want to hold onto them as long as the fundamentals are strong. During the time you hold an investment, there will be spots where you could sell for a large profit and others were youre holding an unrealized loss. This is the nature of market volatility.
The reasons for selling a stock are numerous, but a value investor should be as slow to sell as he or she is to buy. When you sell an investment, you expose your portfolio to capital gains and usually have to sell a loser to balance it out. Both of these sales come with transaction coststhat make the loss deeper and the gain smaller. By holding investments with unrealized gains for a long time, you forestall capital gains on your portfolio. The longer you avoid capital gains and transaction costs, the more you benefit from compounding. (Find out how your profits are taxed and what to consider when making investment decisions in Tax Effects On Capital Gains.)
The Bottom Line
Value investing is a strange mix of common sense and contrarian thinking. While most investors can agree that a detailed examination of a company is important, the idea of sitting out on a bull market goes against the grain. Its undeniable that funds held constantly in the market have outperformed cash held outside the market, waiting for a down market. This is a fact, but a deceiving one. The data is derived from following the performance of indexes like the S
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The Frosty, Festive World Of Investing
The store windows are frosted with artificial snow, the eggnog is flowing, and frantic shoppers are crowding the malls - thats right, its Christmas time. In keeping with the yuletide spirit, lets take a look at the investing vocabulary that goes along with this credit card-shattering time of year.
Santa Claus Rally
Hes bearded, hes jolly and hes permanently associated with Coca-Cola - yep, thats Santa Claus. Santas origins are a matter of speculation, but according to popular belief, he is derived from a Dutch mythical character based on the historical figure Saint Nicholas, who supposedly gave presents to the poor. The modern-day Santa spends his time spreading cheer and promoting world peace by delivering gifts all over the globe.
In the investing world, Santa brings investors a gift in the form of a jump in the price of stocks, known as the Santa Claus rally. This rally usually occurs between Christmas and New Years day. There are many theories as to why this happens. Some people believe it is a result of year-end tax considerations, while others say its because all the market pessimists are away on holidays or because people are buying stock in anticipation of the January effect. Those of us who believe in the magic of Christmas think the rally may be due to seasonal cheer infecting the usually dour inhabitants of Wall Street - a true Christmas miracle.
Boston Snow Indicator
In 1942, Irving Berlin wrote a song called White Christmas, which Bing Crosby brought to life in an immensely popular recording. Since then, a snowy landscape is the ideal place to spend Christmas day.
The Boston snow indicator is a market theory that posits that a white Christmas in Boston will cause stock prices to climb. This is one of several dubious indicators that, while it may appear to be accurate, teaches us more about the fallibility of statistics than the behavior of the market. Other popular indicators of this sort include the skirt-length indicator and the attention paid to the ties worn by Alan Greenspan (the Federal Reserve Boards former chairman). The accuracy of the Boston snow indicator is perhaps best summed up by its nickname: BS indicator.
Elves
In contemporary tales of Santa Claus, the man in red uses an army of small, spry laborers to produce the incalculable amount of toys needed to supply all of the worlds children. Elves most recognizable features are the pointed tips of their ears and their sunny dispositions.
In the investing world, elves are the technical analysts who try to predict the direction of the market. More specifically, the term refers to the guests appearing on the PBS television show Wall Street Week. The elves of Wall Street are not exactly spry, nor do they have pointed ears, but they do seem to have an unfaltering sense of optimism. (To read more, see Elves And Gnomes: A Fairytale World Of Investing.)
Evergreen Funding/Loan
The origin tales of the Christmas tree are as varied and conflicting as those of any of the other Christmas traditions. It is said that the Romans often cut down a fir tree to keep in their houses during the sparse winter months as a form of appeasement to the goddess Ceres (originally Demeter, Greek goddess of the hearth). In the 1500s, Germany became the first nation to associate evergreens, trees that stay green year-round, with the Christian celebration. Martin Luther, founder of the Lutheran branch of Christianity, is fabled to have set up the first Christmas tree lit by candles. Since the late-eighteenth century, Christmas trees have become part of the secular Christmas celebration, and millions of trees - both artificial and real - are purchased every year.
There are two types of evergreens in the business world. For those in the United Kingdom, the term refers to the gradual infusion of capital into a new or recapitalized enterprise. Evergreen funding, like its namesake, is a source of capital that is forever green, in that it is continually replenished. This can take many forms: for example, government assistance or even help from an angel investor. Evergreen funding is very rare in the world of business. For Americans, an evergreen loan is a short-term loan that is continually renewed rather than repaid. This allows people or businesses to defer repayment until they have the funds to do so. But beware: an evergreen loan is not always the gift that it appears to be. (For further reading, see When Companies Borrow Money and Debt Reckoning.)
January Effect
For most people, January is a time of optimism regarding hastily formed resolutions. The fitness industry has an entirely separate type of January effect that sees a spike in sales of home exercise equipment, diet programs and gym memberships. This is followed by the spring slump, when membership cancellations and returned products cause a significant drop in profits.
The January effect is also a stock market phenomenon that occurs at the end of the year as investors begin to fret over taxes. Investors whose portfolios have been very successful may sell any stocks that are down. This locks in the loss and allows the investor to write it off against his or her capital gains. When enough investors do this simultaneously, it causes stocks to go down near the end of the year. However, the stocks are driven back up in January when investors buy back the stocks they sold. The January effect is said to affect small caps more than mid/large caps, but it has not happened in years because the markets have adjusted for the effects. Also, more people are using tax-sheltered retirement plans. The tax shelters remove any reason for selling in order to create a tax loss. Thus, in recent years, the January effect has become somewhat of a non-event - much like the tradition of making New Years resolutions. (For more insight, read Understanding Investor Behavior.)
Thats it for our look at all things frosty and festive on Wall Street. Now, grab yourself a cup of eggnog, relax in front of the fire and fall asleep with dreams of robust ROIs dancing in your head.
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How To Invest In Private Equity
Private equity is capital made available to private companies or investors. The funds raised might be used to develop new products and technologies, expand working capital, make acquisitions or strengthen a companys balance sheet.
Unless you are willing to put up $250,000 or more, your choices in investing in the high-stakes world of private equity are very limited. In this article, well show you why and where you can invest in the private equity game.
SEE: Life-Cycle Funds: Can It Get Any Simpler?, Advantages Of Mutual Funds and The Dangers of Over-Diversification.)
Why Invest in Private Equity?
As you can see from the chart below, private equity is on the upswing, in spite of 2008s crisis:
U.S. Venture Capital Investment By Year
Year Number of Deals Total Investment (USD Mil)
2002 3,183 20,849.83
2003 3,004 18,613.83
2004 3,178 22,355.27
2005 3,262 22,945.71
2006 3,827 26,594.17
2007 4,124 30,826.31
2008 4,111 30,545.51
2009 3,065 19,745.81
2010 3,526 23,253.31
2011 3,673 28,425.08
Source: http://www.nvca.org/ffax.html
Institutional investors and wealthy individuals are often attracted to private-equity investments. This includes large university endowments, pension plans and family offices. Their money goes into pools that represent a source of funding for early-stage, high-risk ventures and plays a major role in the economy.
Often, the money will go into new companies believed to have significant growth possibilities in industries such as: telecommunications, software, hardware, healthcare and biotechnology. Private-equity firms try to add value to the companies they buy, with the goal of making them even more profitable. For example, they might bring in a new management team, add complementary companies, aggressively cut costs and then sell for big profits.
You probably recognize some of the companies below, which received private-equity funding over the years:
• A
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Invest Without Stress
Many investors get a lot of anxiety chasing mutual fund returns, hoping that history repeats itself while they are in the fund. In fact, a fund which has already yielded large returns has less of a chance to do so again when compared with its peer group. A better idea, rather than stressing out over the vagaries of the financial markets, is to look for wisdom in time-tested, academic methods. Once your high-quality investment plan is set up, relax. Let your investment compound, understanding that the plan is rooted in knowledge, not hype.
Good Soil
As with growing a garden, you want to invest in good soil (strategy). Accordingly, you can expect there to be some rainy days (bear market) with the sunny (bull market). Both are needed for overall growth. Once a garden (money) starts to grow, dont uproot it and replant, lest it wither and die. Set up your investment wisely and then let it grow.
Academic research creates good soil. The body of knowledge about the market goes through a rigorous review process where primary goal is truth or knowledge rather than profit. Thus, the information is disinterested - something you should always look for in life to make wise decisions.
Greatly distilling this body of knowledge, here are a few key points to remember when it comes to investing in the stock market .
Risk and Return
This concept is similar to the saying there is no free lunch. In money terms, if you want more return, you are going to have to invest in funds that have a greater probability of going south (high risk). Thus, the law of large numbers really comes into play here, since investing in small, unproven companies may yield better potential returns, while larger companies which have already undergone substantial growth may not give you comparable results.
Market Efficiency
This concept says that everything you need to know about conventional investments is already priced into them. Market efficiency supports the concept of risk and return; thus, dont waste your time at the library with a Value Line investment unless it provides entertainment value. Essentially, when you look at whether or not to invest in a large corporation, it is unlikely that you are going to find any information different from what others have already found. Interestingly, this also gives insight into how you make abnormal returns by investing in unknown companies like Bobs Tomato Shack, if you really have the time and business acumen to do the front-line research.
Modern Portfolio Theory
Modern portfolio theory (MPT) basically says that you want to diversify your investments as much as possible in order to get rid of company- or stock-specific risk, thus incurring only the lowest common denominator - market risk. Essentially, you are using the law of large numbers in order to maximize returns while minimizing risk for a given market exposure.
Now here is where things get really interesting! We just found the way to optimize your risk-return tradeoff for a given market level of risk by being well diversified in your investments. However, you can further adjust the investment risk downwards by lending money (investing some of it in risk-free assets) or upwards by borrowing it (margin investing).
Best Market Portfolio
Academics have created models of the market portfolio , consisting of a weighted sum of every asset in the market, with weights in the proportions that the assets exist in the market. Many think of this as being like the S
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How To Evaluate A Companys Balance Sheet
For stock investors, the balance sheet is an important consideration for investing in a company because it is a reflection of what the company owns and owes. The strength of a companys balance sheet can be evaluated by three broad categories of investment-quality measurements:working capital adequacy, asset performance and capitalization structure.
Tutorial: Financial Statement AnalysisIn this article, well look at four evaluative perspectives on a companys asset performance: (1) the cash conversion cycle, (2) the fixed asset turnover ratio, (3) the return on assets ratio and (4) the impact of intangible assets.
The Cash Conversion Cycle (CCC)
The cash conversion cycle is a key indicator of the adequacy of a companys working capital position. In addition, the CCC is equally important as the measurement of a companys ability to efficiently manage two of its most important assets - accounts receivable and inventory.
Calculated in days, the CCC reflects the time required to collect on sales and the time it takes to turn over inventory. The shorter this cycle is, the better. Cash is king, and smart managers know that fast-moving working capital is more profitable than tying up unproductive working capital in assets.
CCC = DIO DSO – DPO
DIO - Days Inventory Outstanding
DSO - Days Sales Outstanding
DPO - Days Payable Outstanding
There is no single optimal metric for the CCC, which is also referred to as a companys operating cycle. As a rule, a companys cash conversion cycle will be influenced heavily by the type of product or service it provides and industry characteristics.
Investors looking for investment quality in this area of a companys balance sheet need to track the CCC over an extended period of time (for example, five to 10 years), and compare its performance to that of competitors. Consistency and/or decreases in the operating cycle are positive signals. Conversely, erratic collection times and/or an increase in inventory on hand are generally not positive investment-quality indicators. (To read more on CCC, see Understanding the Cash Conversion Cycle and Using The Cash Conversion Cycle.)
The Fixed Asset Turnover Ratio
Property, plant and equipment (PP
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5 Popular Portfolio Types
Stock investors constantly hear the wisdom of diversification. The concept is to simply not put all of your eggs in one basket, which in turn helps mitigate risk, and generally leads to better performance or return on investment. Diversifying your hard-earned dollars does make sense, but there are different ways of diversifying, and different portflio types. We look at the following portfolio types and suggest how to get started building them: aggressive, defensive, income, speculative and hybrid. It is important to understand that building a portfolio will require research and some effort. Having said that, lets have a peek across our five portfolios to gain a better understanding of each and get you started.
The Aggressive Portfolio
An aggressive portfolio or basket of stocks includes those stocks with high risk/high reward proposition. Stocks in the category typically have a high beta, or sensitivity to the overall market. Higher beta stocks experience larger fluctuations relative to the overall market on a consistent basis. If your individual stock has a beta of 2.0, it will typically move twice as much in either direction to the overall market - hence, the high-risk, high-reward description.
Most aggressive stocks (and therefore companies) are in the early stages of growth, and have a unique value proposition. Building an aggressive portfolio requires an investor who is willing to seek out such companies, because most of these names, with a few exceptions, are not going to be common household companies. Look online for companies with earnings growth that is rapidly accelerating, and have not been discovered by Wall Street. The most common sectors to scrutinize would be technology, but many other firms in various sectors that are pursuing an aggressive growth strategy can be considered. As you might have gathered, risk management becomes very important when building and maintaining an aggressive portfolio. Keeping losses to a minimum and taking profit are keys to success in this type of portfolio.
The Defensive Portfolio
Defensive stocks do not usually carry a high beta, and usually are fairly isolated from broad market movements. Cyclical stocks, on the other hand, are those that are most sensitive to the underlying economic business cycle. For example, during recessionary times, companies that make the basics tend to do better than those that are focused on fads or luxuries. Despite how bad the economy is, companies that make products essential to everyday life will survive. Think of the essentials in your everyday life, and then find the companies that make these consumer staple products.
The opportunity of buying cyclical stocks is that they offer an extra level of protection against detrimental events. Just listen to the business stations and you will hear portfolios managers talking about drugs, defense and tobacco. These really are just baskets of stocks that these managers are recommending based upon where the business cycle is and where they think it is going. However, the products and services of these companies are in constant demand. A defensive portfolio is prudent for most investors. A lot of these companies offer a dividend as well which helps minimize downside capital losses. (Find out how these securities can protect you from a market bust.
The Income Portfolio
An income portfolio focuses on making money through dividends or other types of distributions to stakeholders. These companies are somewhat like the safe defensive stocks but should offer higher yields. An income portfolio should generate positive cash flow. Real estate investment trusts (REITs) and master limited partnerships (MLP) are excellent sources of income producing investments. These companies return a great majority of their profits back to shareholders in exchange for favorable tax status. REITs are an easy way to invest in real estate without the hassles of owning real property: vacancy issues, repairs and the other types of issues a landlord faces when trying to rent property. Keep in mind, however, that these stocks are also subject to the economic climate. REITs are groups of stocks that take a beating during an economic downturn, as building and buying activity dries up.
An Income portfolio is a nice complement to most peoples paycheck or other retirement income. Investors should be on the lookout for stocks that have fallen out of favor and have still maintained a high dividend policy. These are the companies that can not only supplement income but also provide capital gains. Utilities and other slow growth industries are an ideal place to start your search. (Find out how this first love still holds its bloom as it ages. To learn more, read Dividends Still Look Good After All These Years.)
The Speculative Portfolio
A speculative portfolio is the closest to a pure gamble. A speculative portfolio presents more risk than any others discussed here. Finance gurus suggest that a maximum of 10% of ones investable assets be used to fund a speculative portfolio. Speculative plays could be initial public offerings (IPOs) or stocks that are rumored to be takeover targets. Technology or healthcare firms that are in the process of researching a breakthrough product, or a junior oil company which is about to release its initial production results, would fall into this category.
Another classic speculative play is to make an investment decision based upon a rumor that the company is subject to a takeover. One could argue that the widespread popularity of leveraged ETFs in todays markets represent speculation. Again, these types of investments are alluring: picking the right one could lead to huge profits in a short amount of time. Speculation may be the one portfolio that, if done correctly, requires the most homework. Speculative stocks are typically trades, and not your classic buy and hold investment.
The Hybrid Portfolio
Building a hybrid type of portfolio means venturing into other investments, such as bonds, commodities, real estate and even art. Basically, there is a lot of flexibility in the hybrid portfolio approach. Traditionally, this type of portfolio would contain blue chip stocks and some high grade government or corporate bonds. REITs and MLPs may also be an investable theme for the balanced portfolio. A common fixed income investment strategy approach advocates buying bonds with various maturity dates, and is essentially a diversification approach within the bond asset class itself. Basically, a hybrid portfolio would include a mix of stocks and bonds in a relatively fixed allocation proportions. This type of approach offers diversification benefits across multiple asset classes as equities and fixed income securities tend to have a negative correlation with one another.
Conclusion
At the end of the day, investors should consider ALL of these portfolios and decide on the right allocation across all five. Here, we have laid the foundation by defining five of the more common types of portfolios. Building an investment portfolio does require more effort than a passive, index investing approach. By going it alone, you will be required to monitor your portfolio(s) and rebalance more frequently, thus racking up commission fees. Too much or too little exposure to any portfolio type introduces additional risks. Despite the extra required effort, defining and building a portfolio will increase your investing confidence, and give you control over your finances.
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Economic Indicators For The Do-It-Yourself Investor
Economic indicators are some of the most valuable tools investors can place in their arsenals. Consistent in their release, wide in their scope and range, metrics such as the Consumer Price Index (CPI) and written reports like the beige book are free for all investors to inspect and analyze. Policymakers, most notably those at the Federal Reserve, use indicators to determine not only where the economy is going, but how fast its getting there.
Admittedly, economic indicator reports are often dry and the data is raw. In other words, information needs to be put into context before it can be helpful in making any decisions regarding investments and asset allocation, but there is valuable information in those raw data releases. The various government and non-profit groups that conduct the surveys and release the reports do a very good job of collating and cohesively presenting what would be logistically impossible for any one investor do to on his or her own. Most indicators provide nationwide coverage and many have detailed industry breakdowns, both of which can be very useful to individual investors.
In this article, well touch on the most important aspects of economic indicators and how they relate to individual investors. (For more detailed information, see Economic Indicators To Know.)
What is an economic indicator?
In its simplest form, an indicator could be considered any piece of information that can help an investor decipher what is going on in the economy. The U.S. economy is essentially a living thing; at any given moment, there are billions of moving parts - some acting, others reacting. This simple truth makes predictions extremely difficult - they must always involve a large number of assumptions, no matter what resources are put to the task. But with the help of the wide range of economic indicators, investors are better able to gain a better understanding of various economic conditions.
There are also indexes for coincident indicators and lagging indicators, the components of each are based on whether they tend to rise during or after an economic expansion. (For related reading, see What are leading, lagging and coincident indicators? What are they for?)
Use in Tandem, Use in Context
Once an investor understands how various indicators are calculated and their relative strengths and limitations, several reports can be used in conjunction to make for more thorough decision-making. For example, in the area of employment, consider using data from several releases; by using the hours-worked data (from the Employment Cost Index) along with the Labor Report and non-farm payrolls, investors can get a fairly complete picture of the state of the labor markets. Are increasing retail sales figures being validated by increased personal expenditures? Are new factory orders leading to higher factory shipments and higher durable goods figures? Are higher wages showing up in higher personal income figures? The savvy investor will look up and down the supply chain to find validation of trends before acting on the results of any one indicator release. (For related reading, check out Surveying The Employment Report.)
Personalizing Your Research
Some people may prefer to understand a couple of specific indicators really well and use this expert knowledge to make investment plays based on their analyses. Others may wish to be a jack of all trades, understanding the basics of all the indicators without relying on any one too much. A retired couple living on a combination of pensions and long-term Treasury bonds should be looking for different things than a stock trader who rides the waves of the business cycle. Most investors fall in the middle, hoping for stock market returns to be steady and near long-term historical averages (about 8-10% per year).
Knowing what the expectations are for any individual release is helpful, as well as generally knowing what the macroeconomic forecast is believed to be at become important functions. Forecast numbers can be found at several public websites, such as Yahoo! Finance or MarketWatch. On the day a specific indicator release is made, there will be press releases from news wires such as the Associated Press and Reuters, which will present figures with key pieces highlighted. It is helpful to read a report on one of the newswires, which may parse the indicator data through the filters of analyst expectations, seasonality figures and year-over-year results. For those that use investment advisors, these advisors will probably analyze recently-released indicators in an upcoming newsletter or discuss them during upcoming meetings. (For articles about analyzing and using this data, see Trading On News Releases and A Top-Down Approach To Investing.)
Inflation Indicators - Keeping a Watchful Eye
Many investors, especially those who invest primarily in fixed-income securities, are concerned about inflation. Current inflation, how strong it is, and what it could be in the future are all vital in determining prevailing interest rates and investing strategies.
There are several indicators that focus on inflationary pressure. The most notable in this group are the Producer Price Index (PPI) and the Consumer Price Index (CPI). The PPI comes out first in any reporting month, so many investors will use the PPI to try and predict the upcoming CPI. There is a proven statistical relationship between the two, as economic theory suggests that if producers of goods are forced to pay more in production, some portion of the price increase will be passed on to consumers. Each index is derived independently, but both are released by theBureau of Labor Statistics. Other key inflationary indicators include the levels and growth rates of the money supply and the Employment Cost Index (ECI). (To learn more, read The Consumer Price Index: A Friend To Investors.)
Economic Output - Stock Investors Inquire Within
The gross domestic product (GDP) may be the most important indicator out there, especially to equity investors who are focused on corporate profit growth. Because GDP represents the sum of what our economy is producing, its growth rate is targeted to be in certain ranges; if the numbers start to fall outside those ranges, fear of inflation or recession will grow in the markets. To get ahead of this fear, many people will follow the monthly indicators that can shed some light on the quarterly GDP report. Capital goods shipments from the Factory Orders Report is used to calculate producers durable equipment orders within the GDP report. Indicators such as retail sales and current account balances are also used in the computations of GDP, so their release helps to complete part of the economic puzzle prior to the quarterly GDP release. (For related reading, see The Importance Of Inflation And GDP and Understanding the Current Account In The Balance Of Payments.)
Other indicators that arent part of the actual calculations for GDP are still valuable for their predictive abilities - metrics such as wholesale inventories, th beige book, the Purchasing Managers Index (PMI) and the Labor Report all shed light on how well our economy is functioning. With the assistance of all this monthly data, GDP estimates will begin to tighten up as the component data slowly gets released throughout the quarter; by the time the actual GDP report is released, there will be a general consensus of the figure. If the actual results deviate much from the estimates, the markets will move, often with high volatility. If the number falls right into the middle of the expected range, then the markets and investors can collectively pat themselves on the back and let prevailing investing trends continue.
Mark Your Calendar
Sometimes indicators take on a more valuable role because they contain very timely data. The Institute of Supply Managements PMI report, for instance, is typically released on the first business day of every month. As such, it is one of the first pieces of aggregate data available for the month just ended. While not as rich in detail as many of the indicators to follow, the category breakdowns are often picked apart for clues to things such as future Labor Report details (from the employment survey results) or wholesale inventories (inventory survey).
The relative order in which the indicators are presented does not change month to month, so investors may want to mark a few days on their monthly calendars to read up on the areas of the economy that might change how they think about their investments or time horizon. Overall, asset allocation decisions can fluctuate over time, and making such changes after a monthly review of macro indicators may be wise.
Conclusion
Benchmark pieces of economic indicator data arrive with no agenda or sales pitch. The data just is - and that is hard to find these days. By becoming knowledgeable about the whats and whys of the major economic indicators, investors can better understand the economy in which their dollars are invested, and be better prepared to revisit an investment thesis when the timing is right.
While there is no one magic indicator that can dictate whether to buy or sell, using economic indicator data in conjunction with standard asset and securities analysis can lead to smarter portfolio management for the do-it-yourself investor.
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Make Money Trading Earnings Announcements
If you watch the financial news media, youve seen how earnings releases work. Its like the big game on Sunday; it comes with hours, and sometimes days, of endless experts providing their predictions of what the numbers will look like, and other experts providing their strategies of how to invest or trade based on the news. Some would say that it is media overhype at its finest and if you watch the endless flurry of graphics and earnings central music, its hard to argue.
But for the individual investor , is there money to be made in earnings announcements? As with most topics on Wall Street, there are a flurry of opinions, and it will ultimately come down to individual choice, but here are two of those opinions to help you decide for yourself.
SEE: Profit From Earnings Surprises With Straddles And Strangles
Why You Should Try
According to CNBC, the percentage of S
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Asset Allocation: The First Step Towards Profit
Financial advisors and brokers, either full or limited service, rarely provide investors with an adequate and concise overview of the investment market. At least, not such that decisions on asset allocation can be made. Investors are faced with a plethora of options on where to put new money; a situation which is often overwhelming.
A primary investment decision is to choose asset classes, particularly equities or fixed income. This decision needs to be considered because each investor has unique objectives. Choosing between equities or fixed income , as well as making investment choices, affects the ability to achieve investment objectives. Individuals need to consider market conditions that are expected to persist over the coming months or years and the influence of economic policy, as well as individual circumstances.
Investment Decision Making
Asset allocation is a term tossed around by investment professionals to describe how to distribute investment dollars in order to achieve an expected rate of return based on certain factors. Individual investors should consider these factors, including current income and expected future income, investment time horizon and tax implications, to name a few. Over any 20-year period, investment returns from various asset classes have been mixed, thus resulting in high returns for one or a couple of consecutive years followed by low returns.
This means that if an investor puts all of his eggs in the same basket year after year, he will receive lower and more volatile returns than if he spread his investment dollars among various asset classes. There are decisions to be made regarding which asset classes to spread or to allocate investment dollars because certain combinations of investments are based upon the degree of aggressiveness (or risk tolerance) needed to meet objectives. Degree of aggressiveness is determined based on a persons age and time horizon as well as tax status. (See Matching Investing Risk Tolerance To Personality to find out more about this crucial step.)
In addition to the long-term perspective inherent in asset allocation decisions based on specific investment objectives, short-term effects on investments need also be taken into account. Short-term and long-term considerations can include, but are not limited to, interest rates and the policies of the Fed, economic outlook and currency.
For example, there are certain investments that do better in a low interest rate environment (equities over fixed income) and some that do well in a rising inflation environment, like treasury inflation protected securities (TIPS) and commodities, that protect the value of the asset (hard assets over soft assets). Currency fluctuations also affect investments. For example, if the dollar is weak vs. foreign currency from country X, then a company domiciled in the U.S. and has its expenses in U.S. dollars, but makes a majority of its revenue from country X, will likely benefit from the weak U.S. dollar. Therefore, the choice of asset class is an important decision for both a short- and long-term investment horizon.
Overview of the Asset Classes
Asset classes include equities and fixed income. Investing in equities means that the shareholder is a part owner in the company - he/she has an equity interest in the company but in the case of bankruptcy, has very little to no claim, resulting in a risky investment. Fixed income means that the investor receives a predetermined stream of income from the investment, usually in the form of a coupon, and in the event of bankruptcy, has senior claim to liquidated assets compared to shareholders. The fixed income traded in the public market is typically in the form of bonds.
Asset classes can be broken up into sub-classes. Sub-classes for equities include domestic, international (developed and developing or emerging countries) and global (both domestic and international). Within these divisions, equities can further be grouped by sectors such as energy, financials, commodities, health care, industrials etc. And within the sectors, equities can be grouped again by size or market capitalization, from small cap (under $2 billion) to mid cap ($2 billion-10 billion) to large caps (over $10 billion) stocks .
Sub-classes for fixed income include investment-grade corporate bonds, government bonds (treasuries) and high yield or junk bonds. The importance of breaking investments down into sub-classes is to manage the degree of risk generally associated with the investment. Investing in companies with small capitalizations and in developing countries has historically been more risky, but has had greater potential for higher returns than investments in large capitalizations, domestic companies. Similarly, due to its junior status to bonds, equity is generally considered more risky than fixed income.
Strategy
Proper asset allocation is the key to providing the best returns over the long term, but there are some general rules of thumb when investing that can help guide through the short term, normal fluctuations of the market. In the short term (one- to three-year time frame), the economy and economic policies of the government have significant influence on investment returns.
• Rule 1 - The stock market is a leading indicator, so its movement often precedes change in the economy that impacts labor, consumer sentiment and company earnings.
• Rule 2 - Policy and the impact of decision making by the government due to various economic data are mid to lagging indicators as to what the market is doing.
• Rule 3 - If you watch money flows (movement of money into and out of a particular stock, sector or asset class), when the chart shows a peak or bottom in money flow, you should do the opposite. Basically, a contrarian view may be best in this circumstance.
• Rule 4 - Options are most profitable in volatile markets. A good indicator of market volatility is the VIX (Chicago Board Options Exchange Volatility Index). At times when the VIX is expected to move higher, investing in options rather than owning the equity may sometimes be more profitable and less risky.
• Rule 5 - If there is a worry about rising inflation, buying protection via TIPS or hard assets like commodities usually insulates a portfolio.
• Rule 6 - In a market that is continually moving up, stock selection is often less important than buying the market, thus buying a market ETF or index fund may lead to high returns with lower risk. But in a market that is moving sideways, stock selection is key and investors need to understand the growth drivers of a companys stock.
Conclusion
Designing a portfolio that performs well in both the long and short term is obviously not easy to accomplish. However, weeding out a lot of the noise and concentrating on some simple rules in the short term, while focusing on proper and re-balanced asset allocation in the long term, can steer investors to a model portfolio that should produce less risky, more stable returns.
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Portfolio Mismanagement: 7 Common Stock Errors
Ignorance may be bliss, but not knowing why your stocks are failing and money is disappearing from your pockets is a long way from paradise. In this article, well uncover some of the more common investing faux pas, as well as provide you with suggestions on how to avoid them.
1. Ignoring Catalysts
The financial pundits, trade journals and business schools teach that proper valuation is the key to stock selection. This is only half of the picture because calculating P/E ratios and running cash flow spreadsheets can only show where a company is at a given point in time - it cannot tell us where it is heading.
Therefore, in addition to a quantitative evaluation of a company, you must also do a qualitative study so that you can determine which catalysts will drive earnings going forward.
Some good questions to ask yourself include:
• Is the company about to acquire a very profitable enterprise?
• Is a potential blockbuster product about to be launched?
• Are economies of scale being realized at the companys new plant and are margins about to rise dramatically?
• What will drive earnings and the stock price going forward?
2. Catching the Falling Knife
Investors love to buy companies on the cheap, but far too often, investors buy in before all of the bad news is out in the public domain, and/or before the stock stops its free fall. Remember, new lows in a companys share price often beget further new lows as investors see the shares dropping, become disheartened and then sell their shares. Waiting until the selling pressure has subsided is almost always your best bet to avoid getting cut on a falling knife stock. (To learn more, read How Investors Often Cause The Markets Problems.)
3. Failing to Consider Macroeconomic Variables
You have found a company you want to invest in. Its valuation is superior to that of its peers. It has several new products that are about to be launched, and sales could skyrocket. Even the insiders are buying the stock, which bolsters your confidence all the more.
But if you havent considered the current macroeconomic conditions, such as unemployment and inflation, and how they might impact the sector you are invested in, youve made a fatal mistake!
Keep in mind that a retailer or electronics manufacturer is subject to a number of factors beyond its control that could adversely impact the share price. Things to consider are oil prices, labor costs, scarcity of raw materials, strikes, interest rate fluctuations and consumer spending. (For more on these factors, see Macroeconomic Analysis and Where Top Down Meets Bottom Up.)
4. Forgetting About Dilution
Be on the lookout for companies that are continuously issuing millions of shares and causing dilution, or those that have issued convertible debt. Convertible debt may be converted by the holder into common shares at a set price. Conversion will result in a lower value of holdings for existing shareholders.
A better idea is to seek companies that are repurchasing stock and therefore reducing the number of shares outstanding. This process increases earnings per share (EPS) and it tells investors that the company feels that there is no better investment than their own company at the moment. (You can read more about buybacks in A Breakdown Of Stock Buybacks.)
5. Not Recognizing Seasonal Fluctuations
You cant fight the Fed. By that same token, you cant expect that your shares will appreciate even if the companys shares are widely traded in high volumes. The fact is that many companies (such as retailers) go through boom and bust cycles year in and year out. Luckily, these cycles are fairly predictable, so do yourself a favor and look at a five-year chart before buying shares in a company. Does the stock typically wane during a particular part of the year and then pick up during others? If so, consider timing your purchase or sale accordingly. (To learn more, see Capitalizing On Seasonal Effects.)
6. Missing Sector Trends
Some stocks do buck the larger trend; however, this behavior usually occurs because there is some huge catalyst that propels the stock either higher or lower. For the most part, companies trade in relative parity to their peers. This keeps their stock price movements within a trading band or range. Keep this in mind as you consider your entry/exit points in a stock.
Also, if you own stock in a semiconductor company (for example), understand that if other semiconductor companies are experiencing certain problems, your company will too. The same is true if the situation was reversed, and positive news hit the industry.
7. Avoiding Technical Trends
Many people shy away from technical analysis, but you dont have to be a chartist to be able to identify certain technical trends. A simple graph depicting 50-day and 200-day moving averages as well as daily closing prices can give investors a good picture of where a stock is headed. (To learn about this method, read the Basics Of Technical Analysis.)
Be wary of companies that trade and/or close below those averages. It usually means the shares will go lower. The same can be said to the upside. Also remember that as volume trails off, the stock price typically follows suit.
Lastly, look for general trends. Has the stock been under accumulation or distribution over the past year? In other words, is the price gradually moving up, or down? This is simple information that can be gleaned from a chart. It is truly surprising that most investors dont take advantage of these simple and accessible tools.
The Bottom line
There are a myriad of mistakes that investors can and do make. These are simply some of the more common ones. In any case, it pays to think about factors beyond what will propel the stock you own higher. A stocks past and expected performance in comparison to its peers, as well as its performance when subjected to economic conditions that may impact the company, are some other factors to consider.
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4 Signs A Private Company Is Going Public
When a private company makes plans to go public, there is rarely any fanfare or advance notice. Some of the radio silence is due to SEC requirements in relation to official filings of notices and the prospectus, and some is simply due to the fact that a company going public is often big news and puts the corporation under a magnifying glass. It is easier for a company to make preparations in the relative solitude of anonymity. There are, however, several signs, prior to the official notification and filing, that can indicate that a company is about to make the big leap.
SEE: IPO Basics
Corporate Governance Upgrades
Public companies that trade on U.S. stock exchanges are required under the Sarbanes-Oxley Act of 2002 (SOX) to maintain certain standards in the management of the corporation. These standards include having an external board of directors, developing and assessing an effective set of internal controls over the financial management of the company, and creating a formal process where employees and others can have direct access to the audit committee to report on illegal activities, as well as those that violate company policy. A sudden flurry of new policies and procedures could be an indication of a move towards an initial public offering (IPO).
Big Bath Write-Downs
Public companies, and those that are about to go public, have their annual and quarterly financial statements scrutinized by investors and analysts. Private companies considering going public often assess their own financial statements and take any write-offs they are allowed under GAAPall at once, to present better income statements in the future.
For example, accounting rules require that companies write down inventory that is unsalable or worth less than its original cost. However, there is substantial leeway in making that determination. Companies often keep inventory on their balance sheets as long as possible to ensure that they are meeting asset ratios for banks and other lenders . Once a company contemplates going public, it often makes sense to write off the inventory sooner rather than later, when it would impact shareholder profitability.
Sudden Changes in Senior Management
Once a company contemplates going public, it has to think about how qualified its current management is and whether it is need of some spring cleaning. To attract investors , a public company needs to have officers and managers who are experienced and have a track record of leading companies to profitability. If there is a full scale overhaul in the upper echelons of a company, it may be a signal that it is trying to improve its image in advance of going public.
Selling-Off Non-Core Business Segments
A company that springs up from scratch can often have some business units attached to it that are ancillary to its core, or main, business purpose. An example of this is an office supplies company that has a payroll processing business; the secondary business does not connect directly to the main business. In order to market a company in an initial public offering, the prospectus is expected to show a clear business direction. If a company is shedding its non-core operations, it may be a sign that it is getting lean and mean in preparation for a public share offering.
The Bottom Line
Because of the ability of a private company to keep quiet on its intentions to go public until the formal SEC-required filings and announcements, it can be difficult to assess whether a company is heading in that direction. However, there are always more subtle signals for those seeking them out.
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