Investing School

Time Deposits Reveal the Incentives for Sticking to Investments

Investing School — Fri, 03 Feb 2012 17:49:42 +0000

Anyone who’s ever attempted to know how to get a how to get a high yield on a savings account knows that the price you pay for a large return is being unable to touch the deposit. While it’s apparent how an individual would see the benefits to this arrangement, the incentive for a bank to formulate such an agreement aren’t as obvious. Yet it takes no more than understanding the basis principles of banking to know why such institutions are willing to give you a higher interest rate on the basis that you don’t touch the money: it allows them to use the funds in your deposit for other purposes, and enables them to avoid having to plan for the possibility of that money being withdrawn. These perks are valuable to banks, and thus they will reward you with a higher interest rate.

It’s clear then, that there is a financial incentive attached to situations where money stays put for a significant length of time. In the world of investing, especially at a time when every stock option seems risky and everyone is telling you to diversify, this financial fact cannot be overlooked. There are big earnings potentials attached to the act of keeping your investments in one place for a long period of time, more so than in situations where it’s either been projected or flat-out expected that you’ll be pulling your capital out in a short amount of time. After all, it’s real money at the end of the day, and the companies and entities you invest in want to be able to use that capital to grow. When they know they can count on that being true, the growth process occurs at a much faster rate.

The bottom line reasons for sticking with an investment or choosing to sell it or dump it are very different from the reasoning behind whether or not to enter into a high yields savings situation. But the overall principle is the same. In exchange for forking over a large amount of capital today, you ensure that you are entitled to more money tomorrow, at least as long as the business itself survives that long. The only real difference is the risks involved; you’ll never lose your deposit and you’ll always net the interest in a bank, whereas investments are not so secure.

Hopping around from stock to stock won’t make a million dollars magically appear, because you’re completely neglecting the entire purpose of stock investments to begin with. The point of the stock market is to enable individuals to support a percentage of a company and in exchange have the potential of seeing the value of that percentage grow as the business grows with the money they invested. Just like a time deposit, the agreement to surrender today’s capital in exchange for the chance for more money in the future is a two-way street: you like this arrangement for the easy profit, while the institution likes it for the easy money.

Never let this cold hard fact about investing leave the forefront of your financial thinking.

Jenna is a journalism student at Saint Louis University. Upon graduation, she hopes to travel the world while producing compelling content for the masses. When she isn’t writing, you can find Jenna with her nose in a book, or her headphones in to block out the rest of the world.

---
Related Articles at Investing School:

Just What is A Leveraged Buy Out (LBO)?

Investing School — Wed, 01 Feb 2012 18:16:09 +0000

You hear the term in the news often enough, but knowing what a leveraged buy out (LBO) is may have been beyond you until know. Simply put, a leveraged buy out involves the purchase of a company while using a large amount of borrowed funds. It is common that the assets of the purchased firm will be used as collateral for the borrowed funds as well as the assets of the purchasing company. This allows the company making the purchase to acquire large items without committing significant amounts of capital.

By using the strategy of a leveraged buyout the purchaser may put down as little as 10% equity. Not considered investment grade purchases, LBOs have a reputation of leading to eventual bankruptcies when managed poorly. The higher the leverage ratio the more likely bankruptcy is. LBO is considered a hostile maneuver since the company’s own assets are used against it as collateral by the opposing firm. If the bonds used in the purchase are not repaid the LBO may be challenged by the creditors under the belief that the transaction was a fraudulent transfer.

The size of a company has little to do with its vulnerability to a leveraged buy out. There are certain characteristics which are common to companies which are in danger of such a maneuver:

A stable history with recurring cash flow
Low debt loads
Market conditions which make the stock appear depressed
Significant hard assets which can be used for collateral
The potential for new management to restructure after the leveraged buy out (LBO) is complete to increase profits

---
Related Articles at Investing School:

Anticipating Earnings Per Share (EPS)

Investing School — Mon, 30 Jan 2012 23:28:27 +0000

As the name implies, the anticipated earnings per share gives investors a simple way to anticipate exactly what they will earn per share of stock they own. The Financial Accounting Standards Board demands that each company include in its income statements the EPS for each major category of income. These categories include continuing operations, discontinued operations, net income and any extraordinary items.

The simplest of the equations used to determine EPS is as follows:

EPS = Net Income – Dividends on Preferred Stock/Average Outstanding shares

For categories outside of continued operations or net income, the EPS formula does not include preferred dividends. Since the calculations are much more complicated in those categories, preferred dividends are removed from net income prior to the math being managed. It is also a result of preferred stock rights being higher on the totem pole than common stock. The monies set aside for preferred dividends are not used in the distribution of each share of common stock. To calculate things more accurately one uses a weighted average number of shares outstanding, which can change over time.

EPS is often considered the most important variable when share price is set. It is used to calculate price-to-earnings ratios, however, since capital is ignored in generating the figures. Companies with vastly different equity could end up with very similar earnings per share (EPS) numbers. The better choice would be the company which produced more with less equity. However, since it is possible to manipulate earning numbers more than one tool should be used to assess a stock or company.

You may also want to check out this EPS article.

---
Related Articles at Investing School:

Figuring Out Value Using Book Value of Equity Per Share (BVEPS)

Investing School — Fri, 27 Jan 2012 18:39:35 +0000

Not sure how to assess a stock or company? It’s not surprising. Few people actually understand this kind of math. By using the Book Value of Equity Per Share (BVEPS) you get a minimum value of the company’s equity. This worth is determined by comparing the original value of the common stock and is adjusted for outflow. Outflow may include such costs as dividends and stock buybacks. It also takes inflow (earnings) into account.

The calculation is based upon the following equation:

BVEPS = Value of Common Equity/# of Shares outstanding

Book value of equity per share is one tool that you can use to help you decide if a stock is properly valued. It isn’t considered a very reliable tool, but in combination with others it gives a global view. Specifically BVEPS is best for giving a quick glance at a moment in time relating to the current situation of a particular firm. The future, though, is completely ignored in this calculation.

Just because a company’s share price is lower than its BVEPS does not necessarily indicate that it is undervalued. By looking ahead it is possible to see if the company will have a chance at growth. If the company is looking at a bleak future with few opportunities for expansion, then the lower share price is justified. This information is not provided by the book value of equity per share (BVEPS), and is only visible when other tools are also added to the assessment. No investment should be made based upon the information provided by only one tool.

---
Related Articles at Investing School:

What Does Understanding Long-Run Average Total Cost (LRATC) Do for the Investor?

Investing School — Wed, 25 Jan 2012 18:54:14 +0000

There are many metrics used to analyze the market and financial trends; the Long-Run Average Total Cost (LRATC) is one of these tools. As the name implies, the LRATC displays the average cost of a particular unit of product over a long period of time. All the inputs into the analysis are deemed variable.

Since long term costs are taken over a long time frame, companies are afforded more flexibility in the way they operate. This allows them to be more efficient, a situation which presents the appearance of greater efficiency. One example cited is that of a company building a bigger plant. The belief is that the LRATC per unit would become lower over time as the company can make use of decreased prices resulting from economies of scale.

It is important to note that the LRATC evaluates the average cost, not the specific cost at a particular point in time. For that the Short-run Average Total Cost is used. It is the combination of many SRATCs that create the LRATC – typically generating a U-shaped curve. There are certain factors which can be anticipated in production costs – for example wages – while others are random and beyond the producer’s control. Costs of water, power and materials vary, sometimes dramatically, from month to month.

By viewing the Long-Run Average Total Cost (LRATC) the investor receives a better picture of the company’s stability and overall costs. For example, while a company may have a monopoly on a particular product initially, as competitors enter the market, the LRATC becomes more of an indicator of long term stability.

---
Related Articles at Investing School:

Understanding the Relative Strength Index (RSI)

Investing School — Mon, 23 Jan 2012 18:00:55 +0000

The Relative Strength Index (RSI) is a technical index used to analyze financial markets. It compares the magnitude of recent losses and gains so as to assess the overbought or oversold conditions of a particular asset. This assessment allows the investor to determine when it is wise to purchase or sell a particular stock.

The formula used in making the assessment is:

RSI = 100-100/(1+RS)

(where RS is equal to the average of x days’ up closes/Average of x days’ down closes)

RSI is charted on a scale of 0-100 points. Once the RSI of an asset exceeds 70 it is considered to be overbought. The odds are that it is overpriced at that point and the investor should expect a correction in price. If the RSI drops below 30 the stock is considered to be oversold and may become undervalued.

Fluctuations within the RSI can be dramatic at times, so it is not always an accurate measure of what a stock may be doing. One of the things that RSI may indicate is an upcoming turn in the market, especially if there is a wide divergence between the strength index and the price action. A bear divergence occurs when a stocks’ price reaches a new high but the RSI doesn’t achieve a matching high. A bull divergence is the opposite with new lows reached.

The disadvantage of using just RSI to track a stock is that large surges or declines can create false buy or sell conditions. Best employed to complement other assessment techniques, the Relative Strength Index (RSI) may provide warning if a stock is not trading at a price commensurate with its worth.

---
Related Articles at Investing School:

What are Futures?

Investing School — Wed, 18 Jan 2012 19:10:53 +0000

A future is a financial contract which requires the buyer to purchase an asset at a previously determined date and price. The asset may by an actual commodity or a financial instrument. All the details are defined within the contract, including the quality and quantity of the assets, making the transaction standardized and simpler to understand. How the contract is settled depends upon the agreement and may involve a physical asset or cash.

The key difference between options and futures is that in an option the buyer has the choice, or right, to make the purchase but isn’t required to do so. With a futures contract, the holder is obligated to fulfill the terms of the contract.

The futures market is characterized by individuals who want to hedge or speculate on the price movement of the underlying asset. The goal of the contract is to minimize the risk to both buyer and seller. To minimize credit risk, traders must post a margin – an initial amount of cash, typically 5%-15% of the contract’s value – and the trades are regulated by a clearing house.

It is actually rare for the goods mentioned in a futures contract to actually change hands between the members of the contract. This is the case since hedging and speculation benefits can be enjoyed without holding on to a contract until it expires. Take for example a case where you are long in a futures contract, or in the buying position, you could also go short in a similar contract to balance your position.

---
Related Articles at Investing School:

The Commodity Futures Trading Commission (CFTC)

Investing School — Mon, 16 Jan 2012 18:53:24 +0000

The Commodity Futures Trading Commission (CFTC) is a Federal agency which was established by the Commodity Futures Trading Commission Act of 1974. The Commission replaced the Commodity Exchange Authority. Its role is to ensure the open and efficient operation of the futures and options markets.

Futures have been traded for over 150 years and have functioned under the auspices of the U.S. Government since the 1920s. Only recently have futures expanded beyond their agricultural roots, moving into government securities and stock indices as well as foreign currency.

Five market commissioners are appointed by the president and are subject to Senate approval. The commissioners serve a five year term, and are elected in a staggered manner. No more than three commissioners may be of one political party at a time. Their role is to protect investors from unscrupulous parties which would manipulate the market and/or engage in abusive trade practices and fraud.

The CFTC has undergone many changes since 1974, the latest of which took place when Congress passed the Commodity Futures Modernization Act of 2000. This Act instructed the SEC and CFTC to put together a joint regulatory body for single-stock futures – those where only one stock was the underlying asset. Unfortunately, the CFTC has been challenged by the SEC many times in an attempt to usurp regulatory jurisdiction.

Part of the role of the CFTC is to encourage competition and efficiency as well as integrity. Effective supervision allows the CFTC to ensure that future markets will continue to provide a means for price discovery while offsetting price risk.

---
Related Articles at Investing School:

What is a Trigger Line?

Investing School — Sat, 14 Jan 2012 05:18:47 +0000

In order to understand what a trigger line is you have to understand what the moving average convergence divergence (MACD) theory is. The theory is a popular index used in the technical analysis of short term market momentum. It allows investors to quickly spot increasing short term momentum. Traders watch to see the short term moving average surpass the long term movement average as a signal of upward movement.

The trigger line is also called the signal line. When the trigger line goes above the established MACD line, traders buy, and when the line falls below the MACD line investors sell.
Different formulations are used to determine the value of long and short term averages. The most common default settings are 12 and 26 days. The centerline is calculated by evaluating the difference between a short term moving average and a long term moving average.

The advantage is that this kind of analysis can give traders data which is easy to interpret. Investors can use the information to see if short term trends are moving in their favor. On the down side, the delay between reading the data and making a purchase or sale can mean that the trader is buying when prices are surging and selling when they are dropping. This experience is called ‘whipsawing’ and can occur several times before a trader hits the timing properly.

Even with the potential risks the MCAD is considered a good tool for short term traders. Learning how to read this instrument correctly is an important skill for any investor.

---
Related Articles at Investing School:

Technical Analysis: How Will That Stock Move?

Investing School — Wed, 11 Jan 2012 22:47:39 +0000

The process of technical analysis doesn’t attempt to predict intrinsic value of a stock; rather it is used to potentially figure out how the stock will move in the future. These calculations are based upon charts, market activity, past price and the volume of sales.

Analysts believe that past performance of a stock or market is a good indicator of how the future will unfold. Unlike a fundamental analyst, who would evaluate each product available for sale before making a decision, the technical analyst is directed by the patterns and activity she sees in the broader scope.

A fundamental analyst searching for clues as to which stock to purchase would look at earnings, dividends, advances and research. A technical analyst would be more interested in how investors feel about the same developments and if the investors had the ability to back up their opinions. Technical analysts are more likely to use tools, such as charts, to identify trends in order to profit by them.

Technical analysts believe that the market moves in trends. Since, they argue, history consistently repeats itself, if you understand the trends you can plan your purchases and sales to maximize profits based upon those trends.

Different markets are more inclined to use one sort of analysis versus another. For example, in the Forex market technical analysis is more popular. Whether these methods work for interpreting and anticipating market movement is debatable. While investors claim to do well employing this kind of analysis, studies only show about 50% of these strategies offer a positive result. However, since investors are notoriously reluctant to share their data, the studies may not present an accurate picture.

---
Related Articles at Investing School: