Investing made easy

Discounted Cash Flow Analysis

2011-06-16T05:58:00.000-07:00

Discounted cash flow analysis is a method of valuing an asset using the concepts of the time value of money. Having one dollar today and one dollar in 1920 is not the same. The reason for this is inflation. Instead of inflation, one could take into account other parameters such as US Treasury Bonds returns. US treasury Bonds could be considered as almost risk free since it is guarantied by US government. For example, an arithmetic average (1928-2010) of annual returns on Treasury Bonds is about 5%.

We say that Future Value (or FV) is a value that is expected in some future, and that Present Value (or PV) is an actual value today. Relationship between Future Value and Present Value is given by the formula FV = PV * (1+i)^n. Having FV you can easily calculate PV = FV/(1+i)^n. Where i is an interest rate, and n is usually number of years.

Let's say that we have two offers for our house. The first one is $150,000 in two years, and the second one is $165,000 in four years. Which offer is better assuming other parameters equal? The second offer is obviously bigger, but is it better? It makes sense only to compare present values. Therefore we will compute PV for both offers.

The first offer:

From 150,000=PV*(1+5%)^2, we compute PV=150,000/(1+5%)^2=$136054

The second offer:

From 165,000=PV*(1+5%)^4, we compute PV=165,000/(1+5%)^4=$135746

Therefore the first offer is better. We took 5% as a low risk annual return.

The second offer might be better for different annual returns. Let's se what happens if we use 3% interest rate.

The first offer:

From 150,000=PV*(1+3%)^2, we compute PV=150,000/(1+3%)^2=$141389

The second offer:

From 165,000=PV*(1+3%)^4, we compute PV=165,000/(1+3%)^4=$146600

Therefore the second offer is better. We see that results of a comparison depends on interest rate you choose. For different problems you might choose different interest rates. For example, for real estates you might choose a conservative (low) rate , and for IT industry you might choose a higher rate.

Things could get more complicated if we there are several cash flow. We should do the math for every one of them. Let's say that we have two offers. The first one is $100,000 in two years and $60,000 in four years. The second one is $31,000 per year for the next five years.

The first offer:

$100,000 in two years would be $90703 today, while $60,000 would be $49362. The total is $140.065

The second offer would yield: 29524+28118+26779+25504+24289 which is 134214.

Therefore the first offer is better.

Investment Strategy: Invest in Small Cap Companies

2010-12-20T00:23:00.000-08:00

Small cap stocks stands for the stocks of companies that have a small market capitalization. A small market capitalization usually means that the market capitalization is less than $1 billion. A large cap stock stands for the stocks of companies that have a large market capitalization. A large market capitalization usually means that the capitalization is greater than $10 billion.

Small capitalization companies tend to bring greater risk and greater gains. In order to grow, each company must earn money by increasing sales and earnings. That stands for the small cap companies too. As they bring more risk, you should be more careful with this investment strategy.

There are several advantages of the small capitalization companies. First of all, they have a greater growth potential. It would be nice to invest in the companies that will eventually grow like Microsoft or Google. The stocks of small capitalization companies tend to be cheaper and therefore more available. There are more small companies than large ones. For example, there are a few large companies in each sector such as Microsoft vs. Apple, Pepsi vs. Coke etc. Having more opportunities leaves more room to diversify a portfolio.

The definition of large cap and small cap may change over time, and may be different for different brokerage houses. A share price of a small cap company is not necessarily small. Keep in mind that a small cap company have small market share and the money they borrow is expensive which means that such companies carry a greater risk. Also, they tend to use profit to accelerate their growth instead of paying the dividends.

Investment Strategy - Trading the News

2010-10-05T04:05:00.000-07:00

Trading the News strategy is based on an analysis of the news related to a certain stock (or some other financial instrument). The good news usually imply that the stock price will rise, and the bad news imply that the stock price will fall. The rule is quite simple: sell if the news are bad, buy if the news are good.

There is a great variety of news that can influence a certain stock: an announcement about corporate profits, a change in management, a rumor about a merger, the results of a rival firm or even the sport news. It is hard to track all the news so an investor is usually focused on a certain type of equity. Even that is difficult to handle, so it is usually necessary to focus on a few stocks.

All the news have some degree of accuracy. The rumors are usually less accurate, while the reports are very accurate. Even reports can be inaccurate but it is less probable, because someone may have to face sanctions if they hide something.

Also, all the news can be more or less important. For example, the invention of a car is very important for a railroad company, and the invention of a computer is not that important for an undertaker.

The third aspect of the news is how frequent you can get it. For example, you can always find a rumor about anything, especially on the Internet. On the other hand, financial reports are available quarterly.

The fourth aspect of the news is how fast you can get them. This is a very important aspect, because when you notice the news, it is usually to late to do something. Meaning that if the news are bad, the price of the stock have already fell down. In order to follow this strategy you should be almost always online looking for the news.

Strategy: Buy Loser Stocks

2010-09-20T05:31:00.000-07:00

According to the analysis of DeBondt and Thaler, portfolio of the 35 biggest losers in a previous year outperformed the market by 30% after five years. It is interesting that the portfolio of the 35 biggest winners in a previous year underperformed the market by 10%. On the long run the winner portfolio will outperform the loser portfolio, but on the short run (three to five years) the loser portfolio will perform better. Therefore this strategy says: Create a loser portfolio and sell it after three to five years.

It is not entirely clear why this strategy works. Perhaps the reason is that those companies had "extremely bad luck", and that in the following years the "bad luck" will turn around. For a certain period of time the loser stocks will continue to lose, and the winner stocks will continue to win, but after that "the wheel of fortune" should turn around. Therefore, selling stocks in the first year is likely to generate a loss. If you might need that money soon, this is not a good strategy for you.

It is important to notice that the loser stocks are not losers without a reason, meaning that the loser stocks tend to have a greater risk. It is even possible that some loser stocks will cease to exist. Also they tend to have a low price, and therefore higher transaction costs, and higher transaction costs might turn this strategy unprofitable. It is important to find a balance between the risk, time available and the transaction costs.

Investment Strategy: Buy stocks with high dividend yields

2010-04-30T04:45:00.000-07:00

The dividend yield is dividend per share divided by the price per share. The dividend yield is also called the dividend-price ratio. The dividend per share is the dividend for the previous year, while the price per share is the current price on the stock market. Instead of dividend per share for the previous year, estimated dividend per share for the next year might be used.

A high dividend yield means that a stock is under priced or that the company is facing problems. Similarly, a low dividend yield might be a sign that a stock is over priced. To determine the health of a company you must check the other fundamental parameters.

The dividend yield of the Dow Jones Industrial Average has fluctuated between 3% and 6.0%. The highest Dow Jones dividend yield was about 15% (1932), and the lowest dividend yield of the DJIA was below 1.5% (2000). At the moment (April 2010) the dividend yield of the DJIA is about 2.7%. It is also important to notice that a profit can be either reinvested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Therefore the dividend yield might be zero. Well established companies usually have higher dividend yields. Growth oriented companies usually have lower dividend yields.

Investment strategy: Buying stocks with low price to sales ratios

2010-04-19T06:51:00.000-07:00

The Price-to-Sales (or Price/Sales or P/S) ratio is defined as (Market Capitalization)/(Sales). The market capitalization is the current price of a share multiplied by number of shares. The sales is the revenue from sales for the previous year. This ratio could be also calculated as (Share price)/(Sales per share).

P/S ratio measure how much is the market willing to pay for the each dollar of sales. For example, if the P/E ratio is 15 then investors are willing to pay 15$ for each dollar of sales. Low P/S ratio might indicate that the company is either undervalued or in troubles. It is necessary to check other parameters to see which is true. Price / Sales could be used as a substitute for a Price to Earnings ratio when the earnings are negative. The Earnings could be negative because it is calculated as Sales-Expenses. It is important to compare P/S ratio to the P/S ratios of other companies in a given industry. It is also necessary to check for trends of this and other ratios. Some companies have cycles in earnings and sales. There might be more expenses in one year than in the previous one. At the same time the company might have more sales than in the previous year. In that case P/E ratio could be low or even negative, while the company is actually getting better.

It is important to notice that low Price to Sales ratio might mean that there is something fundamentally wrong with that company. Always assume that there is a reason why the company has small P/S ratio, and look for parameters confirming that. If you find little or no evidence that the company is in troubles, then consider this as a buy signal.

Investment strategy: Buy low P/E Ratio stocks

2010-03-11T05:59:00.000-08:00

Price-Earning Ratio is calculated as (Current share price)/(Earnings per share), and and we usually write P/E. This ratio reflects how much the market is willing to pay for each dollar from earnings. For example, if the P/E ratio is 15 then investors are willing to pay 15$ for each dollar of earnings. Depending on what earnings are used in the calculation we have past (or trailing), current and future P/E ratio. The past P/E ratio use actual earnings for previous four quarters. The current P/E ratio is calculated actual earnings for the previous two quarters and the projected earnings for the the following two quarters. The future P/E ratio is entirely based on projected earnings for the next year. The price is current share price on the stock market.

High Price to earnings ratio of a company means that the market expect that the EPS of that stock will be increased. If the company doesn't meat that expectation, the price will go down. Low P/E ratio means that the market expect that the EPS is going down. If the company doesn't meat that expectation, price will go up. Such stocks are good opportunities for buying.

The P/E ratio below average for the appropriate industry, might be a buy signal. The market "thinks" that a company with a lower P/E ratio then its industry is less attractive than an average company in that industry. You should figure out whether the market is wrong or not. Also it is necessary to consider a long term trend. For example in 1982 the P/E ratio of the S&P500 index was about 7, while in 1999 it was about 34. As with other ratios, you should consider the other parameters of the company.

Investment strategy: Buy Low P/B stocks

2009-05-29T02:29:00.000-07:00

Price to Book Ratio is defined as (Current Price of a share) / (Book Value of a share). The Current Price of a share is the current price on the stock market, while the Book Value of a share is the value of the share stated in the annual report. After liquidation of the firm and selling every brick, in theory, you should get book value. Therefore, the Current Price should be greater then Book Value meaning that Price to Book ratio should be greater than 1.0, but that is not always true.

In general, low Price to Book ratio of a company might indicate two things: the company is either undervalued or in troubles.

Step by step procedure in selection of a potential winner based on low Price to Book ratio:

1. Choose a company
2. Find Price to Book ratio for the company
3. Find Price to Book ratio for the industry of that company
4. If the PB ratio for the company is greater than the PB ratio of the industry go to the step 1 (choose another company).
5. Check the ROE ratio and its growth.
6. If the ROE ratio isn't growing, or if it is below average ROE for the industry, then go to the step 1 (choose another company).
7. Check for Debt to Equity ratio. If it is low (perhaps even zero) then this company might be worth to buy.

It is important to notice that low Price to Book ratio might mean that there is something fundamentally wrong with that company. That is the reason why you should check for other parameters to see if it is really something wrong with the company. Always assume that there is a reason why the company has small PB ratio, and look for parameters that confirms that. If you find little or no evidence that the company is in troubles, then consider this as a buy signal.

Investment strategies

2009-05-22T04:28:00.000-07:00

Investment strategy is a set of rules that you are guiding you in the stock selection process. A complete strategy should answer several questions:

Which assets (stocks) you should sell?

For each stock in your portfolio, ask yourself "Would I buy this stock having some money to invest?" If the answer is no, you should probably sell this stock.

How much you should buy?

This is a complicated question. Well, the question is simple, but the answer is complicated and it requires a lot of math. To simplify answer here is a proverb "Don't put all your eggs in one basket". The more complicated answer is that you should read about modern portfolio theory. Fundamentals are following: You should know for each stock its risk and return. Knowing this you can select the portfolio with the highest return with desired risk, or vice verse, the portfolio with the lowest risk and desired return. To simplify this answer we could say: "Don't risk more than you can afford", "Don't risk much for little".

Which assets (stocks) you should buy?

The answer to the question depends on the type of an investment strategy you choose.

Here is the list of some investing strategies.

1. Buying low price to book value companies
2. Buying low P/E Ratio stocks
3. Buying stocks with lowest price to sales ratios
4. Buying stocks with highest dividend yields
5. Buying Loser Stocks
6. Buying stocks of firms with idea to replace bad management
7. Trading on News
8. Timing the Market
9. Investing in Small Cap companies
10. Investing in IPO
11. Trend following
12. Investing in Index funds
13. Investing on economic indicators
14. Technical investing

How to get rid of debt?

2009-04-25T00:55:00.000-07:00

If you want to get rid of debts you should follow simple principles.

1. Track down your debts.

Create a debt book. Actually one sheet of paper will be enough. Write down for each debt, the name of your creditor, actual debt, interest rate and current date. You might add the amount of minimal monthly payment and payment due date. There will be about dozen of items. You might add costs of services that are necessary for you. For example, rent and car payments might be necessary for you, and they might not appear on the list (technically it is not a debt, you are just paying the services)

2. Prioritize your debts

There are several ways to prioritize your debts.

- pay the one with the biggest interest rate,
- pay the one you are afraid of (if you don't pay mortgage you might lose your home),
- pay the smallest debt (this way you will reduce the number of debts, and clean your mind)

3. Make a plan

The idea is to have no debts. In order to achieve this you should eliminate the first one. Using the list of debts, mark a debt you should eliminate first. You would probably like to eliminate your mortgage, but that is probably impossible, unless you have $200k on your bank account. Rule of thumb is to payout debt with the biggest interest rate.

So the plan is: "Pay minimal monthly payments for all debts, and pay as much as you can for the one that is marked as eliminate first"
Your financial goal is to payout that debt as soon as possible. With that on your mind whenever you want to buy something ask your self should I buy this or should I save that money and pay the debt? You might choose to pay a certain amount each month until it is payed out.

4. Stick with the plan until the debt is payed off. When you do that choose one of the remaining debts.

I forgot to mention STOP ACQUIRING NEW DEBTS!

What Are Futures?

2008-11-04T07:12:00.000-08:00

In the world of finance, there are many uncommon and niche terms used, which are alien to the rest of the world. ‘Futures’ is one of those terms that is used to identify a form of a financial contract. Futures Contract is a standard contract, to buy or sell a certain asset at a certain date in the future, at a specific time. Usually futures contracts are traded on a futures exchange.

The futures contract detail the quality, quantity and the price of the underlying asset. Usually there are many motives for making a futures contract. Since it is a business agreed to be performed in the future at a specific time and for a specific price, the buyer of the underlying asset is protected against the price fluctuations of the asset in the market. This may result in profit or sometimes, a loss to the contract holder as there is an obligation to buy or sell at the specified price.

Many contracts in the financial world assign the ‘right’ to do something to the contract holder. Futures contracts differ in this aspect by assigning ‘right’ and ‘obligation’ to the contract holders (both parties) for performing what the futures contract details. Some futures contracts call for a physical delivery of the asset and others are settled in cash.

Many assets, especially commodities are subjected to futures contracts in futures exchanges. As an example, there is seller who would like to sell a high volume of corn at the next harvest. Although, the corn is not produced yet, the producer wants to make sure that a proper price is paid for the corn in the future. Then there is a buyer who is looking for corn from the next crop, who will be willing to pay the current market price for it or something similar. In this case, the seller and the buyer can form a futures contract on a specific price, through which both the seller and the buyer are protected against the high price changes.

There are two main traders of futures; hedgers and speculators. Hedgers are interested in the asset subjected to the futures contract and they seek to hedge out the risk of price changes. Speculators usually have no interest or practical use of the assets subjected to the futures contract. They usually buy futures for selling them later with profit to interested parties.

Futures and ‘Forwards’ looks the same in the finance market but they have two significant differences. Firstly, Futures are traded in Futures exchanges, but forwards are traded over the-counter. Secondly, Futures have a less credit risk while forwards carry a high risk.

The current economic crisis

2008-10-29T05:58:00.000-07:00

“Crisis” is clearly not a pleasant word and when it is connected with the economy it surely isn’t too pleasant. But that is exactly what has happened world over as the economic crisis is stealing the lime light in the news, constantly making it to the headlines.

A crisis, be it economic or otherwise can never be attributed to one incident or event, instead occurs due to a chain of events, if not a cycle. But it could be averted by all means given those concerned parties are ready to address the issue, jointly.

From the dawn of the new millennium the globe experienced a sharp increase in essential commodities. Economists attribute this increase to various factors including changing weather patterns, rise of production cost and escalating wars. The situation began to change from bad to worse as several countries began to print money to cover up their expenses. This increased the inflation in almost all countries in the world. The crude oil prices then hit a record high of 147 dollars a barrel and as a result, transportation costs sky rocketed across the states.

The cycle kept on getting worse and the cost of commodities kept rising while the salaries of the average man remained the same, mainly because the companies were trying to deal with rising production costs. Organizations were also compelled to get rid of many of their employees as they could no longer afford them, resulting unemployment to hit the ceiling. This prompted many to obtain financial loans and those who had already obtained loans and mortgages could no longer pay their installments. On the other hand banks were a little bit greedy, so they were lending money even to those with low credit rating. Then, those with the low credit rates stopped to pay their debts. Banks had to start selling houses, and collect insurance. The result of selling houses was the decrease of real estate prices (about 15-20% in last 12 months). The result of collecting insurance was bankruptcy of great insurance companies. This left the leading banks in deep trouble as they faced a crisis of liquid cash and deposits. By then everything had blown out of proportion.

Dubbed the super power of the world, even the United States did not go untouched by this crisis. In fact, it is where this whole menace initiated. The situation aggravated as the dollar weakened day by day mainly due to US dependence on imports. Thus, leading banks began to shut down, the Dow Jones and Wall Street stocks came down sharply. It was only the beginning of the crisis as markets across the continents hit the downward trend. For an example, Iceland which was once considered as one of the wealthiest nations could not bear the heat on its own. It was thus prompted to seek the assistance of the International Monetary Fund to support its banking system. Over in the Middle East, Saudi Arabia pumped in 3 billion dollars to its economy to improve the liquidity in the market and even went on to cut its benchmark interest rates. Even China which boasts of the world’s fastest growing economy could not stand still as they quickly took measures to cut rates, amidst the crisis. But the biggest bailout plan is however being proposed by the US, a staggering 700 billion dollars.

How will it affect the average Joe is the next big question. Well, your savings will be at risk. Your job might be at risk. The prices of commodities will increase. As a result you will have less buying power. Since the shares are tumbling and companies keep losing, the dividends you are expecting at the end of the financial year might end up in a dream. Mortgages and other credits will be more expensive. Therefore cut the frills and stick to the basics, as that is the order of the day. If you have cash, this might be a good moment for buying stocks.

The whole crisis will not end any time sooner, but for the world to see light at the end of the tunnel all global leaders will have to reach a consensus to bail out of the situation, united. But an exact date could not be predicted as many say we have still seen only the tip of the iceberg.

What is Current Ratio?

2008-10-27T03:30:00.000-07:00

Current ratio is one of the many financial ratios used for measuring the financial stability of companies. The main indication of this ratio is whether the company has enough resources (assets) to pay its liabilities over the next twelve months.

This ratio measures the company’s ability to pay back its short term liabilities with its short term assets. The current ratio is calculated as;

Current Ratio = Current Assets/Current Liabilities

Therefore, higher the current ratio, a company is more capable of paying off its liabilities. As an example, the company ‘ABC’ has current assets of $50,000 and it has current liabilities of $25,000. Then ABC’s current ratio will be 2 and it means that for every dollar the company owes, it has $2 available in current assets.

A decline in current ratios warns against increase in short term debts or decrease in assets. This is something that investors need to be aware of. Regardless of any other issue, a declined trend of current ratio means a reduced ability to generate cash.

If a company looks forward to its IPO (Initial Public Offering), many State Securities Bureaus in the US will require that the company has a current ratio of 2 or more. So what does this current ratio say to investors who are looking to buy shares? If you are planning to invest on shares, current ratio and its trend for at least one year needs to be analyzed. If the current ratio has been steady for all this time and now it is going down, that may indicate a recent problem of the firm or some economical impact resulting from share market collapse.

If the current ratio is declining for the past one year, then that company may have a permanent problem such as a bad marketing strategy or bad management. Investors need to be very careful with a company with such trends as it is a clear sign of declination. Therefore, it is best for all investors to always look at a steady or increasing current ratio before investing their money.

What is Quick Ratio?

2008-10-20T01:31:00.000-07:00

Imagine a scenario where you invest all your money on a company and all of a sudden the company collapses. In an incident like this, only recovery for you will be the funds you will get after liquidizing the company. That is of course only if any money is left for share holders after the company is liquidized.

What can you do to avoid such a situation? You need to know whether the company that you are planning to invest has enough money and assets from which you can recover your money at the time of liquidation. Then there comes the important question; is there any index that shows liquidity of the company?

Yes, ‘Quick Ratio’ is the indicator used for identifying the liquidity of any company. This ratio is calculated by taking the sum of current assets and accounts receivable, and then dividing it by current liabilities. This method specifically excludes the inventory.

Usually, a quick ratio of 1 or higher is healthy for a company and it indicates that the company does not have to rely on the sale of the inventory to pay the bills. If the quick ratio is lower than 1, that means the company is in trouble and probably the new investors should keep away.

The formula for quick ratio is:

Quick Ration = (Accounts Receivable + Cash Equivalents + Cash)/(Accruals + Accounts Payable + Notes Payable)

There are also a few exceptions when it comes to quick ratio. As we understood, quick ratio indicates the liquidity of the company. But there are cases in which quick ratio does not give you the correct picture. Imagine a company with no bills due today, but having a lot of bills to be paid tomorrow. If you calculate the quick ratio today, the figure will show as having a good liquidity. But in reality, this company cannot be considered as having a good liquidity because of it’s uncounted liabilities that are pending.

What is Return on Assets?

2008-10-13T02:45:00.000-07:00

As the name suggests, this measurement is all about the return the company got over its assets. It is basically for measuring how good the company does with the assets it has got. This can also be interpreted as how many dollars of earning the company derives from each dollar of assets the company posses. This measurement comes in handy when comparing business organizations in the same industry.

Usually this ratio varies across the industries as they have their own limitations. The businesses with low margins such as consumer products will carry a lower ratio while businesses such as software will record higher ratio. The businesses that need a high capital investment also will have a lower ROA ratio. This ratio is calculated as below:

ROA = Net Income / Total Assets

If you are an investor, ROA gives you an idea of how profitable a company is compared with the companies of the same industry. When calculating the value of total assets, the valuation is done using the carrying value of the assets. Sometimes, the carrying value of assets does not tally with the market value and may produce a defective return on asset ratio. Investors need be careful in a condition like this.

Return on assets is commonly used for comparing the performance of financial institutions because majority of their assets will have carrying value close to the market value.

Return on assets ratio cannot be used for comparing companies across industries as mentioned above. If cross industry comparison is required, then there are other ratios to consider. If you are looking at investing, you should look for the best return on assets among the similar companies and settle on the winner!

What is Return on Equity?

2008-09-29T06:00:00.001-07:00

This is another indicator which measures the business organization’s profitability with respect to the money invested by the shareholders. Due to the impact on the shareholder returns, this ratio is considered as one of the most important financial ratios.

This ratio measures the business organization’s efficiency at generating profits of net assets and shows how well the company is doing with investment money. Return on equity is calculated as fiscal year’s net income divided by the total equity and usually expressed as a percentage. The formula goes as;

Return on equity (ROE) = Net Income / Total Equity

Usually if the ROE is high, the business organization is considered as profitable and many investors will be willing to invest. But ROE does not give you the right picture in some cases. As an example, some industries have a high ROE as they do not require many assets such as software development companies. But some industries such as oil refineries require a huge amount of initial investment and assets even before it starts generating any income. In the latter case, ROE will be very low. So, in these cases, no one can conclude that software companies are better investments than oil refineries.

Return on equity varies between the industries as we saw in the earlier example. Therefore, ROE is commonly used for comparing businesses in the same industry.

If you are interested in making an investment, return on equity is one of the critical measures to look at. One good practice is to calculate the growth on ROE. This is done by taking a period and calculating the ROE at the beginning and the end. If there is a positive growth of ROE, then it is assumed that the earnings have been properly invested in the company and the company is growing.

The standard formula for ROE, DuPont Formula is used by almost all industries for calculating their ROE by breaking down ROE in to three components for making the calculations easy.

60 Places to Look For Information About Stocks

2008-09-23T00:59:00.000-07:00

Google finance
Yahoo finance
MSN Money
AOL Money & Finance
CNN Money
Reuters
Quote.com
Hot Penney Stock Finder
Market Watch
Ask Research
India Infoline
Big Charts
Forex
NASDAQ
Estockwise
Hemscott
Advice for Investors
Tickerspy
WallStreetCourier.com
StockMaster
All China Stocks
CNBC
DividendInformation
India Finance & Investment Guide
SiteBySite
Australian Securities Exchange
Stock Kenya
InvestorPoint
Daily Stocks
Finra
Netquote
Bloomberg
Futures Briefing
Hoovers
Canoe Money
TheStreet
PC Quote
Share Wadi
TSX
Euronext
Boston.com
Stock Shop
Euroland
BseNsedaily
Stock Tiger
The Privateer
All Penney Stocks
Thai Stock Market
Barchart
Free Realtime
Clear Station
eSignal
InvestorTech
Real Time Quotes
Stock Charts
IVolatility
Money Control
Trading Markets
Huge Upside Stocks
Investopedia

Passive income and 13 ways to achieve it

2008-09-18T02:42:00.000-07:00

Active income is income generated from your continuous action, meaning that there is income as long as you work. Stop working and there is no income. Passive income is continuous income generated from one time action. That means (in theory) that there is income without your active work. Sometimes passive income is called residual income.

Term residual income is ambiguous because its main meaning is "an income reduced by all debts payments". It is used by banks to calculate how much money do you have to payout future debts. As you can see, this meaning of residual income has nothing to do with its other meaning (passive income). To avoid confusion we will use the term passive income.

At the first look, passive income sounds great. You are sitting and dollars are flowing into your pockets. Unfortunately, you will always have to do something for your income. The question is how much time you will spend to achieve that. Let's look at the following example. You own one apartment and you rent it. You might say that renting it is a perfect example of a passive income without work on your side. However this is not entirely true. What if your tenants decide to go to Alaska? You will have to find another one. Therefore you should put some advertising. Also, you should talk with the potential tenants. What if your apartment needs some painting and fixing before renting? As you see, you will always work for your money but that work might not require 50 hours per week.

The benefit of passive income is in fact that after initial effort you will have to invest a little time occasionally. That means that you could try several passive income operations. Some of them may bring you a great success. Also, it is possible to run passive income operation, while working on your current job. On the other hand, you cannot work on two full time jobs at the same time. That means that you can try with only a limited number of full time jobs in your life time in order to achieve a financial success. Therefore, you can try much more passive income operations than full time jobs. Some of them might be a big success.

At the end, it is important to ask yourself "What will I do when I create a solid passive income?" Why is that answer important? Your motive to create a passive income might be to start doing something else. Then a logical questions arises "What stops me from doing that right now?". After all we all seek happiness, and work is one third of our lives (or one half of our wakeful life). Why not doing for work things we like the most?

Basic types of passive income

1. Buy and rent a property

The idea is to buy a real estate and rent it. If you pay it with cash then afterwards you will only have to maintain the property and collect the money from renting. Apart from the rent, the profit is generated through the appreciation of the property. Be aware that it is also possible for real estate prices to go down. In that case you might have a loss. Also, it is possible to use a mortgage. Then you have to balance a rent and a monthly mortgage payment. In ideal situation you might have a monthly positive income stream.

2. Vending machine

The idea behind this kind of income is to install a vending machine somewhere. This is not entirely passive, because you will have to "feed" your machines with stuff, but you will have to do this only occasionally (for example once a month). Of course, you will have to make a deal with the property owner where you install candy machines.

3. Create a web content and sell ads

If you have something to write about, and that appears to be popular, you could put it on the Internet and earn revenue through the ads. Topics could be cats, sports, movies, education, science, leisure ....

4. Sell on eBay

Find a reliable source of some cheap goods and sell it through the eBay. Your source could even do the delivery to your customers.

5. Write an ebook

Write an ebook about something in your area of expertise and sell it.

6. Write a book

Remember Harry Potter? J.K.Rowling was once a single mother living on welfare, and now she has one billion. It is unlikely that you can earn one billion, but the idea is to write a good book once, and earn a steady cash inflow afterwards.

7. Create a software product

This is quite similar to writing a book. Write a good software that people wants to use, and here is the steady income. You should probably maintain that software, but that is an excellent opportunity for selling even more of new versions of your software. That probably means that you should work, but you could also hire someone to do it for you.

8. Dividends and capital gains

Invest in a good company that pays it's dividends. If you invest 100$ in a stock today, and after a year its worth is 110$ then you have earned 10$ doing nothing. That is a capital gain and it is completely passive income. Warren Buffet has been doing this for more than 50 years.

9. Interest income

You could put your money into savings account or you could buy some CDs and earn an interest. For more options visit your bank. Visit other banks as well.

10. Royalties & patents, inventions, songs, photos

This is similar to the book writing. Being a good inventor, singer or photographer means that you could earn a little whenever someone use your inventions, songs or photos. Let's mention some examples: Edison, Madonna, Pitt.

11. Delegate your work to others and pay them less than you are payed.

Imagine that you work for 2000$ per month. If you find someone to do your job for 1500$, then you will earn 500$ doing nothing. Of course, your employer might dislike this approach so be aware.

12. Create a product and sell it

A product could be anything from candies to the space shuttle. For the beginning I propose you to stay closer to the candies. It is not necessary to manage production by yourself. There is a lot of companies that could do that for you.

13. Create a business and employ a manager

Of course that would require time. Creating a business that is profitable will take several years. But after that you are in the zone of possible passive income. Employ a manager to replace your role and here you are with a passive income.

Save 1000$ on Shopping

2008-06-15T06:00:00.000-07:00

1. Reduce the number of shopping trips

Dedicate one day in week for shopping. Don't buy anything on other days. The reason for this is to reduce your exposure to temptations. At the moment when you decide to buy something, you are at risk of buying something else that you don't need and that could be even harmful (alcohol, junk food, ...). Therefore, reduce the number of shopping trips and you will reduce the number of temptations and save money.

2. Buy from the list

Before shopping make a list of things that you want to buy. Buy only things that are on the list. Make the list even if you want to buy only one thing. By the way, buying one thing is a waste of time and sign of bad organization. At each buy you spend some fixed amount of time (going to the shop, waiting to cross the street, ...) probably at least 5-10 minutes for shops that are in your neighborhood. Imagine that you go shopping seven times a week that takes 35-70 minutes. Shopping three times a week will take 15-30 minutes. The difference is about 30 minutes. Find your hourly wage and calculate how much money you can save only on your time (probably about 5$ per week).

3. Make a don't buy list

If you have problems with buying things that you don't need, make a list of forbidden things (alcohol, junk food, ... ). Before buying anything read a list of things that are absolutely forbidden. Make a promise to yourself or someone else that you will not buy such things.

4. Track your expenses

Note each thing you buy and its price. That will help you to memorize prices and find things on which you spend the most of your money. Using this book keeping, you can search for shops with the best offers for you. For example, you might find that groceries costs 2$ less in another shop in your neighborhood. That might sound little, but shopping 3 times a week, will result in saving 312$ per year.

5. Reduce shopping list

Go through your shopping list and ask yourself for each item "Is this item really, really necessary?". If the answer is no delete it from the list. After that you could delete the most expensive item from the list. With that you will delay spending money.

You can now calculate how much money you can save. 312$ on better deals + 300$ on free time + 350$ on things that you don't need. In sum that will be 962$ per year.

Are you frugal or miser?

2008-06-15T05:51:00.000-07:00

Yes, yes. I know that you are not a miser. But let's first take a look at what does being frugal and being miser actually mean. Frugality means using or spending no more than necessary. On the other hand a miser is a man that lives poorly in order to pile up wealth. So we can conclude that a frugal person spends no more than necessary, while a miser spends less than necessary. On the other side there is a spendthrift who spends more than necessary.

I believe that all of us are sometimes miser, sometimes frugal and sometimes spendthrift. Probably we are more on the side of being spendthrift. Whenever you buy something cheap compromising functionality you need, you are a miser.

In the process of organizing your personal finances, there is a risk of acting as a miser. Be aware of that. The point is to get things done, not to spend as little as possible.

But don't worry too much. You don't need to be perfect. You will certainly make mistakes, but that is OK as long as you keep your eyes open.

What are DRIPs (Dividend Reinvestiment Plans)?

2008-06-12T03:45:00.000-07:00

DRIP (or DRP) is an abbreviation for Dividend ReInvestment Plans. DRIP is an investment plan that allow us to reinvest dividends (to use dividends to buy more stocks) without paying brokerage commissions. Some DRIPs allow purchasing additional stocks, also without paying brokerage commissions. Usually (but not always) DRIPs don't charge commissions. On the other hand the company might give you a discount of 3-5%. To sign in to the DRIP you should already have at least one share of the company on your name. Some companies request owning a minimal number of shares in order to sign in to their DRIP (for example HP). Therefore, you must use a broker to buy the first shares, or buy them directly from the company. Note that not all companies allow direct purchasing. Usually a company that allows direct purchase allows DRIP.

DRIP doesn't necessarily mean that you can purchase shares directly. So what is the point if you have to go to the broker anyway? The benefit is in the possibility to invest and reinvest small amount of money and in the fact that you will avoid the brokerage fees on subsequent buying. For example, if you have a share that earns 3% dividends, and you have shares worth $100, then you will receive $3 dividends. The company will send you a check but you will not be able to reinvest it (due to commissions). Using DRIP the company automatically reinvest your $3. Another advantage is ability to purchase only a fraction of a share. For example, if one share worth $5, then you could buy 0.6 of share reinvesting the $3 dividend.

Being able to invest small amounts of money, you can build a portfolio and diversify your assets without having thousands of dollars. Another benefit is dollar cost averaging. Investing regularly fixed amounts of money will result in buying less shares when their price goes up, and more shares when their price goes down.

Another benefit of DRIPs is possibility to invest automatically. You could arrange that your bank send 50$ each month to the company of your choice. Using this technique you will free some of your time and invest on autopilot. There is a great chance not to invest if you have to think about it. This way you will have to invest your time only once.

The problem with DRIPs is that you will have to invest a certain amount of time in research. You have to find the companies that allow DRIPs. After that you will have to buy the first share. That means that you have to find a low commission broker, or to find a way to buy a share directly. That process you will repeat for each company you chose. There is a little bit of work, but you could tune your system to work without you.

Places to find DRIPs

DIRECTInvesting
DripWizard

What is Payout Ratio?

2008-05-30T18:00:00.000-07:00

Payout Ratio is sometimes called Dividend Payout Ratio or DPR. It represents the percentage of earnings payed in dividends. It is calculated as follows: DPR = (Annual dividend per share)/(Earning per share).

Lower DPR means that the company retains earnings for development. Higher DPR means that there is no much room for development, and the best use of earnings is to pay dividends. Higher DPR is sometimes associated with more mature companies.

As other ratios DPR should be considered in the context of industry. DPR alone doesn't tell us much about the company.

What is dividend yield?

2008-05-27T11:54:00.000-07:00

Dividend yield tels us how much money we will receive for each dollar invested. Dividend yield is Annual dividend per share divided by Current Share Price. For example, if the Annual dividend per share is $2 and the Current Share Price is $20, then Dividend yield is 2/20 or 10%.

High Dividend yield could means that the Annual dividend is high or that Current share price is low. We can conclude that high Dividend yield could mean that the share is undervalued. So having other parameters equal one should buy stocks with higher Dividend yield.

A simple way to track expenses

2008-05-23T06:00:00.000-07:00

An ideal system for tracking expenses should be simple enough and good enough. It is hard to maintain both simplicity and quality. Therefore, you should think about things you actually want to catch using your tracking system. There are several issues you might want to track.

date and time of spending
amount
specific product that you buy
type of expenses
point of sale
manufacturer
environmental issues (recyclable or not)
...

It would be nice to have all those features in our tracking system, but it would take several hours per week to type in all those data. One solution is to hire somebody to do it for you, but it is wasting of money if you don't need all those features. So what you could do now?

What types you are going to track? It would be nice to track gifts to family, gifts to friend, even maybe gift to a person, but it would take time. My suggestion is "No more than 10 types of expenses". Reserve one type called "Other expenses". Take a look at the following example:
- transport
- house maintenance
- leisure
- mortgages and other financial expenses
- food
- junk food
- kids
- clothes
- investments
- other expenses
Create a spreadsheet. Label three columns as: type of expenses, date of expense, amount spent. You could add one column for specific notes if you like.
Type in data daily or weekly.

Some recommendations

Usually is doesn't matter if you miss accurate date. It is important to put in appropriate month. Therefore, you could even create combo boxes for choosing types, and months. Any actual data you have to type in is the amount of an expense.
Even actual amount is not that important (there is not big difference between $27.89 and $28). Such data would be perfect but it could help to get a rough picture about your spending.
Resist the need to modify types for first month or year. After that you can modify the list of types, but keep it simple as much as possible. The key point it to keep is simple because the more difficult tracking is, it is more is probable to abandon the tracking.
You can group several expenses. For example: You buy apples for $5, carrots for $4, milk for $4.5 and pretzels for $1.5. You can type in:
1. food, May, $13.5.
2. junk food, May, $1.5

Using this method, you should spend no more than 30 minutes per week, or 3-4 minutes per day. And that is perfect for filling the time gaps in daily schedules.

What is Price to Free Cash Flow ratio?

2008-05-20T11:09:00.000-07:00

Price to Free Cash Flow ratio is a stock valuation method that compares a company's market price to its free cash flow for a given period. This ratio is similar to the price-to-cash flow. It uses the free cash flow instead of cash flow. Free cash flow reduces operating cash flow by capital expenditures. The lower price to free cash flow ratio the better. This ratio basically tells us how much we spend for each dollar of free cash flow.

For example, if a company generated $100 million in operating cash flow and spent $20 million on capital expenditure, then it generated free cash flow of $80 million. If the company currently has a market capitalization of $2 billion, the company trades at 25 times free cash flow ($2 billion/$80 million).

Capital expenditures are funds used by a company to buy, repair or improve assets such as property, industrial buildings or equipment.