1. Can I in one sentence say exactly what the company does?
2. Is operating cash flow higher than earnings per share?
3. Is Free Cash Flow/Share higher than dividends paid?
4. Debt to equity below 35%?
5. Debt less than book value?
6. Long Term debt less than 2 times working capital?
7. Is the debt to EBITDA ratio less than 5?
8. What are the debt covenants?
9. When is the debt due?
10. Are Pre-tax margins higher than 15%?
11. Is the Free Cash Flow Margin higher than 10%?
12. Is the current asset ratio greater than 1.5?
13. Is the quick ratio greater than 1?
14. Is there growth in Earnings Per Share?
15. Is management shareholding > 10%?
16. Is the Altman Z score > 3?
17. Does the company have a Piotroski F-Score of more than 7?
18. Is there substantial dilution?
19. What is the Flow ratio (Good < 1.25, Bad > 3)
20. What are management’s incentives?
21. Are management’s salaries too high?
22. What is the bargaining power of suppliers?
23. Is there heavy insider buying?
24. Is there heavy insider selling?
25. Any net share buybacks?
26. Is it a low risk business?
27. Is there high uncertainty?
28. Is it in my circle of competence?
29. Is it a good business?
30. Do I like the management? (Operators, capital allocators, integrity)
31. Is the stock screaming cheap?
32. How capital intensive is the business?
33. Does management have the ability to naturally re-invest in the business at a high return?
34. Is the company highly profitable?
35. Has it got a high return on capital?
36. Has the business got an enormous moat?
37. Is there room for future growth?
38. Does the business have strong cash flow?
39. What has management done with the cash?
40. Where has the Free Cash Flow been invested?
40.a. Share buybacks
40.b. Dividends
40.c. Reinvested in the business
Showing posts with label analysis. Show all posts
Showing posts with label analysis. Show all posts
Thursday, September 29, 2011
Saturday, September 10, 2011
8 Steps To Financial Analytic Intelligence
The following 8 financial ratios offer terrific insights into the financial health of a company -- and the prospects for a rise in its share price.
1. Ploughback and Reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book Value per Share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India [ Images ] have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE) and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.
1. Ploughback and Reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book Value per Share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India [ Images ] have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE) and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.
Monday, February 22, 2010
The Golden Ratio
The three great bull markets of the Twentieth Century are dramatically reflected in a chart of the Dow/Gold ratio, which is simply the quotient of the Dow Jones Industrial Average divided by the gold price in US Dollars. It is basically the price of the leading index of paper claims on productive assets, divided by the dollar price of an ounce of gold.
When the ratio is high, as it is in a boom, equities are expensive and gold is cheap.
When the ratio is low, as it is in a bust, equities are cheap and gold is dear.
Today, the Dow/Gold ratio is at its highest level ever. We believe this signifies the financial world is on the cusp of a huge inflection point, similar to that of the two prior peaks.
Just as at those prior peaks, financial assets are grossly overvalued, and gold is grossly undervalued.
Just as those prior valuation extremes resolved themselves through dramatic reversals in both the numerator and the denominator of the Dow/Gold ratio, so will today’s, and soon.
The key to understanding the Dow/Gold ratio and what it portends lies in isolating the principal factors that affect the numerator (equity prices) and the denominator (the price of gold).
At every peak, we find the same phenomena:
- Overvaluation of equities
- Over-ownership of equities
- Excessive liquidity
- Excessive credit
At every trough, we find their opposites.
And at each extreme, we find a background of breakdown in the global monetary system:
- Collapse of gold exchange standard (1929 -1934)
- Collapse of Bretton Woods standard (1961 -1971)
- Collapse of floating rate standard (pending)
Friday, February 5, 2010
Earthquake Theory For Stock Market Movements
The earthquake science working for markets is an opinion as old as the butterfly effect and the study on Sun cycles influencing markets. Earthquake do not cause market behaviour, but large-scale events in the stock market adhere to distinct patterns which can be witnessed in seismic activity. Economists should borrow the earthquake math from scientists who model natural disasters, the power curve mathematics.
The reason that economists are uncomfortable with power laws is that “unlike the bell curve they are not based on any assumptions about how markets or people work. They are simply curves that fit the data”.
The Power Law
The power law cannot predict when catastrophes happen, but only how often they will occur. An earthquake that is twice as big will be four times as rare. The power law school of thought is not working on the timing problem as they are convinced that power law is not about predicting time, it is just a recurring pattern in nature, which is an unexplainable rule.
Something can’t be understood so it is better to focus on things at hand rather than interpreting the science behind the law of nature. Power law is believed to allow policy-makers to set regulations that better shore up the financial world against extreme events.
Time Decay In Earthquakes
Probability of a disastrous economic fluctuation seems to be fairly independent of time period. Time independence could be an illusion and an idea which could assist physicists to ignore time. Many scientists have talked about the same earthquake science but from a time dependence aspect. Seismologists are now talking about recurrent time and use elapsed time to calculate earthquake probabilities. Elapsed time is now believed to influence future earthquake events. There is an effort to understand seismic cycles and improve earthquake maps. The researchers say that time dependent models are intuitively appealing.
Though this is an idea in the right direction, it has ground to cover before the scientific community reaches time fractals. We have talked about time decay on prior occasions. This time we are illustrating the time decay in earthquakes. Haiti was in the top destructive earthquakes of all time and has been extensively studied by the US geological survey. We pulled out the minute by minute data from 23 January to 29 January and isolated the time between shocks across the region. The plotted chart was an exponential curve again, suggesting the time (number of days) between shocks was proportionally spread even when smaller time was studied. We get a similar plot when we study earthquake date from 1575 and similar time patterns are seen when we study nuclear tests or any other social and natural activity.
How can time exhibit the same exponential order when the order is believed to be everywhere else? We can either see fractals and patterns all around us, in everything, or accept that time is indeed what gives every living entity, anything which ages, this distinct pattern. Everything from earthquakes, to volcanoes, to cotton prices, to human behaviour and even to the Sun is patterned by time. “When” remains a more important aspect than how often can earthquakes repeat, a crisis occur, a stock rise, or an asset outperform. The focus on “when” can assist us more even if we don’t have a perfect answer. Time is perfect, our interpretation of it can never be.
We started the year attempting to time relative performance. We asked early January, if it was time for Grasim to outperform Nifty? Grasim was at the bottom of numeric rankings on 29 December 2009 and now it is at the top of list. What does this mean? This means that end of December Grasim was ready to outperform Nifty and it did. Long Grasim, short Nifty delivered 13 per cent in January. Now that Grasim has hit a top in rankings, a performance reversal should not be far away, when it starts to underperform Nifty.
The anticipated breakdown we have been talking on markets also happened. Metals, small cap and capital goods are ready to underperform the market. Tata Motors and M&M also seem overstretched in performance and should not sustain outperformance against Nifty for long. HDFC’s performance cycles continue to suggest that there is more catch up for the stock against Nifty; the stock should outperform the benchmark. If everything is cyclical like time suggests, research solutions of tomorrow might just simplify things.
via the smart investor
The reason that economists are uncomfortable with power laws is that “unlike the bell curve they are not based on any assumptions about how markets or people work. They are simply curves that fit the data”.
The Power Law
The power law cannot predict when catastrophes happen, but only how often they will occur. An earthquake that is twice as big will be four times as rare. The power law school of thought is not working on the timing problem as they are convinced that power law is not about predicting time, it is just a recurring pattern in nature, which is an unexplainable rule.
Something can’t be understood so it is better to focus on things at hand rather than interpreting the science behind the law of nature. Power law is believed to allow policy-makers to set regulations that better shore up the financial world against extreme events.
Time Decay In Earthquakes
Probability of a disastrous economic fluctuation seems to be fairly independent of time period. Time independence could be an illusion and an idea which could assist physicists to ignore time. Many scientists have talked about the same earthquake science but from a time dependence aspect. Seismologists are now talking about recurrent time and use elapsed time to calculate earthquake probabilities. Elapsed time is now believed to influence future earthquake events. There is an effort to understand seismic cycles and improve earthquake maps. The researchers say that time dependent models are intuitively appealing.
Though this is an idea in the right direction, it has ground to cover before the scientific community reaches time fractals. We have talked about time decay on prior occasions. This time we are illustrating the time decay in earthquakes. Haiti was in the top destructive earthquakes of all time and has been extensively studied by the US geological survey. We pulled out the minute by minute data from 23 January to 29 January and isolated the time between shocks across the region. The plotted chart was an exponential curve again, suggesting the time (number of days) between shocks was proportionally spread even when smaller time was studied. We get a similar plot when we study earthquake date from 1575 and similar time patterns are seen when we study nuclear tests or any other social and natural activity.
How can time exhibit the same exponential order when the order is believed to be everywhere else? We can either see fractals and patterns all around us, in everything, or accept that time is indeed what gives every living entity, anything which ages, this distinct pattern. Everything from earthquakes, to volcanoes, to cotton prices, to human behaviour and even to the Sun is patterned by time. “When” remains a more important aspect than how often can earthquakes repeat, a crisis occur, a stock rise, or an asset outperform. The focus on “when” can assist us more even if we don’t have a perfect answer. Time is perfect, our interpretation of it can never be.
We started the year attempting to time relative performance. We asked early January, if it was time for Grasim to outperform Nifty? Grasim was at the bottom of numeric rankings on 29 December 2009 and now it is at the top of list. What does this mean? This means that end of December Grasim was ready to outperform Nifty and it did. Long Grasim, short Nifty delivered 13 per cent in January. Now that Grasim has hit a top in rankings, a performance reversal should not be far away, when it starts to underperform Nifty.
The anticipated breakdown we have been talking on markets also happened. Metals, small cap and capital goods are ready to underperform the market. Tata Motors and M&M also seem overstretched in performance and should not sustain outperformance against Nifty for long. HDFC’s performance cycles continue to suggest that there is more catch up for the stock against Nifty; the stock should outperform the benchmark. If everything is cyclical like time suggests, research solutions of tomorrow might just simplify things.
via the smart investor
Monday, December 28, 2009
Seven Themes For 2010
1. Buy SOE (State Owned Enterprises) Banks: The Central Bank is likely to start raising rates in January 2010. Rising rates favor Indian banks as they run a maturity mismatch on their balance sheets (liabilities have a longer maturity). Thus NIMs will rise; coupled with acceleration in loan growth (which trails IIP growth), this will help earnings. The stocks of SOE banks trade at better valuations than their private sector counterparts and SOE banks will also be helped by a declining fiscal deficit, which will likely cap long bond yields.
2. Avoid Technology: Tightening by the Central Bank will put upward pressure on the rupee with negative consequences for technology stocks. Tech stocks have done particularly well over the past six months and also suffer on a relative basis in an accelerating domestic growth environment. Tech stocks correlate negatively with INR.
3. Buy Energy: Energy, especially Reliance Industries, has delivered its worst relative performance ever on a trailing-six-months basis. The sector correlates positively with crude oil, short-term yields (read: local inflation) and industrial production. Thus it provides a hedge against a spike up in crude oil prices.
4. Buy Industrials: Acceleration in industrial growth will help close the output gap faster than what is possibly in the price right now. This will help a new private capex cycle to start in 2010 and further boost performance of industrials.
5. Shift Bias From Rural to Urban Plays: No doubt rural growth remains very strong, helped by rising food prices and government spending. Yet at the margin, urban growth will close the gap vs. rural growth as industrial activity picks up. Two-wheeler and large cap staple stocks tend to correlate negatively with industrial growth and should be avoided in 2010. In contrast, media and niche mid-cap staples may still perform well.
6. Buy Mid-caps: The broader market is likely to generate faster earnings growth of around 25% in 2010, trades at better valuations than the narrow market, and accordingly could outperform the narrow market.
7. Stock Picking Could be in Vogue in 2010, Market to be Driven by Earnings: A high market effect, high sector correlation and middling micro factors such as valuation, fundamental and return dispersion sets us up for a better stock picking environment in 2010. Most of the market returns in 2009 have come from a PE re-rating, and as the key driver of returns shifts to earnings in 2010, so will the key driver of stock prices from macro to idiosyncratic stock related factors.
2. Avoid Technology: Tightening by the Central Bank will put upward pressure on the rupee with negative consequences for technology stocks. Tech stocks have done particularly well over the past six months and also suffer on a relative basis in an accelerating domestic growth environment. Tech stocks correlate negatively with INR.
3. Buy Energy: Energy, especially Reliance Industries, has delivered its worst relative performance ever on a trailing-six-months basis. The sector correlates positively with crude oil, short-term yields (read: local inflation) and industrial production. Thus it provides a hedge against a spike up in crude oil prices.
4. Buy Industrials: Acceleration in industrial growth will help close the output gap faster than what is possibly in the price right now. This will help a new private capex cycle to start in 2010 and further boost performance of industrials.
5. Shift Bias From Rural to Urban Plays: No doubt rural growth remains very strong, helped by rising food prices and government spending. Yet at the margin, urban growth will close the gap vs. rural growth as industrial activity picks up. Two-wheeler and large cap staple stocks tend to correlate negatively with industrial growth and should be avoided in 2010. In contrast, media and niche mid-cap staples may still perform well.
6. Buy Mid-caps: The broader market is likely to generate faster earnings growth of around 25% in 2010, trades at better valuations than the narrow market, and accordingly could outperform the narrow market.
7. Stock Picking Could be in Vogue in 2010, Market to be Driven by Earnings: A high market effect, high sector correlation and middling micro factors such as valuation, fundamental and return dispersion sets us up for a better stock picking environment in 2010. Most of the market returns in 2009 have come from a PE re-rating, and as the key driver of returns shifts to earnings in 2010, so will the key driver of stock prices from macro to idiosyncratic stock related factors.
Friday, September 12, 2008
KYC: Know Your Company
Know Your Company
These are a few things we need to ask ourselves before we pin down an investment.
Transparency:
Is the company in which you are planning to invest or hold shares communicative with the necessary information on resource raising?
Does the company have an interactive website packed with every conceivable detail, update regularly and easily navigable?
Are changes in address and other missives from you taken note of and rectified in the shortest time possible?
Is there prompt credit of dividends of your saving account and bonus shares into your demat account?
Market Intelligence:
Order wins, tie-ups, accidents at manufacturing facilities, and aggressive takeover bids can affect the stock prices, positively or negatively.
Liquidity of the stock in your portfolio will suffer if it is shifted to the compulsory-delivery category.
Change in Ownership:
Is your company seeking to allot preferential shares to the promoters without any valid reason?
Are promoters selling shares (an indication that something is amiss), or they quietly consolidate holding through open market purchases(a signal that they have confidence in the future, or may want to thwart an unwanted raid).
Have the owners suddenly decided to transfer ownership to a holding company? Are you satisfies that this move was in the interest of the company’s many businesses?
Demerger of divisions, accompanied by the offer of shares in the news company based on valuation, is given a thumbs-up by the market as it brings clarity and focus to a company doing too many things.
Know your intermediary:
Whom will you invest through? Can you access them easily, either physically or through the internet?
Do they maintain a proper record of your transactions and are thorough in after-sales services?
Are they been penalized by the market regulator for any irregularities?
Wrong stock selection is excusable. But not investment in opaque companies.
These are a few things we need to ask ourselves before we pin down an investment.
Transparency:
Is the company in which you are planning to invest or hold shares communicative with the necessary information on resource raising?
Does the company have an interactive website packed with every conceivable detail, update regularly and easily navigable?
Are changes in address and other missives from you taken note of and rectified in the shortest time possible?
Is there prompt credit of dividends of your saving account and bonus shares into your demat account?
Market Intelligence:
Order wins, tie-ups, accidents at manufacturing facilities, and aggressive takeover bids can affect the stock prices, positively or negatively.
Liquidity of the stock in your portfolio will suffer if it is shifted to the compulsory-delivery category.
Change in Ownership:
Is your company seeking to allot preferential shares to the promoters without any valid reason?
Are promoters selling shares (an indication that something is amiss), or they quietly consolidate holding through open market purchases(a signal that they have confidence in the future, or may want to thwart an unwanted raid).
Have the owners suddenly decided to transfer ownership to a holding company? Are you satisfies that this move was in the interest of the company’s many businesses?
Demerger of divisions, accompanied by the offer of shares in the news company based on valuation, is given a thumbs-up by the market as it brings clarity and focus to a company doing too many things.
Know your intermediary:
Whom will you invest through? Can you access them easily, either physically or through the internet?
Do they maintain a proper record of your transactions and are thorough in after-sales services?
Are they been penalized by the market regulator for any irregularities?
Wrong stock selection is excusable. But not investment in opaque companies.
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