Category: Articles

The name penny stock can be somewhat misleading to those who aren’t familiar with the stock market. The name tends to express that there isn’t very much money involved. This is true because they often trade at less than $5, but they are very high risk investments.

That means you don’t have very good odds in your favor of earning any return on them. These types of stocks are best left for those who have money they can afford to lose. Many people do invest in them though because should they get a return on them it is usually quite substantial.

It is very important to understand that the information out there about penny stocks can be manipulated. They are often involved with fraud, false reports, and information that show them to be liquid in nature when they really aren’t. There are less shareholders and so there isn’t going to be the liquidity with penny stocks as you will find with many other types of investments.

In fact, that is often the case so new investors should steer clear of them. Even those with a great deal of expertise in the market can’t predict what will happen with them most of the time. It is important to carefully consider the pros and cons of penny stocks before you move forward with investing in them.

Repurchase agreements are commonly referred to in the market as repos. This type of agreement involves someone owning a security that hasn’t yet matured. They can still use that security though as a type of collateral with a lender. They will be able to get the money they need now. They also agree to buy that security back at the cost of it plus interest. The rate of interest is variable and so it will depend on the market at that time.

This same concept is often referred to as a reverse repo when you are talking about the involvement of the entity that offers the funds. These are the lenders who willfully agree to buy them at this time and then resell them for face value plus interest at a later date. The terms are the same but a repo is from the view of the borrower while the reverse repo is from the view of the lender involved in the same transaction.

A repo and reverse repo are often associated with a type of secured loan. They are basically a way to have collateral that the lender can access should the recipient default as to the terms of the loan agreement. It significantly reduces the amount of risk that the lender has to carry. As a result they are often more willing to provide the borrower with the funds that they have requested.

P/E Multiple stands for Price / Earnings multiple and is one of the most frequently used measure to value a share price.

Here price stands for the current market price at which the stock is trading. Earnings stand for EPS (Earnings per share) and normally the annual profits for the last financial year are considered while calculating EPS.

For arriving at the P/E Multiple you need to divide the Current market price by the EPS of the company. So if the stock is trading currently at $100 and the EPS is $10 then the P/E multiple is 10.

A rule of thumb is that high growth stocks would trade at a higher P/E multiple and that is why investors would observe that the P/E multiple for Google would generally be higher than the P/E multiple of Walmart, even though both are excellent companies in their own right.

P/E Multiple can really help investors to determine whether the price that an investor is paying for a stock is high or low. Usually investors just consider the price and say, well Apple trades at $170 and Google at $544 so Google is more expensive. What they completely ignore is that Apple is making $4.85 per share or the EPS of Apple is $4.85 so its P/E Multiple is 35 whereas the EPS for Google is $14.23 so its P/E Multiple becomes 38 and therefore both companies are priced more or less equally by the market.

P/E Multiple is a good measure to determine whether to buy a stock when you have already done your research about the fundamentals of the company and are confident that the company in itself has sound operations and that buying it would be a good idea.

This is like saying that you have done your research among various car manufacturers and are confident that buying a Honda or Toyota would be a good deal.

The next step is to compare the prices of the car. However in case of stocks you cannot do a stock price comparison because of the difference in EPS between various companies. If you were to compare Google to Apple strictly based on the stock prices you would be misled as we just saw in the example above. Therefore a good way to compare what is being offered by the market is to take the P/E multiples and see how much you are paying for the stock.

It is usually best to compare stocks within the same sector because different sectors trade at different range of multiples. For example technology stocks normally command a higher P/E than utility stocks because of the higher earnings growth potential.

So the key factors to be kept in mind while using P/E ratio is to do your fundamentals research first and then to use it on companies narrowed down on the same sector.

Earnings per Share or EPS is calculated by dividing the profit after taxes or net profits by the total number of outstanding shares of a company. EPS indicates how much money the company is making per share.

So if a company made $100 as net profits and had 100 shares outstanding in the market, their EPS would be $1.

This calculation helps an investor to judge the profitability of the company. EPS is also needed to calculate the P/E ratio of a stock which is another popular way of estimating the price of a company.

PAT or the profit after tax is the profit that is available to the shareholders after paying the corporate tax and all other expenses.

From the company’s total revenues operating expenses like employee remuneration and administrative expenditure is deducted to arrive at Operating profit. From operating profit, finance charges are deducted like Interest or Depreciation, and this amount is profit before tax.

The taxes that have to be paid are deducted from profit after tax and the resultant amount is known as profit after taxes.

Usually the only expense that is deducted from profit after tax is the profit that has accrued due to changes in the accounting policies of the company. This is because profits which, have occurred due to changes in accounting policy would have already been factored in the earlier years in which they were originally made and hence tax paid on them.

What is an ETF?

ETF or Exchange Traded Fund is quite simply a mutual fund that itself trades in an exchange.

Typically mutual funds invest in stocks or other assets, but they themselves do not trade in any stock exchange. After trading hours are finished a mutual fund’s value is calculated based on the price of whatever stocks it held.

ETFs differ in the sense that they themselves are also traded on the exchange like other stocks and their value also keeps changing every instant the market is trading.

A popular reason for buying ETFs in place of mutual funds is the fact that an investor can keep a track of the ETF during market hours and when it touches a price that they like they can go ahead and buy it. Over the longer term ETFs can sometimes prove to be cheaper than mutual funds because typically they charge lesser annual fee and have no entry loads or exit loads. However because the method to buy ETFs is similar to stocks they do have a brokerage fee associated with them. This does not imply that you will make more money buying an ETF instead of mutual fund because that really depends on how much your mutual fund or ETF grows. This simply means it generally costs less to own an ETF than it would to own a mutual fund.

The philosophy of ETF is very similar to Index funds and it promotes diversifying risk by holding a bucket of stocks having a common feature and taking advantage of growth in that particular sector, region etc.

This article is the second in the series which describes how Warren Buffet has described a Great. Good and Gruesome business in his letter to shareholders for 2007.
A good business according to Buffet is one that has a long term competitive advantage in an industry where there is growth though there needs to be significant capital investment in order to finance the growth. The example that Buffet gives is FlightSafety. Buffet says that in this business the profits rose from $159 million in 1996 to $270 million in 2006 however the capital needed to make this happen has been an incremental investment of $509 million. While these are good earnings these are not what will make a business an extra ordinary business. This is the kind of business where if you want to earn more you will need to invest more.
Finally Buffet discusses the gruesome, which he describes as a business which grows rapidly and requires significant capital for that growth but doesn’t earn as much money as would be required to justify growth. Buffet gives the example of the airline industry which has always required massive investment but has never really provided any returns to investors. This is primarily because in the airline business no company has been able to create a lasting competitive advantage for itself.
Buffet summarizes by saying that the great, good and gruesome investments are like three savings account where the great one pays you a extraordinarily high rate of interest which rises as the years rise, the good one pays an attractive rate of return which will be earned also on deposits that are added. The gruesome is one which pays an inadequate rate of interest and also makes requires an investor to keep adding money in order to make that low interest rate.

Every year Warren Buffett writes a letter to its shareholders informing them about the year gone by and his outlook on the future as well as the good and bad things done in the past by his company.
This letter is a great source of knowledge and wisdom as it comes from the world’s best investing mind and has a frank tone to it.

The letter for 2007 had his pearls of wisdom about how to pick the right company for investment. While Buffett goes ahead and buys the whole company common investors can take this wisdom and apply them to their own investment decisions.
The letter under a sub-heading “Businesses – The Great, The Good and the Gruesome” takes a look at the factors which make a business attractive. In this article we discuss the great businesses as discussed by Buffett in this letter.

The following four factors are discussed in the letter:
a) Business that is easy to understand
b) Favorable long term economics
c) Able and trustworthy management
d) Sensible price tag

Buffett discusses the need for a truly great business to have an enduring ‘moat’ . This was a term coined by Buffet himself who uses this to describe a competitive edge of one business over its competitors such as being a low cost producer in the case of Costco or being a global brand in the case of Coca – Cola. The need for such a moat is that any successful business would attract competitors and in the wake of competition a business should be able to protect its market share.
In addition to having a ‘moat’ Buffett insists that the moat should be an enduring one. By saying that there are a lot of companies that get eliminated. These are companies that operate in industries prone to rapid and continuous change. The obvious reason for this is what could be a competitive edge today may eliminate altogether tomorrow because of the changing economics of the industry.

Another interesting thing that comes along with this definition is that Buffett says that a truly great business should never really have to depend on a great CEO. A great business can’t be one whose success depends on superstars. Of course having a great CEO is an added asset but it shouldn’t be a factor upon which the success of the business is totally dependent.

Having established that a business has got a long term competitive advantage Buffett develops the concept further and states that long term competitive advantage in a stable industry is what makes a stock interesting. A great company in such an industry is one that comes with rapid organic growth however even if the business doesn’t have rapid growth the earnings from this business can be taken and invested in another business which has rapid growth. The example that Buffett takes is See’s Candy which was bought by them for 25 million dollars in 1972 and which had a pretax profit of 5 million dollars. The business needed a capital of 8 million dollars to run and this meant that it was earning a cool 60% profits on invested capital. In the last year this company made a profits of 82 million dollars with a capital investment of just 40 million dollars. So effectively the capital that had to be invested in the company was $32 million and the profits so far have totaled to $1.65 billion which have been re-invested in into other attractive businesses.

While IPOs in their literal sense mean that the company is for the first time issuing its stock to the general public, in reality whichever company is coming out with an offer to sell its share to the general public is known to go the IPO route. So that also includes company who already have their stock trading in the stock market.

Generally the investing community is excited about IPOs because traditionally it was thought that during its first offer companies sell their stock to the general public at a discount to their intrinsic value. While this was true for the Indian markets a few years ago one look at the IPOs coming out today tells us that this is not true anymore. Many companies who do not even have a financial history of five years or so, come out with IPOs to take advantage of the booming financial markets and therefore are not only ‘not’ selling their stock at a discount but even at outrageous prices.

There can be two kinds of investors for IPOs the long term investors who have bought the stock because they believe in the company and think that by holding the stock of the company for a long period they will be able to make profits. The other kind is the short term investors who just buy into the IPO to sell during the initial few days or even hours of listing and make what are known as listing gains.

While investing in IPOs investors should be careful about the history of the company because a lot of companies these days are just listing their shares out because they think that they can take advantage of the general optimism which prevails today in the markets.

The operational history can be a good judge and along with the pedigree of the promoters these two parameters can be a very good indicator of whether to invest in a stock or not.

After analysing the past performance of the company and making sure that the IPO is not being issued by fly by night operators, an investor needs to look at the price at which the IPO is being issued at and decide whether it is a fair price or not. While there is no fixed indicator for this the P/E Multiple provides a good yardstick and you can see what P/E is being demanded by the issuing company and whether it compares with the P/E that prevails in the industry. An important and often unnoticed thing about the P/E Multiple of IPOs is that it is calculated on the current number of shares that the company has got. However as soon as the IPO takes place most of the times fresh shares are issued in the market which will automatically push the P/E Multiple higher by pushing the EPS lower. So whatever P/E you are looking at, keep in mind that you will have to increase that by a bit most of the times after issue of stock.

These are a few tips to be taken care of while investing in IPOs so that  you don’t end up burning your fingers.

CAGR is compound annual growth rate and it is used to calculate what your principal would grow to if your interest earned is invested back at the same rate. So if you invest 100 bucks at 10% at the end of first year you would get 10 bucks as interest but at the end of the second year you would earn interest on 100 (original investment) + 10 (interest earned at the end of first year) = 110 and your interest would be 11 instead of 10.

CAGR is widely used in business to calculate the growth rate of revenues and profits as the assumption in business is that the money that is made is reinvested for future growth (the part which is not given as dividends to shareholders)

CAGR is a helpful tool when you are looking at a particular stock to buy and have its historic revenues and profits available. You can input the revenues at a year 2003 and then at the year 2008, enter the number of years as 5 and see what the CAGR comes out to be.

This will give you an idea of the rate at which the company has grown.
CAGR is also helpful to calculate the amount of money that you would have after a certain period of time if you were to invest a certain sum now at a given rate of interest. So in the above example 100 bucks will become 121 in two years time at a CAGR of 10%.

In this calculator you could calculate both, if you know what is the principal you are going to invest, number of years and rate of interest you could calculate the amount it would result in after the period.

Or if you knew the number of years, initial principal and then the resultant amount you could key in that to see at what CAGR the growth took place.