Investing
Picking Commodity Options Markets Making Price Moves
December 6, 2011 | 
Author 
This article discusses the things you need to know about to profit from commodity options trading.
These key points will help you trade more successfully:
Commodity Option characteristics Commodity Options Trading Basic Terms Commodity Options Trading Analysis The Greeks
1. Commodity Option Trading Introduction
What Are Commodity Options?
An option is a contract that gives you the right, but not the obligation, to either go long or go short the underlying futures contract at a pre-determined entry price on or before a specific date. It lets you take advantage of price moves in the futures markets without actually having a futures position.
There are two types of options, Call options and Put options.
The Call option gives you the right, but not the obligation, to go long the underlying commodity futures contract at a pre-specified entry price on or before a specific date. You would buy a Call option when you believe the futures price will increase.
A Put option gives you the right, but not the obligation, to go short the underlying commodity futures contract at a pre-specified entry price on or before a specific date. A Put option is used when you believe the futures price will decrease.
Commodity Option characteristics
Buying commodity Options have several characteristics which make them more attractive to traders. They include:
Limited Risk. You cannot lose more than the amount paid for the option. Staying Power. You don’t run the risk of getting stopped out of a trade. Profit Is Not Limited. If correct in your analysis, profit potential is not limited. Quick Fills. You can quickly enter and exit markets at a reasonable price. No Margin Calls. You won’t encounter a margin call on option positions. No Limit Moves. Options are immune from the risk of limit moves. Numerous Strike Price Selections. Options are available in a range of strike prices. Lower Capital Requirements. Buying an option is less than the futures margin cost. * Provide Trading Alternatives. Options can be used as a substitute for protective stop.
2. Common Options Basic Terms
The following terms are commonly used in option trading.
The “strike price” is the price that you may enter the underlying futures contract if you exercise the option. For Call options, the strike price is the entry price that has the right to go long the underlying commodity futures contract. For Put options, this is the entry price at which one has the right to go short the commodity.
The “option premium” is market-determined price of the option that you pay to purchase either a call option or a put option. It is a non-refundable cost that the option seller keeps, and is your maximum amount of risk in the market. The premium is quoted just like the price of the underlying futures contract; in cents, points, etc. Option premiums fluctuate daily due to market conditions.
Options have two separate components which together define the option’s premium. They are time value and intrinsic value.
“Time value” is the amount of time remaining before the option expires. “Intrinsic value” refers to how much the price of the underlying futures price is, relative to the strike price of the option. The option will have intrinsic value when the price of the futures contract is higher than the strike price of a call, or when the price of the futures contract is lower than the strike price of a put. Options with intrinsic value are referred to as in-the-money options.
All options are assigned an “expiration date” after which they are no longer valid for trading purposes. This is the last day that the option may be exercised. Frequently, this date will be 2-4 weeks before the underlying futures contract’s Last Trading Day (LTD), although some futures items synchronize the option expiration date with the futures contract LTD. The farther out into the future an option’s expiration date is, the more expensive the option will be (time = money).
3. Commodity Options Trading Analysis
First, you must analyze the futures market to identify the current (and likely future) price trend. My complete Commodity FUTURES Trading Course gives you the tools to help you intelligently analyze the futures markets and identify options which have a high probability for profit. This is what losers don’t do. There will be times when your analysis suggests that a commodity is ready to start a major move. But the margin may be too large, or it may be volatile and the futures contract may require a large stop-loss risk amount ($1,200 to $2,500 or more) to avoid getting easily stopped out and is an amount which your money management rules prohibit. In other instances, the margin may just be too high. In these cases, you can use an option if your money management rules permit its purchase.
Practical Rules for Selecting Options
After you have analyzed the markets, you must first determine how much you want to risk. Your money management plan will be part of this determination. You should also consider the margin required for a futures contract as compared to the premium paid for the option. With commodity futures contracts, the margin is a refundable deposit – if you are correct about the direction of the move. With options, the premium is a non-refundable cost. For speculators, options work best in volatile markets because you don’t get stopped out. They give you “staying power” – for a price.
Use the following items as a guide to help you in selecting a simple option position.
The option type (will you be trading a call option or a put option) Buy an option with as close to 3 months before expiration as possible. Buy an option within 3 strike prices away from being in the money. Never risk more than $300 of the premium paid for the option. When possible, buy an even multiple of options (i.e., 2, 4, 6, 8 options, etc.)
4. The Greeks
The term “greeks” is used to describe specific data values which are used by professional traders to analyze options. Top option traders know how changes in the greeks will affect the profitability of their trades and adjust their trades accordingly. This information will help you define the risk of an option trade. The expected profit or loss of an option is based on changes in market price, time until expiration, as well as changes in implied option volatility.
Note: The only way to get the greeks for individual options or for option spreads is to use an option software program such as OptionVue, or from a broker who uses one. Manually calculating these values daily is too cumbersome.
Delta
Delta tells you how much of a change to expect – either an increase or decrease – in the option’s premium when the underlying futures price moves. The expected price change in the option’s premium is expressed as a percent of the change in the price of a full futures contract. The Delta of an option is not fixed, but changes with variations in the futures price. As the futures price gets closer to the strike price, the value of Delta increases.
Gamma
The Gamma tells you how much the option’s Delta will change when the underlying futures price changes. As the futures price moves, the Delta changes, and Gamma can tell you how much change to expect in the Delta. If you start out with a Delta of 0.50 in a call option, a rally in the underlying futures price will cause Delta to increase.
Gamma tells you how much you would expect Delta to change on a 100 point move in the futures. Gamma will always be positive if you are long premium in either calls or puts, and negative if short.
Theta
This value tells you how much the option’s price will decline in one day if the future price does not move at all. It is a reflection of time value loss and is expressed as a dollar amount. Theta is a variable that can be affected either by changes in the futures price, time left until expiration, and changes in implied volatility.
Vega
This value tells you how much the option price will change if implied volatility changes. It is the “sensitivity” of the option’s price to volatility. Vega is expressed as a dollar amount. A positive Vega indicates that a rise in implied volatility will benefit your position. Vega tells you how much you can expect the theoretical value of an option to change based on a 1 percent change in implied volatility.
Special Note: There is substantial risk in trading commodity futures and options.
(C) 2008 Thomas Wnorowski
By: Thomas Wnorowski
Posted in Investing | 
Tags: Call Option, Commodity Futures, Commodity Markets, Commodity Option, Commodity Options, Commodity Price, Commodity Trading, Futures Contract, Futures Margin, Futures Markets, Futures Price, Greeks, Margin Call, Option Characteristics, Option Positions, Option Trading, Options Markets, Price Selections, Staying Power, Trading Commodity | 
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How Does the Stock Market Work?
Before you start investing in the stock market it is a good idea to ask yourself, “How does the stock market work?” The answer to this question is simple. Companies go public by offering a specific number of shares in their company to the public through the stock exchange. Investors then can use the stock exchange to buy and sell stocks of companies that they are interested in. While this basic description of how the stock market works is adequate enough to understand what the stock market is, to get a better understanding of how it actually works it will be important to learn about some of the terms that are commonly used when discussing the stock exchange including stock prices and market capitalization.
The first term that you may hear when you start learning about how the stock market works is stock prices. Stock prices are the price that a specific stock sells for. This price is set by several market factors including the health of the economy, trading trends, spending trends, and financial or technical reports put out by a company or an independent third party. The next term that you may hear about is market capitalization. Market capitalization is the value of the company or the stock that is being offered. To calculate the market capitalization of a company, or stock, simply use this formula: The number of outstanding shares X the price of the stock = market capitalization of the company.
After you learn about the basics features of the stock exchange you will next need to learn how to buy and sell shares. To buy a stock you will need to establish some kind of investment account. In most cases you will open an investment account with a stock broker that works at a local firm. However, today you can also open an online investment account and make trades without the help of a stock broker. After you have set up your account you will need to fund it before you can make a purchase. Once your account is funded you will be able to enter your order for a stock purchase. When you are ready to sell your shares you will either tell your stock broker that you want to sell X number of shares of Company A, or you will need to enter a sell order via your online investment account.
By: Sarah Freeland
Posted in Investing | Tags: Buy Stock, Exchange Investors, How Does The Stock Market Work, Investing In The Stock Market, Investing Stock, Investment Account, Local Firm, Market Factors, Outstanding Shares, Spending Trends, Stock Broker, Stock Exchange, Stock Market Capitalization, Stock Market Work, Stock Market Works, Stock Price, Stock Prices, Stocks, Third Party, Trades | No Comments »
The Concept of Residual Earnings
It is the duty of the equity analyst, more specifically the common stock analysts, to determine the value of a company, its intrinsic value relative to its current market capitalization and determine if their is a margin of safety in between these two values. Of course, this assumes you follow the traditional Graham & Dodd value strategy. Without getting into investing philosophy and sticking strictly to valuation, let’s consider the differences between some of the more popular strategies (all of these strategies assume statements have been reformulated so that operating and financing items have been separated):
Discounted Cash Flow Analysis:
Free cash flow (FCF) is calculated easily by finding the difference between Operating Income (OI) and the change in Net Operating Assets (^NOA or NOA1 – NOA2) or FCF = OI – ^NOA
The FCF forecast model uses FCF now and estimates into the future discounted by the Required Return on Capital (RC). The RC is calculated using the stock’s Beta, the risk free rate of return (usually 3 mo. t-bill), and a market risk premium (expected return on the market – risk free rate). This calculation is made however many years out the forecast is intended to extend to, maybe 3-5 years. So it looks like:
Value = FCF/RC + FCF2/RC2 + ….. + FCFn/RCn + CV
The last part of the formula, CV, is the continuing value, is an estimate of value for a finite forecast horizon of FCF’s. It is calculated as follows: FCFn+1/(RC-1) or if you forecast FCF to grow at a constant rate then FCFn+1/(RC-g), where g is 1 plus the forecasted rate of growth in FCF.
The problem with using discounted FCF is that it does not measure value added. FCF is a measure of stocks and flows. The analysis charges this flow of money with the required return on capital. Assume a company makes a large investment and as a result ends a quarter with negative cash flow. Value is not derived from this figure and cannot be accurately forecasted, but in the long run there is potential value added from the cash investment. FCF does not measure this.
The Residual Earnings Forecast Model:
First, let’s define residual earnings (RE); RE = Return on Common Equity (ROCE) – RC * Common Shareholders Equity (CSE)
So what does this measure exactly? This measures the return to shareholders above the required return on capital. The discounting process is the same as with FCF, where a CV is used at the end, but RE is used instead of FCF; V = CSE + RE/RC + RE1/RC1 + … + REn/RCn + CV.
One important note must be accounted for; this model can only be used when there is no debt recorded on the books. Otherwise debt acts to lever up ROCE, distorting real value added.
So here we have a cleaner forecast, one that determines whether value is being added in earnings. You can tell by the difference in ROCE and RC. If it is positive, RE will be positive and value is added. The opposite is true if ROCE is less than RC.
Again, debt distorts this forecast, in which a different formula will be needed, but I will not cover in this particular article. Also, beware of long forecasts, the longer the time horizon the more speculative in nature it becomes. For this reason, I do not forecast out beyond the current year and scrap the CV.
If you have any comments or suggestions, especially with regards to the use of risk free rates and expected returns on the market, please comment here.
By: Matthew Scullen
Posted in Investing | Tags: Cash Flow Analysis, Discounted Cash Flow, Discounted Cash Flow Analysis, Equity Analyst, Fcf, Fcfn, Flow Value, Forecast Horizon, Forecast Model, Free Cash Flow, Market Capitalization, Market Risk Premium, Measure Value, Negative Cash Flow, Operating Assets, Residual Earnings, Return On Capital, Risk Free Rate Of Return, Stock Analysts, Value Strategy | No Comments »
Investment Performance Expectations and Broker Account Statements
As impossible as it is to predict the future of the markets, it’s relatively easy to anticipate what you are going to experience when you view your next brokerage account statement.
Whether you go the discount route through Schwab, Ameritrade, Fidelity, etc., or enjoy a higher level of service through an independent like LMK Wealth Management, you should never be surprised by the market values reflected on your monthly statement.
None of the firms make it easy for you to examine asset allocation, particularly on a working capital basis, and most refuse to even acknowledge that Municipal CEFs should not be lumped in with the equities. Additionally, no brokerage statement ever includes a warning label about the dangers of margin borrowing. Surprised? Not.
But you can be sure that all statements will emphasize (in every conceivable way) the short-term change in your market value. Any long term or cyclical analysis (if any) is reserved for the “we understand your long term objectives” propaganda that fills their prospect-only glossies.
Statement market value movements in both directions need to be anticipated and understood, not labeled bad or good (rhyming not intended). Investigation is required when you reasonably expect one direction and you wind up with another— with the emphasis on the reasonableness of your expectations.
Someone should provide a simple analytical mechanism that will allow investors to know precisely what to expect from the monthly statement opening ritual— and to have a fairly good idea of why the values have changed the way they have. No shocks, surprises, or indigestion.
I’ll take a shot at it, but you should know that IGVSs are those few “value stocks” (in the classic definition) that are also B+ or better rated by S & P, dividend paying, generally profitable, and traded on the NYSE.
The IGVS expectation analysis process will prepare you for the dreaded monthly account statement— whether you get there by password and click or by post office and letter opener.
Only four bits of information are really needed (for WCM users), and I’m assuming a 70% to 30% portfolio asset allocation— equities vs. income, respectively:
One: An increasing Investment Grade Value Stock Index (IGVSI) will lead to higher market values for the stocks in your portfolio, but not if you just think that you own mostly IGVSs in your Mutual Funds.
Two: When you are looking for stocks that fit your buying parameters (not hot tips from “Heard on the Street”, “Mad Money” or CNBC), a higher number of “bargains” will generally mean lower equity market values.
Three: If monthly (IGVS) Issue Breadth numbers are significantly positive, higher market values should be expected. For the uninitiated, issue breadth analysis compares the daily number of stocks going up in price with the number going down.
Four: If there are fewer IGVSs establishing new 52-week lows than new 52-week highs, it is likely that overall equity market values are rising.
So how do you think you did in August— click, click, head-scratch?
The Investment Grade Value Stock Index was up for the fifth time in the past six months. The number of bargain stocks was below the average of the past six months. Issue breadth was positive. There were more 52-week highs than lows— only one new 52-week low all month.
In other words, all indicators point to a higher market value in August than in July and a continuation of the upward trend that started in March.
Additionally, in spite of conditions where interest rates cannot really go much lower, rate sensitive CEFs continued to move slightly higher— signaling further strengthening (for now) in the credit markets.
So what could keep you from having a better portfolio picture this month than last (from a short-sighted market value perspective)?
Well, Virginia, in the non-government world where most of us attempt to survive, disbursements in excess of income and deposits will do it every time. And when the market corrects, as it absolutely always will to some extent, the double whammy on the bottom line can be painful.
Tracking breadth, new highs and lows, bargain numbers, and an index that mirrors the types of securities you hold in your portfolio, can explain what is happening. Regular additions to your portfolio can soften the impact of a correction and help you prepare for the rally that inevitably follows.
Now if we could only convince the SEC to require that account statements be divided by security purpose (growth or income, for example) instead of by trading unit— and market cycle analysis? Maybe next year.
By: Steve Selengut
Posted in Investing | Tags: Account Statements, Ameritrade, Asset Allocation, Broker Account, Brokerage Account, Cefs, Cyclical Analysis, Dividend, Fidelity, Indigestion, Investment Performance, Nyse, Performance Expectations, Reasonableness, Schwab, Shocks, Term Objectives, Value Stocks, Wealth Management, Working Capital | No Comments »
Factors Affecting Share Prices
Like any other commodity, in the stock market, share prices are also dependent on so many factors. So, it is hard to point out just one or two factors that affect the price of the stocks. There are still some factors that are that directly influence the share prices.
Demand and Supply – This fundamental rule of economics holds good for the equity market as well. The price is directly affected by the trend of stock market trading. When more people are buying a certain stock, the price of that stock increases and when more people are selling he stock, the price of that particular stock falls. Now it is difficult to predict the trend of the market but your stock broker can give you fair idea of the ongoing trend of the market but be careful before you blindly follow the advice.
News – News is undoubtedly a huge factor when it comes to stock price. Positive news about a company can increase buying interest in the market while a negative press release can ruin the prospect of a stock. Having said that, you must always remember that often times, despite amazingly good news, a stock can show least movement. It is the overall performance of the company that matters more than news. It is always wise to take a wait and watch policy in a volatile market or when there is mixed reaction about a particular stock.
Market Cap – If you are trying to guess the worth of a company from the price of the stock, you are making a huge mistake. It is the market capitalization of the company, rather than the stock, that is more important when it comes to determining the worth of the company. You need to multiply the stock price with the total number of outstanding stocks in the market to get the market cap of a company and that is the worth of the company.
Earning Per Share – Earning per share is the profit that the company made per share on the last quarter. It is mandatory for every public company to publish the quarterly report that states the earning per share of the company. This is perhaps the most important factor for deciding the health of any company and they influence the buying tendency in the market resulting in the increase in the price of that particular stock. So, if you want to make a profitable investment, you need to keep watch on the quarterly reports that the companies and scrutinize the possibilities before buying stocks of particular stock.
Price/Earning Ratio – Price/Earning ratio or the P/E ratio gives you fair idea of how a company’s share price compares to its earnings. If the price of the share is too much lower than the earning of the company, the stock is undervalued and it has the potential to rise in the near future. On the other hand, if the price is way too much higher than the actual earning of the company and then the stock is said to overvalued and the price can fall at any point.
Before we conclude this discussion on share prices, let me remind you that there are so many other reasons behind the fall or rise of the share price. Especially there are stock specific factors that also play its part in the price of the stock. So, it is always important that you do your research well and stock trading on the basis of your research and information that you get from your broker. To get benefit from the effective consultancy service it is therefore always better from professional stock trading companies rather than getting lured by discount brokerage advertisements that you must be coming across everyday.
By: Amit Malhotra
Posted in Investing | Tags: Commodity, Earning Per Share, Economics, Fundamental Rule, Last Quarter, Market Capitalization, Market Share, Mistake, News News, Outstanding Stocks, Positive News, Press Release, Quarterly Report, Share Prices, Stock Broker, Stock Market Cap, Stock Market Trading, Stock Price, Stock Prices, Volatile Market | No Comments »
Why Do Value Stocks Tend To Come Out Ahead?
Since about 1990, it has been accepted practice in the investing world to divide stocks into “growth” and “value” categories. Furthermore, over long periods, value stocks tend to have greater total returns than growth stocks. Warren Buffett’s empire is built on this fact.
Why is this true? First, let’s define what the terms mean. Value stocks are the ones that have low Price-to-X ratios, where X may be book value (P/B), earnings (P/E), or sales (P/S). Growth stocks generally have high growth rates in things like earnings and sales.
Because of the way the market tends to value stocks, those with high growth rates also tend to have high Price-to-X ratios. So a simple and common way to categorize a group of stocks is to rank them from high to low on a Price-to-X ratio basis, and then draw a line straight through the middle of the list. Everything above the line (higher ratios) is considered a growth stock, everything below the line is considered value.
This is a pretty crude, some might say simplistic, distinction. After all, if you divide the S&P 500 into two groups as just described, is there that much difference between the 250th and 251st stocks? Of course not. Yet the first will be called a growth stock, the second a value stock.
Nevertheless, studies show consistently that value stocks (as a group) outperform growth stocks when stocks are held for long periods. For example, between 1983 and 2006, value stocks outperformed growth stocks in 16 out of the 24 five-year holding periods that ended in those years. From 1979 through 2006, the Russell 1000 Value Index returned 2.4% more than the Russell 1000 Growth Index. (Each index is reconstituted annually.)
Why do value stocks produce higher long-run returns?
There are several reasons:
The first reason derives from the way the two categories are constructed. By definition, if growth stocks include all stocks above the median Price-to-X ratio for a given universe of stocks, the growth category will include practically all the stocks in that universe that are overvalued-priced too high compared to what they are really worth. Investors as a group have a tendency–when analyzing fast-growing stocks–to overestimate both the rate of growth and the timeframe during which fast growth can be sustained. They therefore tend to overvalue such stocks. Over time, the inexorable market forces of rationality and reversion to the mean will bring these stocks, on average, closer to their true worth. Overvalued stocks will see their prices reduced (or grow more slowly) in comparison to their value-stock cousins.
The same principle works in favor of the value stocks. That group, by definition, contains almost all the stocks that are undervalued. Market participants as a group tend to underestimate the growth potential of slower-growing stocks, some of which may just be living through a tough patch in their business and so are undervalued. The same market forces as previously mentioned will tend to bring the prices of those stocks up relative to the growth group.
The second reason is a camouflaged outcome of the long-holding-period ground rule. None of the studies consider what happens if an investor utilizes sell-stops or some other selling discipline to lock in gains or curtail losses on his or her holdings. Many sensible investors buy growth stocks because they are on a tear, growing not only their revenues and earnings but also their stock prices. If there were a law that any stock, once purchased, must be held for five years (the holding period reflected in the study mentioned earlier), not many rational investors would participate. It is unreasonable to expect a fast-growth stock to outperform for five years running. So the rules of the studies are stacked against growth stocks and in favor of value stocks.
A third reason is that the value group tends to harbor more dividend payers. Several studies have shown that dividends-especially reinvested dividends-account for up to half the total return of stocks over long periods of time. So again, the growth stocks are at a long-term disadvantage compared to the value stocks–but not necessarily at a short-term disadvantage.
What are the lessons for the individual investor? To me, there are three:
o It is reasonable to have a “value tilt” to one’s stock holdings. That said, remember that the value advantage tends to reveal itself over long holding periods. If long holding periods do not suit your personality, be careful. You will find it psychologically difficult (or impossible) to hold onto a declining or “dead money” stock for a long time while you are waiting for the market to figure out its true value-which may take years. Not only that, you may be wrong about the stock’s potential. Just because a stock is a value stock does not mean that its price is going to rise. It may have a justifiably low valuation because it is a lousy stock. Which leads to lesson number 2:
o Analyze your purchases before making them. Take a holistic approach. Don’t buy any stock just because it is a value stock, pays a dividend, or for any other single reason. Know why you are buying a stock before you buy it. Look at it from multiple perspectives. The crude value-versus-growth categorization is just a single factor, and perhaps not a very helpful one at that.
o Have an exit strategy. Whether you use sell stops or some other discipline, you should know under what circumstances you will sell every stock you own. If a growth stock does great for you for a year or two but then goes into reverse, sell it, unless there are good reasons which you can articulate for holding onto it. Don’t feel that you have to be in the buy-and-hold school to be a good investor.
By: David Van Knapp
Posted in Investing | Tags: Ahead, Distinction, Earnings, Empire, Growth Category, Growth Index, Growth Stock, Growth Stocks, Holding Periods, Investing, Long Periods, Median Price, Ratios, Russell Index, Universe, Value Stock, Value Stocks, Warren Buffett | No Comments »
Stock Market Trading Systems – Part 1
Every successful stock market trading system is comprised of three critical elements. In this article, we will examine the first of these components. As with anything that is to be constructed in a robust manner, the first part of a trading system is its foundation.
Most stock traders and investors spend the majority of their time studying the daily action of equities. They closely watch the price action on daily charts. This is perfectly fine if you are built your foundation first. And the foundation is the prevailing trend of the stock you are watching.
The very first chart you should look act are those that depict the long range price action of your stock. When we say long range, we are talking about looking at charts that span one year or more. Do not look at daily price action, look instead at weekly price action. Use a trend following tool such as either moving averages or a MACD histogram to tell you whether you should buy or sell the stock.
Probably the easiest way to do this is to plot 20, 50, and 100 period moving average lines on the chart. When the lines are layered probably to support a bullish or bearish trend, then you will know whether this stock is a potential buying opportunity or a selling short opportunity. If you are fairly new to trading, it is recommended that you stay away from sell stocks short as this is a totally different animal than buying stocks.
Now that you have built the foundation of your trading system, you will be ready for Part 2. However, do not take any action until adding parts 2 and 3 to your trading system.
By: Chuck Cox
Posted in Investing | Tags: Bearish Trend, Buying Stocks, Chuck Cox, Critical Elements, Different Animal, Investors, Macd Histogram, Moving Averages, Prevailing Trend, Robust Manner, Sell Stocks, Span, Stock Market Trading, Stock Market Trading System, Stock Market Trading Systems, Stock Traders, Stock Trading, Trading Stock | No Comments »
How to Work In the Stock Market – Price Earnings Ratio Is Used For Long Term Investments
Stock markets jobs are tedious. They call for patience and endurance. For the better part of the day, the employee will be working on the computer, transacting shares. I speak from a practical point of view, having worked for a stock market. A sound knowledge of the goings on or how to work in the stock market sector was a must for my success in my position. Often, there were changes in the way business was transacted. This called for me to keep on updating my skills as new practices were embraced.
The most important thing I had to learn was how to value stocks. Stocks are valued in twofold. These ways include the use of cash flow and fundamental earnings or sale. The other way is by market forces, that is demand and supply. The latter is dictated by how much the seller is willing to sell or what the buyer is willing to buy. The ways of analyzing these stocks change as soon as they are bought because investors are more concerned about the stability of the stocks. The most common way of valuating stocks is the fundamental valuation. This is mostly used to justify share prices. The commonest way is the price-earnings ratio.
The most fascinating experience for me was realizing that the fundamental valuation is what influences long-term investment. It is measurable and predictable. It is a historic way of evaluating stocks. It employs the use of statistics. Demand and supply is also used to assign value to stocks. It is however difficult to predict stocks based on this method. It is mostly used for short-term share market trends.
By: Doreen Norris
Posted in Investing | Tags: Cash Flow, Doreen, Endurance, Investors, Market Sector, Market Trends, Patience, Point Of View, Price Earnings Ratio, Share Market, Share Prices, Sound Knowledge, Stock Earnings, Stock Market Price, Stock Markets, Stock Price, Term Investment, Term Investments, Term Share, Value Stocks | No Comments »
Investing – Assess A Company’s Valuation
It is advisable and an advantage for investors to have an understanding of financial statements. It enables investors to draw their own conclusions about the company and possibly survive in challenging markets. However, it is not a simple task. Thus, it is probably easier to assess a company by using basic yardsticks.
Business
Analyzing the business of a company provides an understanding about how well positioned the company is in the industry and also the potential growth of the industry itself.
You should understand and identify what type of business and industry the company is in, what and where the risks could come from and what is the market segment of the business.
Management
Good people will run a good company. In fact, most goodwill built over the years is largely due to good management. The honesty, integrity and commitment of the people are a crucial determinant of the success of a business. Dishonesty and mismanagement can easily bring about the downfall of even large multinational companies like Enron, WorldCom and the National Australia Bank.
Earnings
To provide an estimation of how well the company is doing, investors should assess the nature, quality and predictability of future revenue streams, as well as earnings before interest, tax and depreciation.
The earnings of a good company if not growing, should be sustainable. The earnings of a company should justify the capital employed as in the long term; investors would withdraw their support if profits of the company do not justify their investment value.
Cash Flow
Most analysts will consider a company’s cash flow as the best way to determine the company’s health. Cash could come from three sources; operating activities, investing activities and financing activities.
The cash flow statement provides detail of all incoming and outgoing cash from each of the three sources. Revenue from the operating activities is consists of cash items only. Cash flow from investing activities includes the purchase and sale of property, plant and equipment. Cash flow from financing would show any monies raised or paid out to shareholders (including the dividends payment).
Dividends
For a company that does have a dividend policy, it’s good to know whether it employs a constant dividend growth policy, residual method or none. For a profitable company with a lack of investment opportunities, it would be wise to return part of the profits as dividend to its shareholders. In most cases, profitable cash generating companies in mature or slow growth industries are the common dividend distributors. By knowing a company’s past dividend distribution and the management’s intentions, a good gauge of future distributions can be made. Popular models to value dividend paying companies are to discount the future dividends using either a constant or multiple period growth rates.
To determine the value of an investment requires ascertaining whether a current price reflects sufficient growth to allow an investor to generate a return that meets their cost of capital. Clearly, all the above have to be considered collectively for a fair assessment of a company’s valuation.
By learning to recognize the tell tale signs, you are better prepared to protect your interests. If you can interpret the information, you able to determine the magnitude of any underlying problems.
By: Michael Russell
Posted in Investing | Tags: Cash Flow Statement, Depreciation, Determinant, Dishonesty, Downfall, Estimation, Financial Statements, Good Company, Good Management, Honesty Integrity, Interest Tax, Investment Value, Market Segment, Mismanagement, Multinational Companies, National Australia Bank, Predictability, Revenue Streams, Term Investors, Worldcom | No Comments »
Stocks VS Bonds – Differences and Risks
In the world of investments, you’ll often hear about stocks and bonds. They are both feasible forms of investment. They allow you the opportunity to invest your money with a specific company or corporation with the possibility of future profits. But how exactly do they work? And what are the differences between the two?
Bonds
Let’s start with bonds. The easiest way to define a bond is through the concept of a loan. When you invest in bonds, you are essentially loaning your money to a company, corporation, or government of your choosing. That institution, in turn, will give you a receipt for your loan, along with a promise of interest, in the form of a bond.
Bonds are bought and sold in the open market. Fluctuation in their values occurs depending on the interest rate of the general economy. Basically, the interest rate directly affects the worth of your investment. For instance, if you have a thousand dollar bond which pays the interest of 5% yearly, you can sell it at a higher face value provided the general interest rate is below 5%. And if the rate of interest rises above 5%, the bond, though it can still be sold, is usually sold at less than its face value.
The logic behind this system is that the investors deal with a higher rate of interest then the actual bond pays. Thus, the bond is sold at lower value in order to offset the gap. The OTC market, which is comprised of banks and security firms, is the favourite trading place for bonds, because corporate bonds can be listed on the stock exchange, and can be purchased through stock brokers.
With bonds, unlike stocks, you, as the investor, will not directly benefit from the success of the company or the amount of its profits. Instead, you will receive a fixed rate of return on your bond. Basically, this means that whether the company is wildly successful OR has an abysmal year of business, it will not affect your investment. Your bond return rate will be the same. Your return rate is the percentage of the original offer of the bond. This percentage is called the coupon rate.
It is also important to remember that bonds have maturity dates. Once a bond hits its maturity date, the principal amount paid for that bond is returned to the investor. Different bonds are issued different maturity dates. Some bonds can have up to 30 years of maturity period.
When dealing in bonds, the greatest investment risk that you face is the possibility of the principal investment amount NOT being paid back to you. Obviously, this risk can be somewhat controlled through the careful assessment of the companies or institutions that you choose to invest in.
Those companies that possess more credit worthiness are generally safer investments when it comes to bonds. The best example of a “safe” bond is the government bond. Another is the blue chip company bond. Blue chip companies are well-established companies that have proven and successful track records over a long span of time. Of course, such companies will have lower coupon rates.
If you’re willing to take a greater risk for better coupon rates, then you would probably end up choosing the companies with low credit ratings, companies that are unproven or unstable. Keep in mind, there is a great risk of default on the bonds from smaller corporations; however, the other side of the coin is that bond holders of such companies are preferential creditors. They get compensated before the stock holders in the event of a business going bankrupt.
So, for less risk, choose to invest in bonds from established companies. You will be likely to cash in on your returns, but they will probably not be very large. Or, you can choose to invest in smaller, unproven companies. The risk is greater, but if it pays off, your bank account will be greater, too. As in any investment venture, there is a trade-off between the risks and the possible rewards of bonds.
Stocks
Stocks represent shares of a company. These shares give part of the ownership of the company to you, the share-holder. Your stake in that company is defined by the amount of shares that you, the investor, own. Stock comes in mid-caps, small caps, and large caps.
As with bonds, you can decrease the risk of stock trading by choosing your stocks carefully, assessing your investments and weighing the risk of different companies. Obviously, an entrenched and well-known corporation is much more likely to be stable then a new and unproven one. And the stock will reflect the stability of the companies.
Stocks, unlike bonds, fluctuate in value and are traded in the stock market. Their worth is based directly on the performance of the company. If the company is doing well, growing, and attaining profits, then so does the value of the stock. If the company is weakening or failing, the stock of that company decreases in value.
There are various ways in which stocks are traded. In addition to being traded as shares of a company, stock can also be traded in the form of options, which is a type of Futures trading. Stock can also be sold and brought in the stock market on a daily basis. The value of a certain stock can increase and decrease according to the rise and fall in the stock market. Because of this, investing in stocks is much riskier than investing in bonds.
The Wrap-Up
Both stocks and bonds can become profitable investments. But it is important to remember that both options also carry a certain amount of risk. Being aware of that risk and taking steps to minimize it and control it, not the other way around, will help you to make the right choices when it comes to your financial decisions. The key to wise investing is always good research, a solid strategy, and guidance you can trust.
By: Markus Heitkoetter
Posted in Investing | Tags: Corporate Bonds, Dollar Bond, Face Value, Fixed Rate, Gap, Interest Rate, Logic, Market Fluctuation, Otc Market, Profits, Rate Of Interest, Rate Of Return, Receipt, Security Firms, Specific Company, Stock Bonds, Stock Brokers, Stock Exchange, Stocks And Bonds, Stocks Bonds | No Comments »