October 30, 2007
Why Do Share Prices Rise and Fall?
The question in the title might be a little unfair. After all, if share prices are inherently unpredictable (and in one sense, they are - more on that later), there's no answer. Nevertheless, over a period of decades the stock market has had better returns than any other investment - 8-12% depending on various factors and it's one of the most widely studied markets on Earth. With that kind of historical data and brain power to lean on, one should be able to make a few valid observations. Well, here are some. You judge their validity.
In the long run, there's no doubt share prices are heavily influenced by earnings. When companies make money, consistently over long periods, investor confidence grows and bid the price of shares up. What influences earnings and confidence?
Everything from interest rates to debt load, taxes, lawsuits, management, technological and other social changes, and the general economy affect earnings - both short and long term.
Almost all companies borrow money and even when they don't their competitors, suppliers and customers do. That affects how much money they have to invest in research and new products or improving existing ones, relative to other companies in the similar lines of business.
Sometimes even stellar managers can be threatened by social or technological changes, unless they evolve the company to adapt. In that case, a company which once sold light bulbs - and made good profits doing so - can become an almost entirely different company in time. General Electric - the only original Dow stock that is still part of the DJIA (Dow Jones Industrial Average) - is an excellent example.
Over shorter time frames, influences become even more numerous and harder to quantify. Everything from the latest analyst recommendation and rumor or actual news event to fraud, the herd mentality and a blizzard of technical factors plays a part.
Google's share price quadrupled in a two year time frame and is projected to grow yet another 50% over the next year. Microsoft - once the most reliable growth stock in the world, even ridiculously so as admitted by its senior executives - has been in the doldrums for years now. Earnings alone can not explain these and other, similar, cases.
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Political changes play a part, and sometimes they too are unexpected by most investors. No one can say when or whether a tax bill will pass that reduces or increases corporate rates. The election of a new Prime Minister or President can have a large, short term affect or longer, sometimes, depending on the individual.
And, then there's the inherent unpredictability mentioned earlier. Short-term, and to some degree long-term, prices are a statistical phenomenon. As with any statistical effect you can't make a prediction - except with some degree of probability. And, since investors - some of whom own large blocks - can change their minds on a whim, you can only make educated guesses about what or when those choices will be.
So, what's the average investor to do? That depends on the kind of investor you want to be.
For those with the talent and time to do intense moment-by-moment research, it is possible to do well in short-term trading. Though almost all day traders lose money. For those, even big risk takers, who are more inclined to fundamental factors and willing to research long-term trends - take comfort in the fact that 8-12% return over decades is as good a prediction as you need.
Posted by Stock at 05:28 PM | Comments (0)
October 27, 2007
What's Foreign Depends On Where You Stand
The New York Stock Exchange is not the oldest operating securities market. Though measured by total market capitalization, it's among the largest at $12 trillion - yes that's twelve trillion dollars. The Paris bourse goes back to 1724 and the Deutsche Boerse is even older: founded in 1585.
There is a new stock exchange in Budapest (1993) and old ones in Brazil (1890) and Australia (1837), and larger ones in Hong Kong - which trades six times the volume of the NYSE (7 billion shares per day).
Apart from some interesting historical info, that's to remind everyone that, though the U.S. market is large, it is not the only game in town - even for U.S. investors. And the latter are far from the only traders on Earth, though they sometimes think that way.
How to go about playing it?
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A call to a broker is generally required for a U.S. investor to trade a non-U.S. company stock, and a larger commission is charged. 1% is normal. On a $5,000 trade - often the minimum - that's $50, hefty in this day of online trading accounts. But other than that, the transaction is carried out, from the investors point of view just as normal business.
The research requirement to avoid losing money at more than the normal rate is considerably higher, however. Keeping tabs on the activity of foreign companies means understanding the local culture and business environment. It entails tracking many more laws that can impact earnings and knowing the rules that govern trades in different countries.
Fortunately, with the growth of consolidated exchanges like Euronext - formed in 2000 by merging the Paris, Amsterdam, Lisbon and Brussels exchanges - has made that significantly easier. That trend is likely to continue.
Risk, too, is higher. Trading outside one's home country means having to pay attention not only to all the usual factors, but exchange rates as well. And currency exchange is the largest and most active market in the world. For several years, the U.S. dollar was king of currencies but lately it's been taking a beating.
That isn't necessarily bad even for U.S. investors, since risk can be minimized and profits maximized in two ways. One way is to invest in offsetting currencies and equities - as one country's currency rises, one can buy more of their shares with that country's currency. The other, better, way for the average investor is to look to ETFs (Exchange Traded Funds) that focus on foreign securities and let those issues be handled by professionals.
Whatever your plan, having a healthy respect for research and a commitment to a well-thought out trading strategy is required for anyone interested in capitalizing on the growth of businesses far from home. Unless you just enjoy losing money.
Posted by Stock at 05:25 PM | Comments (0)
October 24, 2007
Tips on Buying and Selling Stocks
'SOFT' FACTORS
The first thing to consider about investing isn't technical at all. EPS, P/E, P/S, MA and EMA, RSI and dozens of other indicators are all important. But start at the beginning by looking not outside, but in.
What kind of investor are you? Young with a little capital to risk but a large earnings potential over several decades? Retired, or near it, with a healthy savings but living on limited income?
And, more psychologically, what's your temperament for research and your tolerance for risk? Are you comfortable with statistics or intuitive? Are you detail oriented, or tend to look at the big picture? Not mutually exclusive categories, to be sure.
All these factors will influence your investment strategy. You do have a strategy, right? If not, go back to square one and develop that first.
'HARD' FACTORS
PEG - Projected Earnings Growth
Traditionally, Price to Earnings (P/E) ratio was a helpful indicator of value. Low price, relative to large earnings (per share) suggested a company's share price would likely rise in the future. But that was before thousands of new companies entered the public markets and when investing meant buying Coca-Cola stock.
But P/E isn't entirely useless, even today. Just supplement it with a little more information to calculate the PEG - Projected Earnings Growth.
Calculate PEG by taking the P/E and dividing it by the projected growth in earnings. For example, a stock with a P/E of 20 and projected earning growth next year of 10% would have a PEG of 2 (20/10 = 2). The lower the number the less you're paying for a unit of future earnings growth. Therefore, a company with a high P/E may still be a value if it has a high projected earnings.
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ROE - Return On Equity
Some companies can make silk purses out of pigs ears, others couldn't make a profit if they were given Apple's engineering and marketing teams for free. Return on Equity is one measure of how well a company uses its assets to produce earnings. (By the way, silk comes from worms, not pigs.)
Easy to calculate, simply divide Net Income by Book Value (assets minus liabilities). Both numbers needed are easy to obtain from Internet sites. Three percent is low, 15% is healthy - but be sure to compare to other companies in the same economic sector, and track the number over the long term.
Obviously, when projected ROE is high (based on historical trend) you want to buy. Timing the sell is a matter of estimating when ROE is trending downward.
Some factors to consider for the latter involve major mergers which look to be unwise (HP acquiring Compaq is one example), major technology or management changes (this can be positive or negative), lawsuits initiated or settled, and general economic factors influencing that company more than others.
Continually add to your database and your toolkit. Track the numbers and add new numbers to track. MA - moving averages and RSI - Relative Strength Indicator are two of the more common technical indicators used, for example. After you're comfortable with those, seek out some of the methods of quantifying risk.
And don't forget to develop that strategy. Tools are useless if you don't know what you want to do with them.
Posted by Stock at 05:22 PM | Comments (0)
October 21, 2007
Securities Regulation
Necessary Evil or Valued Partner?
As with the equities markets themselves, complexity reigns in (and reins in) regulation. The history of regulation is almost as old as the securities markets. Stock exchanges, then called bourses, were born in the 15th century in Burgundy's northern trading centers.(Now Belgium. The term 'bourse' is from the Latin 'purse' and is still used for some exchanges.) The Royal Exchange, created in 1566 to compete with Amsterdam, evolved into the current London Stock Exchange.
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Well, that's all very interesting history but why should the average investor care? The answer, for good or ill, is simple: they make the rules. Every trade is governed by a set of complex regulations formed by the interplay between self-interested exchange members and the various government bodies overseeing their activities.
Though lobbyists abound in all industries, nowhere is the process so formalized as in the equities trading businesses.
In the U.S. the 800-pound gorilla granddaddy is the SEC, formed in 1934 on the basis of the Securities and Exchange Act after the market crash of 1929. (Governments moved slowly then, too.) It oversees almost all of the activity in the U.S. markets and it's a very busy body. The NASD monitors more than 5,400 securities firms with over 58,000 branch offices and 505,000 registered securities professionals. NASD regulation is governed by a Board made up of half securities professionals and half representatives from the public.
Other countries have similar arrangements.
UNITED KINGDOM
The UK Treasury has governmental responsibility for policy and for financial services under the Financial Services Act of 1986 ('FSA'), along with oversight of the Securities and Investments Board (the 'SIB') and the London Stock Exchange. The SIB is responsible for most of the functions under the Act.
The London Stock Exchange, especially since 1987, has evolved from a quasi-governmental agency to a for-profit enterprise.
HONG KONG
The Stock Exchange of Hong Kong (HKEx) was formed in 1980 by unifying four separate exchanges and commenced trading in 1986, though it's roots go back to the 19th century. (Even private, quasi-governmental organizations move slowly sometimes.) The SFC, whose directors are appointed by the Chief Executive of the Hong Kong Special Administrative Region Government, supervises the HKEx. The rules are determined by both bodies, though.
ITALY
The Italians have an interesting experiment underway. The regulatory structure of the Italian Stock Exchange changed radically in 1997 due to the Legislative Decree No.416 of 1996. The Italian Stock Exchange Council established a private company, 'Borsa Italiana Spa', responsible for defining the functioning of markets and market surveillance. It regulates the admission of securities and is behind a Code of Behavior for all market operators.
Most of the large exchanges have either completed or are undergoing a process called 'demutualisation', essentially turning the exchange from a quasi-governmental overseer into a fully private, for-profit organization. As a consequence, most are publicly traded companies themselves with shares that trade and Boards of Directors.
But whatever the name or form, they all have the same mission. To keep markets orderly, information public and trades honest. While keeping one skeptical eye open, as investors we can all wish them success in that. Our success depends on it.
Posted by Stock at 05:20 PM | Comments (0)
October 17, 2007
Program Trading - Should You Care?
Probably you know by now that the big boys don't play nice. In the stock market, institutional and other investors with large sums have much more influence on events than the average trader. One way they do that is through the use of something called 'program trading', the purchase (or sale) of a group of stocks, usually by automated buy/sell orders.
Originally the term had little to do with 'computer program'. Program Trading got its name when index funds and other institutional investors embarked on large-scale trading to replicate a stock index. Before long, clever statistical analysts joined hands with even more clever arbitrageurs to try to 'beat' the market through the use of sophisticated trading algorithms, assisted by (then) new, high-speed computer programs.
Fundamental analysis met technical analysis and introduced themselves to software. The rest is rather bumpy history. In one famous case, though some studies deny this, it may have contributed heavily to the well-known Black Monday of October 1987 when the market dropped by over 20% in one day.
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While the NYSE defines a program trade as a basket of 15 stocks or having a total value of $1M (or more), trades can be executed in small lots (100-300 shares, for example). In theory, this allows orders to be completed before other investors get wise, and helps avoid large price movements before positions are solidified or liquidated.
As finance professors and large-firm specialists develop ever more sophisticated methods of taking advantage of small price discrepancies across global markets, program trading becomes ever more complex. In many cases, the individuals involved don't themselves understand well the consequences of implementing a particular strategy.
Program trading now comprises over 50% of NYSE volume on average and it can introduce large swings in a few stocks or large portions of the market. Clearly, the big boys wouldn't bother unless they believed - backed now by decades of studies - that there was an advantage in using the technique.
But whether villain or savior, it's here to stay. Over 50% of the volume on one exchange that trades over 1.6 billion shares a day is a huge amount of arbitrage activity. That effect can work against the average investor or for him, but only if included in a trading strategy that pays attention to where those trades are going.
Posted by Stock at 05:17 PM | Comments (0)
October 13, 2007
How To Research Stocks
As with gamblers in Las Vegas so it is with stock investments, 'everybody's got a system'. The goal of research, however, is to make the activity a lot less like gambling and a lot more like investment.
For those without the time or temperament to carry out research themselves, there are full time research services available - for a fee, of course. Full-Service brokerages, such as Merrill Lynch and other large, well-established firms offer research as part of their value to clients.
But there are firms, both traditional and the newer online variety, that offer research without the advice available from the broker. Whether the research (and the advice) are worth what it costs is an ongoing debate.
For those who see research not as a necessary evil or time-consuming burden, but as part of the process or even an adventure, there are now more sources than could be used in a lifetime.
Starting with the source of data is always a safe bet, since it's the most unbiased, thoroughly audited information around. That source is the legally required filings of individual publicly traded companies.
In the U.S. those are 10-K's - more or less equivalent to lengthy annual reports - which can be viewed or downloaded from the SEC's website (www.sec.gov). (10-Q's are filed quarterly, 8-K's for significant financial changes in between.) Other countries have their equivalents, such as the Hong Kong Securities Regulatory Commission (HKSRC).
In those reports you'll find recent (as of the filing date) financial data about income, expectations, competition and lines of business, current senior management listings and other information useful to those inclined toward Fundamental Analysis.
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For a modest annual or one-time fee, a blizzard of chart data is available that matches any produced by the in-house research departments of the large brokerages. (Sometimes they're produced by the same people.)
Newsletters are another potentially good source of information, though opinions about the market vary so widely that researching whom to believe takes as much time and care as researching individual stocks. Sometimes they're a few dollars per year, sometimes many hundreds - and price is no indicator of quality here.
One direct source of one kind of information are the in-person, on TV, or on the Internet interviews of company senior managers, usually by one or a panel of analysts.
CEOs, CFOs, and others often talk to the financial press and brokerage stock analysts to give their views on where their company stands, what challenges they face, and where they expect to be in the near to long-term future. Often they're asked about specific pending lawsuits or legislation and to assess its potential impact.
Of course, executives have an interest in painting a rosy picture, but analysts have often heard it all and are very adept at keeping the 'spin factor' to a minimum. If nothing else, it tells you what the executives want you to believe, which in itself is useful.
Even armed with nothing more than an inexpensive online trading account, the average investor has access to charts of historical and current data, future expectations, and a wide variety of statistical information which would keep even the most technically inclined busy for quite some time.
Posted by Stock at 05:14 PM | Comments (0)
October 09, 2007
How To Evaluate Stocks
Stock picking is akin to weather prediction - no one can predict with certainty five hours from now if the price will rise or fall, much less five years from now.
Nevertheless, there are indicators that help to reduce the risk and increase the odds of profiting over the long term. After all, historically stocks have returned over 10%, as measured by the growth of the S&P 500.
The first step is to get educated. Learn not only about dividends yields and earnings per share, but also some basic accounting. Reported figures have an air of authority but the sad fact remains that those numbers are arrived at, in part, by accounting methods which are not cut and dried.
The Enron case (case in which the executives of Enron manipulated their earnings figures to appear to be much more
successful than they were) is extreme, but even ordinary procedures involve judgment calls on the part of financial officers and auditors.
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RESEARCHING BUYS
Obtain the latest, and some historical, financial statements. The SEC provides these free (www.sec.gov) in their EDGAR database, but other exchanges have similar arrangements.
Analyze the quarterly statements covering two to three years, looking for EPS (earnings per share) and revenue trends. Calculate dividend yields, if the company pays dividends.
Compare the company's P/E (Price to Earnings) ratio to others in the same economic sector. Look at P/S (Price to Sales) ratios, too. Sales growth is easier to predict than earnings and less volatile than P/E ratios.
Examine general economic factors. Interest rates affect stock prices as well as bonds (though less directly), since almost every company borrows money. Even when they don't, their competitors, suppliers, and customers do. Interest charges reduce profits for all but the lenders, for whom it's income.
Even when researching a bank, though, high interest rates increase short-term profits, but can reduce the number of loans and cause certain current ones to be repaid early. High interest rates aren't necessarily good for banks either, therefore.
Use some of the more common technical indicators, such as MA (moving averages) and RSI (Relative Strength Index, which compares the number of days a stock finishes up versus down). An RSI of 70, or above, for example, does tend to indicate a stock which is overbought and due for a fall in price.
RESEARCHING SELLS
Pick a target price, which amounts to deciding how much profit (in dollars or percentage terms) you seek then sell at that price, unless your continuing research has turned up significant new information.
Consider selling if the price has dropped substantially or remained unchanged for several months. Losses are hard to bear, but consider that you can't always pick winners and while you're invested in one stock, you're forgoing potential profit from another. That profit could help reduce or more than make up for the loss from the sale.
Continue to monitor the company's fundamentals by obtaining updated filings. Re-evaluate them by updating earnings trend calculations, significant management or general economic changes.
You can ease the difficulty of performing calculations (which is a useful exercise at least once) by finding Internet sites that provide objective data and go easy on the "here's how to pick winners" sales talk.
And remember, 'on the street' opinions are a dime a dozen - including mine.
Posted by Stock at 04:39 PM | Comments (0)
October 06, 2007
Government Influence on Share Prices
First, some statistics.
At the end of fiscal year 2005, the U.S. Federal debt was approximately $7.9 trillion. Yes, you read that correctly. That's almost eight trillion dollars. That's up from 930 billion in 1980, an increase of more than 849%. $4.5 trillion of that is owed to 'the public' - individual T-Bill and T-Bond (and other) holders, a third Japanese.
And that's just one form of influence from one country's government. Granted, the Federal debt and the U.S. in general are large components of the global picture.
Another big factor is interest rates.
Not all interest rates are set by government action. Private lenders determine - in the final analysis - whether a home mortgage, a CD (Certificate of Deposit) or a margin rate is 2% or 10%. But the Fed, Her Majesty's Treasury, and other countries' governments have a large influence. Whether by setting 'the prime' - the rate large banks pay to borrow short-term funds - or simply by being the enormous borrowers (as shown above) they are, interest rates are other than what they would be in their absence.
So, what's that got to do with stocks?
Apart from the general economic impact of regulations and direct taxation, bond rates (and interest rates generally) are one of the largest factors affecting share prices, outside of daily speculation.
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When governments borrow, they raise interest rates for everyone. The difference is, the government doesn't pay it back out of profits - they haven't any. They pay it back out of taxes and by inflation, which reduces the real amount they have to pay back. Thus, large government borrowing whacks the investor twice.
Also, since stocks effectively compete for investor dollars with bonds and other instruments, changing bond rates influences how attractive equities are versus those others.
Now, of course governments don't have infinite power to determine prices - in shares, bonds or loans (interest rates). A T-Bill or UK Govt Bond paying 1% is - other things being equal - going to attract fewer buyers than an 8% AAA bond or even (one may speculate) a 5% dividend from Google. (Google doesn't, and doesn't intend to, pay dividends by the way - it's just an example.)
Whether all this is a good or bad thing, or somewhere in between, is a debate we leave for another time. But whatever one's view, it definitely has an impact on the equities markets.
So next time you're researching whether to buy 100 shares of the next GoogYah NextBigThing, Inc be sure to factor in how affected they might be (relative to others in the same economic sector) by interest rates and government debt. And don't forget that impact on your own future cash flows either. After all, you may want to buy 100 more later.
Posted by Stock at 04:34 PM | Comments (0)
October 03, 2007
Equities Trading and the Internet
Once upon a time there was no Internet. OK, now take a deep breath. It's alright because there is one now. For several decades (roughly from 1960 to 1990), large companies such as Merrill Lynch and Morgan Stanley were able to trade among themselves electronically, but these trades took place over private networks.
In 1978, the Intermarket Trading System (ITS) opened for business, providing an electronic link between the NYSE and competing exchanges, enabling brokers to access several markets. But still, only for the 'in-crowd'.
Then in 1994, Aufhauser Securities (now owned by Ameritrade) created the first Internet trading system. As Internet trading grew dramatically, companies developed systems allowing individual investors to not only trade, but access information once available only to those large companies.
The world has never been the same since.
Trading commissions fell to negligible territory. Twenty years ago, it was common to pay $100 or more on a $1000 trade; online trading fees are less than $10 today. Yet, despite the considerable drop in prices, brokerages are making enormous profits, thanks to the increase in trading volume.
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Research, once available only to specialized analysts in large brokerage firms, is now accessible to the average investor with an online trading account - often for free. And the research itself has grown from simple Earnings Per Share and Dividend Yield data to a bewildering array of Relative Strength Indexes (RSI), Moving Average Convergence Divergence (MACD), Bollinger Bands and others even more arcane.
Networked trading, along with other computer technology, has made exchanges international and in some cases global. Only a few years ago the Amsterdam, Brussels, Lisbon and Paris exchanges merged into Euronext - a single trading exchange for countries with widely differing backgrounds. Efforts continue to bring the London Stock Exchange into partnership with Euronext or FWB (Frankfurter Wertpapierbörse, the major German exchange), or both.
As a consequence of the emergence of merging exchanges, trading has improved not only for members but the individual investor as well. It isn't just citizens of the countries involved in Euronext who can trade there. Exchanges the world over are now open to almost any investor anywhere. Now anyone, not just London's professional traders, can enjoy the effects of sleep deprivation monitoring and trading on exchanges that cross every time zone on the globe.
All this change, while difficult to absorb, has one overriding goal and result - you can now make (or lose) a lot more money a lot faster, in a lot more places, than your father. That ought to produce at least a few interesting family dinner conversations.
Posted by Stock at 04:31 PM | Comments (0)
October 01, 2007
Do You Need A Broker?
The question in the title is misleading. Most individuals have no choice whether to use a broker, since they're not members of an exchange. Those members (their employees, really) are the only ones who can actually execute a trade and they don't take calls from individual investors.
They're called Floor brokers and they're the one's who actually buy and sell securities on the floor of a securities exchange. You can watch them on TV waving their hands vigorously and yelling at one another.
So the question really should be: "What Kind of Broker Do You Need?"
Prior to 1975, Full-Service brokers were about the only choice. Then the world gave birth to discount brokers and life changed. In the 1990s, it changed again with the beginnings of Internet trading for average investors. Note that trading over networks had already been going on between large investors for decades.
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Those two facts - technology and research - are the basis for deciding what kind of broker you need.
Some are comfortable with executing trades by making those few mouse clicks, others want some human contact - even if nothing more than an efficient-sounding voice - before plunking down a few thousand.
Full-Service brokers, if you find not only the right company but that special individual, can provide you with more than an efficient-sounding voice. Good brokers, and they do exist, offer their clients sound advice based on good research.
No one can predict with certainty any particular price for any stock five hours from now, nor five years from now. But massive statistical studies are undertaken and research analysts do conduct and study them then pass on their recommendations to brokers.
When those brokers are astute they can make reasonable judgments about the likelihood that long rock-solid Acme, Inc will fold in three months, or that newcomer Whizzard Techno-Babble is about to skyrocket.
If that kind of advice and 'partnering' is worth the commissions you'll pay, then a Full-Service broker is for you - especially if you have neither the time nor the temperament to undertake that research yourself.
Others, with more time or analytical interests - or perhaps, just more chutzpah - may find it not only financially worthwhile, but intellectually and emotionally satisfying to take the reins themselves. This is especially true for short-term traders, day traders even more so.
To these types, research isn't a burden or a bafflement it's an adventure. And the deep discount brokers, or pure Internet trading accounts, are the perfect fit for them. Reports, some free others available at varying cost, can be had in greater abundance than even they have time or desire to study.
So, along with determining how much money can be saved by using the broker behind Door #1 vs Door #2, study yourself and decide which kind of trader you are. That's the best way to choose which kind of broker you need.
Posted by Stock at 04:26 PM | Comments (0)
