Posts Tagged ‘investing’

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What’s the difference between stocks and bonds?

Wednesday, January 13th, 2010

When you buy stock, you own equity – that is, you are actually buying partial ownership of a company in the form of shares. The percentage of the company’s total shares that you own is how much of the company you own – for example, if the company has 100 shares and you buy 50 of them, you own 50% of the company. This means that you share the company’s ups and downs: if the company does well, your stock becomes worth more than what you paid for it, and you make a profit, but if the company does badly, its stock decreases in value, and you suffer a loss. Equity holders are last in line among creditors if the company’s value goes to zero. This is why the stock market always has a certain amount of risk attached: you can never know for sure what’s going to happen to your stock.

With bonds, on the other hand, you virtually always know exactly what you’re going to get. Bonds are not shares, so they don’t give you any ownership. Rather, when an institution wants to raise money, it sells bonds, which are like IOUs; they’re basically promises to pay your money back later, with interest in the meantime. The interest rates are usually fixed, so you can calculate your profits. For example, a company could sell you a bond for $1,000, and under the terms of the agreement, you’d get 5% of that $1,000 every year for the next ten years, and then your original $1,000 back at the end of that decade. Of course, this means you’re only going to make a profit of $500 over ten years, but you are guaranteed that money.  If the company goes bankrupt, bond holders are usually first in line to be paid among those owed money. So people who prefer bonds like the security they offer, and people who prefer stocks like their potential to make their owners an incredible profit in the future.

One final note – there are three main types of bond: government, municipal, and corporate. Government bonds are sold by the government, municipal bonds by cities, and corporate bonds by companies. Government bonds are the most secure, followed by municipal, then corporate (because a company is much more likely to go bankrupt than a government is). However, because corporate bonds are the most risky, they also offer the highest rates of interest.

Who says Facebook is worth $10 billion?

Tuesday, December 22nd, 2009

Valuation, the process of determining how much a corporation is really worth, is always partly objective and partly subjective. There are several different methods commonly used, but there’s going to be some guesswork involved no matter what.

The most common way to value a company is according to its earnings, which are usually calculated according to earnings per share: you simply divide the company’s net profit by the number of shares it has. (You want the earnings per share value because that makes it is a standard measure to reflect each piece of ownership in the company). You can also value a corporation according to its assets – that is, if a company paid off all its debts and added up everything of value it had left, how much money would that amount to? Another technique involves measuring cash flow, or how much money passes through a company in various transactions over the course of a quarter or fiscal year (not counting predetermined expenses like taxes and interest).

Investors compare “like” companies, as defined by industry, growth rates, or geography, based on their Price to Earnings (PE), Price to Cash Flow, or Price to Growth (PEG) ratios. Price to Growth is used for companies like Facebook, that are yet to have earnings! Higher quality companies get higher ratios, or valuations, versus lower quality earnings.  Historically, the average PE within the S&P 500 since 1936 is a PE of about 15.8x.

These are the most basic techniques, but there are many alternative techniques that are used or that some people claim are more effective. And ultimately, no matter which method you use, the “true value” of a company is only something that can ever be approximated; it’s more of an ideal than a calculable number.

Stop Crying, It’s Hurting Your Portfolio

Wednesday, November 25th, 2009
If investors just trusted classic investing strategies instead of getting so emotional, their portfolios would be much better off…
  • A new study found investors are making two big mistakes: 1) they get too emotional about their investments and make hasty decisions, and 2) they assume recent performance dictates future performance.
  • The study also explained that the most classic investment strategies – asset allocation and portfolio rebalancing – would help investors avoid these mistakes.

Facts & Figures

  • Over the past 2 years, a basic portfolio with conservative asset allocation and annual rebalancing dropped by only 3.5% compared to a 30% S&P drop during the same time.
  • During a boom, a basic portfolio with conservative asset allocation and annual rebalancing returned 8.3%, not so much less than 9.7% for the S&P.

Best Quote

“People spend all their time looking at the trees and not the forest. It’s the forest that’s important, and that’s asset allocation.” – Gary P. Brinson, Chicago-based Asset Manager

Investments in Art Roaring Back

Friday, November 13th, 2009

Huge sales continue to beat expectations as collectors and investors start to buy art again.

  • Pieces by Andy Warhol, David Hockney and Alice Neal were among large lots sold for prices that have not been seen since before the recession.
  • Large auction houses like Sotheby’s or Christie’s host auctions and then take a percentage of the sale price of every lot.
  • Auction houses lowered expectations by 50-75% so that when they make large sales, it looks as if the numbers are better than they actually are. Still, selling a large amount of high-priced art is impressive, regardless of the recession.

Facts & Figures

  • Warhol’s 1962 “200 One Dollar Bills” sold at a Sotheby’s auction for $43.8 million. The seller originally paid $385,000 for the piece in 1986.
  • The Sotheby’s auction totaled $134.4 million against the company’s earlier/ estimate of $97.7 million.
  • Sotheby’s highest auction total was $362 million in May of 2008.

Best Quote

“The art vacation is over. Art has come back more than stocks or housing.” – Jack Tilton, New York Art Dealer

What’s the difference between futures and options?

Wednesday, October 21st, 2009

Options and futures are both contracts under which you agree to buy or sell an asset at a later date, but the main difference is that options offer you just that – an option to buy. You have to pay a premium for an option, but in return you are not obligated to do anything: you can choose to buy the agreed-upon assets at any time during the period set out in the contract, but you are never required to do so.

Futures contracts come with no premium attached, but they do impose obligations on both buyer and seller. When the predetermined time comes, the buyer absolutely must buy the assets, and the seller must sell them. In addition, the value of the assets used in futures contracts are usually greater than those used for options, so there’s much more risk in a futures contract: by the time you have to buy (or sell) your assets, their value may have changed dramatically, for better or for worse, but you still have to buy (or sell) at the price agreed upon when the futures contract was drawn up.

An Investment is…

Wednesday, October 7th, 2009

An investment is something you buy in the hopes of making money on it, like stocks, bonds, real estate, etc..

On Boards, More Members Provide More Security

Tuesday, August 18th, 2009

This fascinating study shows that charity boards with fewer members lost an overwhelmingly larger amount of money to Bernie Madoff, and the accompanying article provides advice on what makes a better board.

  • A study carried out by the National Committee for Responsive Philanthropy demonstrated that the majority of charities that lost at least 30% of their assets to Bernie Madoff’s Ponzi scheme had four or fewer board members.
  • The reason behind the study’s results seems to be that among small, homogeneous boards, if one member decides an investment is a good idea, the rest of the board is not large or varied enough to argue.
  • In order to avoid becoming victims of the next Bernie Madoff, charities ought to enlarge and diversify their boards.

Facts & Figures

  • The study used a list of 150 charities linked to Bernie Madoff.
  • Of the 105 organizations that lost at least 30% of their assets, 38 had one or two trustees listed on their tax forms, and 46 had three or four.
  • Only 16 of the 105 organizations had five or more members on their boards.

Best Quote

“We think part of what’s going on here is small, homogeneous boards where someone knew someone who trusted Bernie Madoff and that was enough. But it’s not enough to allow Uncle George or Grandpa to say Bernie’s a good guy and make an investment.” – Aaron Dorfman, Executive Director of the National Committee for Responsive Philanthropy

What does it mean to be Sharia-compliant?

Monday, August 10th, 2009

Sharia, or Islamic law, strictly forbids the lending of money for fees or interest. Today, many modern Muslim countries (such as Saudi Arabia, Pakistan, and Malaysia) still rule according to elements of Sharia law. So, in order to bring banking to the Islamic world, investors have created products and services that are Sharia-compliant, or that follow the principles of Islamic law.

In order to be Sharia-compliant, an institution cannot offer or receive interest, nor can it profit from any activities considered illegitimate, such as gambling, tobacco, drinking, or pornography. But how can Sharia-complicit banks profit if they can’t offer loans at a rate of interest? So far, there are several varieties of transactions that produce profits without breaking Islamic principles, but the most basic method is through risk sharing. According to this model, a Sharia-compliant bank shares the risk of an investment with a customer, and the two split any profits. There are also mortgages, current accounts, and even personal loans that are Sharia-compliant.

The goal of all these modified products is to attract Muslims who don’t currently use established banking because they want to live according to their religious principles. This is an incredibly valuable target demographic because Islam is the largest religion in the world, and for a long time the Western business world wasn’t catering to the needs of this group. So financial institutions think it’s worthwhile to tweak their established methods if it means securing an untapped market.

Breaking Even is…

Monday, August 3rd, 2009

Breaking even is the point where your total revenue equals your total cost – you haven’t made any money yet, but you also haven’t lost any. For example, when you buy a financial instrument there are the costs to purchase the item plus transaction costs – like paying your broker. The investment doesn’t “break even” until the value increases enough to cover ALL costs.

Can a bad stock be a good stock?

Friday, July 17th, 2009

One of the most basic principles of investing is that you want to buy stocks you think will achieve significant growth – you pay a certain price for them now in the hope that they will soon be worth much more. When you end up with stocks that aren’t increasing in value, you usually sell them. But is it ever worth it to hang onto a stock that isn’t growing rapidly?

An alternate way to profit from your stocks involves earning dividends, or payments a corporation makes to its shareholders out of the company’s quarterly earnings. Companies don’t have to pay dividends, so those that choose to do so are trying to attract shareholders. These companies’ growth rates have usually leveled off, and they don’t think they’ll benefit from trying to increase their growth any further, so they have to provide their investors with something else of value. As long as the company is stable – that is, as long as it’s not rapidly decreasing in value – you can still earn money from dividends, even if your stock isn’t growing as quickly as you’d like. So there are times when a stock that’s considered bad by conventional standards can actually turn you a profit through less conventional means.

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