Articles - Page 19 of 20 - PersonalFinanceLab

Cash Flow Per Share

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Definition: A ratio of the cash generated divided by the number of outstanding shares.

In Depth Description:
A measure of a firm’s financial strength, calculated as:

Cash Flow Per Share = (Operating Cash Flow – Preferred Dividends) / Common Shares Outstanding.

Cash flow per share shows the after-tax earnings plus depreciation, on a per share basis. Many financial analysts place more emphasis on the cash flow per share value than on earnings per share values. While an earnings per share value can be easily manipulated to appear more positive than it really is, therefore putting its reliability in question, cash is more difficult to alter, resulting in what some analysts believe is a more accurate value of the strength and sustainability of a particular business model.

A -G, Advanced, Fundamental Analysis, Glossary

Form 10-Q

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Definition: Form 10-Q, is also known as a 10-Q or 10Q, is a quarterly report mandated by the United States federal Securities and Exchange Commission, to be filed by publicly traded corporations.

Explanation: Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, it’s an SEC filing that must be filed quarterly with the US Securities and Exchange Commission. It contains similar information to the annual form 10-K, however the information is generally less detailed, and the financial statements are generally unaudited. Information for the final quarter of a firm’s fiscal year is included in the 10-K, so only three 10-Q filings are made each year.

These reports generally compare last quarter to the current quarter and last years quarter to this years quarter. The SEC put this form in place to facilitate better informed investors. The form 10-Q must be filed within 40 days for large accelerated filers and accelerated filers or 45 days after the end of the fiscal quarter for all other registrants (formerly 45 days).

A company’s earnings per share is the portion of a company’s profit that is allocated to each outstanding share of common stock, and, like cash flow per share, serves as an indicator of a company’s profitability. Because the cash flow per share takes into consideration a company’s ability to generate cash, it is regarded by some analysts as a more accurate measure of a company’s financial situation than the earnings per share metric. Cash flow per share represents the net cash a firm produces, on a per share basis.

Glossary, N-T

Stop Loss Order

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Definition:Just like the Limit Order, this is another form of trade with a different set of limitations. A Stop Loss Sell order is a conditional sell order that will only execute if the price of the stock reaches a target price (set by the seller) or lower. For example, say you bought Apple at $100 and they are currently trading at $104. I could set a Stop Loss order at $101. This means that once the price of Apple starts to dip and hits $101, my order becomes an order to sell. This should limit any losses I could take on my profits. If it sells at $101, then I still made a profit of $1 per share.

Explanation:Setting a stop-loss order for 10% below the price you paid for the stock will limit your loss to 10%. This strategy allows investors to determine their loss limit in advance, preventing emotional decision-making. It’s also a great idea to use a stop order before you leave for holidays or enter a situation in which you will be unable to watch your stocks for an extended period of time.

Glossary, N-T

Stop Order

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Definition: A stop order is an order to buy or sell a stock when the stock price reaches a specified price, which is known as a stop price. When the specified price is reached, the stop order becomes a market order.

More Detail: Stop orders are different from limit orders in that a buy stop order is placed above the current market price, and a buy limit order is placed below the current market price. A sell stop order is placed below the current market price, and a sell limit order is placed above the current market price.

(a) A Sell Stop Order is used by investors and traders long a stock to protect an existing profit or avoid further losses if the stock price drops. A stop order to sell must be placed below the current market price.

(b) A Buy Stop Order is used by investors and traders short a stock to protect a profit or limit a loss if the stock price increases. Remember, a stop order to buy must be entered at a price above the current market price and a sell stop order must be entered at a price below the current market price..

Stop orders may be placed as “Day” orders which are good for the day only, or as “GTC” orders, which are good until cancelled.

Example:

Scenario 1: You have bought 100 shares of stock ABC.

Stock: ABC
Quantity: 100
Purchase Price: $10
Position type: LONG
Market value: 100 X 10 = $1,000

Say you did not want to lose more than $500 on your long position in ABC. You would put in a “STOP SELL” order with a target price of $5 for all your 100 shares.

This way, if the market price in the market dropped from $10 to $5, and continued falling even more, you can rest assured that your shares would be sold at your target price, and the maximum loss you would incur would be:
($5 – $10) X 100 shares = -$500.

Scenario 2: You have shorted 100 shares of stock XYZ.

Stock: XYZ
Quantity: -100
Short Price: $10
Position type: SHORT
Market value: -100 X 10 = -$1,000

Say you did not want to lose more than $500 on your short position in XYZ. You would put in a “STOP BUY” order with a target price of $15 for all your 100 shares.

This way, if the market price in the market rose from $10 to $15, and continued rising even more, you can rest assured that your shares would be bought at your target price, and the maximum loss you would incur would be:
($10 – $15) X 100 shares = -$500.

Glossary, H-M

Limit Order

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Definition: A limit order is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. A limit order is not guaranteed to execute. A limit order can only be filled if the stock’s market price reaches the limit price. While limit orders do not guarantee execution, they help ensure that an investor does not pay more than a per-determined price for a stock.

Explanation: Limit orders typically cost more than market orders. Despite this, limit orders are beneficial because when the trade goes through, investors get the specified purchase or sell price. Limit orders are especially useful on a low-volume or highly volatile stock.

Beginners, Glossary, H-M

Market Order

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Definition: Market Orders are an order to buy or sell a stock at the best available price. Generally, this type of order will be executed immediately. However, the price at which a market order will be executed is not guaranteed. It is important for investors to remember that the last-traded price is not necessarily the price at which a market order will be executed. In fast-moving markets, the price at which a market order will execute often deviates from the last-traded price or “real time” quote.

Explanation: A market order guarantees execution, and it often has low commissions due to the minimal work brokers need to do. Be wary of using market orders on stocks with a low average daily volume: in such market conditions the ask price can be a lot higher than the current market price (resulting in a large spread). In other words, you may end up paying a whole lot more than you originally anticipated! It is much safer to use a market order on high-volume stocks.

A -G, Beginners, Glossary

Ask Price

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Definition: The ask or offer price is the lowest price that a seller is willing to accept for a stock or other security. The ask size will specify the number of shares the seller is willing to sell at that ask price. This is also sometimes called “the ask” or “ask price” or “offer price.”

Example: When you get a quote on a stock or security you will often see the Last Trade Price and the current Bid/Ask prices. For example, Google might have a Last of $700.75 and be Bid $700.50 and Ask $701.00. A quote screen might also show the bid/ask size and show $700.50 x 1,000 and $701.00 x 500. This would mean that you could immediately buy 500 shares at $701 or sell 1,000 shares at $700.50. The ask price is the complement of the bid price. The bid is the highest price a buyer is willing to pay for a stock or security. The ask will always be higher than the bid.

A -G, Beginners, Glossary

Bid Price

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Definition:When you are selling your shares of a security, the bid price is what the buyer is willing to pay for your shares. This Bid Price offers you an exact price of how much you can sell your shares for. The Last Price offers you a look at what price the last trades were made; which is not sufficient to give you a price a buyer is willing to pay. Bid Price and Last Price are often different. On the other side of the market, even though you are willing to offer a seller a bid price, he/she will only sell at the Ask Price. The Ask Price is the price at which a seller is willing to let go of her shares. More specifically, this is the price you will buy your stocks at. Finally, the Bid Size comes hand-in-hand with the Bid Price. This is the amount of shares a buyer is willing to pay for a specific amount of shares. This gives the seller a better view on where they stand.

Example:$23.53 x 1,000 is an example of a bid. This means that an investor is asking to purchase 1,000 shares at the price of $23.53. The transaction will be completed if a seller is willing to sell that security at that price. Another example would be a Market bid for 1,000 shares. That means that the investor is willing to take 1,000 shares at the current market price.

Uncategorized

P/E Ratios

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Definition
P/E Ratio. It sounds good and makes novice investors feel like they have a grasp of the situation but how valuable is the Earnings Price Ratio? Surprisingly, the price to earnings ratio is a useful tool but certainly not the holy grail of investing as it is sometimes made out to be. For those novice investors, the P/E Ratio provides a numeric representation of the value between the stock price and earnings. To derive the P/E Ratio you divide the share price by the company’s EPS or Earnings Per Share. The formula looks like this: P/E = Stock Price/ EPS

- Market sentiment. An overly optimistic P/E Ratio can indicate the market expects big things from this company. Temper optimism with reality.
- Cover priced or over-bought. A high P/E Ratio can indicate a given stock is priced to high and ready for a correction. Be sure to compare against industry norms.
- Lack of confidence. A low P/E Ratio may indicate a lack of confidence in the future of the company.
- Sleeper. A low P/E Ratio might be a sleeper just waited to be discovered.Formula

Example
For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).

Coca-Cola and Pepsi operate in the same industry and produce goods that are very similar in nature.
Coca Cola’s (KO:NYSE) stock price (Price per Share): $66
Coca-Cola’s Earnings-per share (EPS): $5.26
Coca-Cola’s P/E Ratio: $66 / $5.26 = 12.55

Pepsi’s (PEP:NYSE) stock price (Price per Share): $69
Pepsi’s Earnings-per share (EPS): $3.73
Pepsi’s P/E Ratio: $69 / $3.73 = 18.50
From our calculations, we can see that Pepsi has a higher P/E Ratio than Coca-Cola.

This could be perceived a couple of different ways:

1. - Coca-Cola is under-valued and should be bought.
  - Pepsi is over-valued and should be sold or shorted.
  - Investors do not perceive Coca-Cola as doing as well as Pepsi presently.
  - Pepsi is launching a new product that Coca-Cola is not.

The truth is normally some combination of these perceptions.

How to use the P/E Ratio

The P/E Ratio by itself is just a number. Just because it is high or low does not lend much intuition by itself.

But, when we compare P/E ratios between companies and industries, we really start getting the picture for the particular company we are analyzing.

It does not make much sense to compare P/E Ratios of companies across different industries, as each industry has its own unique way of conducting business.

It’s like comparing a doctor with an engineer to see which one is more valuable.

Hence, if comparing P/E ratios, you should compare between companies in the same or similar industries.

You may also compare the P/E ratio of a company to the P/E Ratio of the entire industry that it operates in to analyze whether the stock is over or under-valued.

How to interpret the P/E Ratio

High P/E Ratio may mean:
Market sentiment: An overly optimistic P/E Ratio can indicate the market expects big things from this company. The company has high growth possibilities.
Lifecycle: The company could be entering into the Growth or Shake-Out stage of its lifecycle.
Industry: Specific Industries have a certain level for the P/E Ratios. For example most technology companies have high P/E Ratios.
Cover priced or over-bought: A high P/E Ratio can indicate a given stock is priced to high and ready for a correction. This means that it might be over-valued. Be sure to compare against industry norms.

Low P/E Ratio may mean:
Lack of confidence: A low P/E Ratio may indicate a lack of confidence in the future of the company.
Lifecycle: The company could be in the Mature or Decline stage of its lifecycle.
Industry: Specific Industries have a certain level for the P/E Ratios. For example most utility companies have low P/E Ratios.
Sleeper: A low P/E Ratio might be a sleeper just waiting to be discovered. This means that it might be undervalued, and a perfect time to start buying the shares.

Important Note

1. - The Earnings-Per-Share in the P/E Ratio formula is a number that comes from the accounting books of the company.
  - Hence, it is possible to manipulate the EPS and hence the P/E Ratio in order to trick investors into perceiving the stock differently.
  - It is important to independently verify that the company’s’ financial statements are sound and true.

Conclusion
A PE Ratio is an important valuation tool that can give key insights into whether a stock may be over or under-valued.

Also sometimes known as “price multiple” or “earnings multiple.”

BEGINNERS: Learn To Trade Stocks

Intro to Stocks		IPO
Trading Rules		Bid
Volume Precedes Price and Confirm Price Patterns		Ask
Trade with the HTMW Game		Market Order
Making Your First Stock Trade		Ticker Symbol
P/E Ratio		Stock Quotes
Dividend		Stock Charts
Dividend Yield

A -G, Advanced, Fundamental Analysis, Glossary

Dividend Yield

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Definition: A ratio showing how much a company pays in dividends each year relative to its share price. Assuming that the stock price does not change, the dividend yield is the only return on the stock holder’s investment.

Dividend Yield = Annual dividends per share / Price per share

Example: Dividend yield is a way to measure how much “bang for your buck” you are getting from your investment through dividends.

To better explain dividend yield, lets explore an example. If two companies pay the same annual dividends of $1 per share per year, but XYZ company’s stock sells at $20 while ABC company’s stock sells at $40, then XYZ has a dividend yield of 5% while ABC is only yielding 2.5%. Assuming that all other factors are the same, an investor that is looking to add to his or her income would likely prefer XYZ’s stock over that of ABC’s stock.

A -G, Glossary, Stocks

Dividend

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Definition: Payments made to shareholders by corporations. When a company earns profit, the company can use the money to either re-invest in the business (called retained earnings) or to give shareholders as dividends or share repurchase. Many corporations keep a portion of their profit and pay the remainder as a dividend.

Explanation: Corporations can pay dividends in the form of cash, stock or property. Most large profitable companies offer dividends to their stockholders. Their share prices might not move much, but the dividend they pay make up for this.

Higher-growth companies typically don’t offer dividends because their profits are reinvested to help continue their higher than average growth.

Beginners, Glossary, N-T

Preferred Stock

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Definition: Preferred stock is a special class of stock issued by a company that pays dividends. Preferred stock is more like a bond than true stock because the main appeal is dividend income. Most preferred stocks are limited in the total profit they can earn.

Explanation:There are certainly pros and cons when looking at preferred shares. Preferred shareholders have priority over common stockholders on earnings and assets in the event of liquidation and they have a fixed dividend (paid before common stockholders), but investors must weigh these positives against the negatives, including giving up their voting rights and less potential for appreciation.

A -G, Beginners, Glossary

Common Stock

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Definition: Common stock is a form of corporate equity ownership, a type of security. The terms “voting share” or “ordinary share” are also used in other parts of the world; common stock being primarily used in the United States. It is called “common” to distinguish it from preferred stock. Common stock usually carries with it the right to vote on certain matters, such as electing the board of directors. However, a company can have both a “voting” and “non-voting” class of common stock.

Further Explanation: If the company goes bankrupt, the common stockholders will not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets. This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run.

A -G, Glossary

Capital Gains Distribution

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Definition: By law, every year, mutual funds must distribute that year’s net investment income (the total of dividends and interest received, less fund expenses) and net realized gain (gains less losses on securities sales) to its shareholders. These distributions are taxable income reported to the IRS on Form 1099. Investors must report the income on their tax returns. This poses a problem for some mutual fund investors who make initial purchases of mutual funds near the end of a calendar year. Because they receive a capital gains distribution, they immediately receive taxable income and face a mutual fund NAV that is reduced from the distribution.

A -G, Glossary

Capital Gain or Loss

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Definition: Profit or loss resulting from the sale of certain assets classified under the federal income tax legislation as capital assets. This includes stocks and other investments such as investment property.

Example: Long-term capital gains are usually taxed at a lower rate than regular income. This is done to encourage entrepreneurship and investment in the economy. For example, if you own your home for more than one year, if you had bought your home for $200,000 and sell the home for $$225,000, then you have a capital gain of $25,000. There is a move by many in government to increase capital gains taxes as they see this lower rate as unfair???

A -G, Glossary, Options, Options

Call Option

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Definition: A Call Option gives the holder the right, but not the obligation to purchase one hundred (100) shares of a particular stock at a specific price by a specified date. Call Options are bought by investors who anticipate a price increase.

Example: Options are derivative instruments, which means that their prices are derived from the price an underlyiny security or stock. Normally, options values are determined from the price of an underlying stock, the difference between the current stock price and the option’s strike price, and the amount of time left until the option expires. Let’s assume you bought a call option on shares of Intel (INTC) with a strike price of $40 and an expiration date of April 16th. With this option you would have the right to purchase 100 shares of Intel at a price of $40 on or before April 16th. The right time to do this will only be beneficial if Intel is trades above $40 per share at that particular point in time. Take notice that the expiration date consistently lands on the third Friday of each month when the option is scheduled to expire. (Note-recently the exchanges started issues weekly expiration options on the high volume stocks.)

Each call option corresponds to a contract between the buyer and the seller. The call option buyer has the right to buy the stock at the strike price, and the seller has the obligation to sell the stock at the strike price if the buyer chooses to exercise his option. When an option expires and it is not in the buyer’s best interest to exercise the option, then they are not obligated to take action.

As a quick example of how call options make money, let’s say IBM stock is currently trading at $100 per share. Now consider that an investor purchased one call option contract on IBM with a $100 strike and at $2.00 per contract. Because each options contract is for 100 shares of stock, the real cost of this option will be $200 (100 shares x $2.00 = $200). Take a look at will happen to the value of this call option under an assortment of several scenarios.

A -G, Glossary, Options

At the Money

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Definition: At The Money refers to an option whose strike price equals the price of the underlying equity, index or commodity.

Example: If Pepsi stock is trading at $75, then the Pepsi $75 call option is at the money, and so is the Pepsi $75 put option. An at-the-money option has no intrinsic value (since the strike and the underlying prices are the same), but will have time value (value if the stock goes up during the period of the call option). The options that are at the money tend to be more active than when it is not at the money. These options are also referred to as ATM options (At The Money).

A -G, Glossary

All-or-None Order

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Definition: An order type that only executes when the full amount of the shares in the order can be executed, otherwise the order doesn’t execute at all. In other words, this order type guarantees there are no partial fills.
Example: If you place a Market Buy order for 100 shares of Google (GOOG) and there are only 75 available at the time the order is placed, then the order would not be executed. The order would wait until there were 100 shares available to purchase and then execute at that price.

Advanced, Glossary, N-T, Technical Analysis

Technical Analysis

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SIMPLE DEFINITION: Technical Analysis is the use of technical indicator to predict which direction the stock price will move in the future. Technical indicators use past stock prices to calculate their value.

COMPLETE DEFINITION: Technical analysis evolved from analyzing 100s of years of stock data. The theories for technical analysis began in Joseph de la Vega’s accounts of the Dutch markets in the 17th century. In the 1920s and 1930s Richard W. Schabacker wrote books continuing the work of Charles Dow and William Peter Hamilton from their books Stock Market Theory and Practice and Technical Market Analysis. In 1948 Robert D. Edwards and John Magee published Technical Analysis of Stock Trends. This book is considered to be the break through works of the discipline.

Technical Analysis dates back hundreds of years ago. According to historical records, a great Japanese rice trader by the name of Homma Munehisa (1724-1803) fathered candlestick charting and at today’s value, would have made over $100 billion in profits. He was considered the greatest trader in the history of the financial markets. This type of charting will be covered in subsequent articles (candlestick charting will be used in all articles). Therefore, technical analysis emerged from Japan. In the U.S., technical analysis first started to gain some following due to Charles Dow’s Dow Theory in the late 19th century. Charles Dow formed 6 principles that formed the foundation of technical analysis:

Three-moving Parts – The market has a primary movement, a secondary reaction, and a minor swing movement. The primary movement is the long-term trend that lasts for years, the secondary reaction is the retrace from the primary movement (typically lasting for months), and the minor swings are the much shorter swings that occur within a chart (usually neutral and lasting from hours up to a month).
Three-Phase Trends – The market is composed of three phases: an accumulation phase, public/media phase, and a distribution/selling phase. The “smart money” (sophisticated professionals) as the ones who are purchasing shares in Phase 1. In Phase 2, the media starts to focus on the particular stock or sector and the public (retail traders/investors) jump in. These are the momentum traders/investors that see a trend forming and want to get in on the action. In Phase 3, the “smart money” actually sells while the retail traders/investors keep buying.
Discounting Mechanism – The market discounts all news. This means that news that comes out is already factored in, or “priced” in. Obviously, this does not include illegal inside information.
Major Average Confirmation – This means that one industry that is dependent on another cannot rally unless both are rallying. This is especially true if the entire market is rallying but several key sectors are declining. In the chart below, you can see that the homebuilders (orange line) declined long before the market declined. The banking sector (sky blue) declined soon after. The financial sector used to be the #1 sector in terms of capitalization (banks were doing very well at the time!). Real estate and its related industries account for at least 25% of the U.S.’s GDP. With these two major powerhouse sectors declining, the market didn’t stand a chance.
Volume Confirms Action – Volume is extremely important. For a trend to continue, volume must increase. This represents added interest and additional buying which is required for a trend to propel itself to new highs. If a rally continues on lower volume, the trend cannot sustain itself and will fail. Let’s take a look at the rallies we had in 2008 as an example. Notice how the rallies were made on low volume and on the declines, we saw increasing volume. A healthy, strong market would exhibit the complete opposite.
Trends Continue Until They End – This is self-explanatory. An up trend continues until it ends and a downtrend continues until it ends. Typically, a trend ends when a lower high (for an up trend) or a higher low (for a downtrend) is achieved.

Now that we covered the basic history and foundation of technical analysis, let’s move on to its purposes and uses. It’s not designed to be a crystal ball! Patterns can and will fail and you will occasionally take losses. However, if you focus on highly reliable patterns, combine indicators, and perfect your entry and exit points, you’ll be way ahead of the game.

Entry & Exit Points – Technical analysis gives traders and investors advanced warning of when a trend changes against their favor. If you know how to recognize certain chart patterns and use price-volume divergences to your advantage, you’ll join the ranks of the “smart money” that accumulate long before everyone else jumps in. You’ll also be able to identify reversals, sometimes on the very same day and know when to exit a position.
Low-Risk Trading – The chances of putting on a successful trade is greater if you use technical analysis.
Know When to Sell Short – Technical analysis is not only used for “going long” (buying stock). 9 out of 10 investors/traders do not know how to sell stocks short, or are afraid to do so.
Use Candles to “Light the Path” – Candlestick charting, will help you see warnings in advance and give you enough time to react.
Identify and Trade Gaps and News – There are four main types of gaps: area, continuation, breakaway, and exhaustion gaps. Can you tell the difference? Gaps are usually formed on news, such as earnings or FDA approvals, etc.
Identify Potential Support & Resistance Areas – Trend lines are a part of basic chart reading.
Combine Indicators to Support Trading Decisions – There are dozens of indicators that are available to make trading decisions. You may have heard of the MACD, RSI, Stochastics, Money Flow, and many others. Or, perhaps you didn’t.

Glossary, N-T

Trailing Stop

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Definition: Trailing Stop is a Stop Loss order which is placed as a percentage value as opposed to an absolute dollar value. The order will only execute if the price of the security falls by a certain percentage. The trailing stop adjusts automatically as the price of the security rises and bases itself on the new appreciated value. This type of order allows profits to be made while cutting losses simultaneously.

Explanation: This is such a useful tool, yet many fail to use it. Using a trailing stop allows you to let profits run while cutting losses at the same time.

Glossary, H-M

Margin

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Definition: Margin buying is buying securities/stocks with money borrowed from a broker. Since this money is borrowed, margin buying can multiply profits or losses made on the securities. The stocks/securities are used as collateral for the loan.

Explation: The broker will have a set minimum margin requirement which is the maximum percent of the investment that can be paid for with margin/borrowed money. A Margin Call is when the value of your investment drops your equity in the investment below the requirements of the broker at which time you have to add more money to your account or sell the security.

A -G, Advanced, Financial Ratios, Glossary

Current Ratio

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Definition: Current Ratio is the ratio of current assets divided by current liabilities. It provides A liquidity ratio that measures a company’s ability to pay short-term obligations. Also known as “liquidity ratio”, “cash asset ratio” and “cash ratio”. The Current Ratio formula is:

Example: The ratio is mainly used to give an idea of the company’s ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt – as there are many ways to access financing – but it is definitely not a good sign.

Current ratio = Current Assets / Current Liabilities.

The current ratio can give a sense of the efficiency of a company’s operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry.

This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and prepaids as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales.

A -G, Glossary

Buy Side Firms

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Buy-side Firms are companies that provide advice on buying stocks and securities for use within their own organizations.

Examples of buy-side firms are mutual funds, pension funds and hedge funds. These firms provide recommendations about upgrades, downgrades, target prices and opinions within the company itself. These firms which are also called non-brokerage firms, work exclusively for the company’s own money and not for outside investors. Buy Side firms are not to be confused with Sell-Side firms.

Analysts in buy side firm are independent with little or no conflicts of interest due mainly to the Chinese wall.

Roles and Responsibilities of Buy Side Firms

Buy side firms, do their own research and buy securities for the company’s own projects
Buy-side analysts work with portfolio managers within their organization which makes it easy to explain their analysis
fixed-income buy-side analysts grade high yield bonds used for their company’s review and benefit

Limitations of Buy Side Firms

Buy side firms can not involve external investors in trading based on their research
They are restricted from brokerage activities for investors and earning transaction costs and brokerage commissions
Buy-side analysts are prohibited from releasing any private recommendations
Investment costs and losses while buying securities are covered by the buy-side firm and cannot be outsourced.

Examples of Buy-Side Firms

Some examples of Buy-Side Firms are:

Fidelity Funds
Putnam Funds
Vanguard Funds
T Rowe Funds

Conclusion

Buy side firms typically engage in trading investments and generating profits/losses using only their own resources.

These firms do not buy and sell investments for public traders.

Advanced, Financial Ratios

Total Asset/Equity Ratio

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DefinitionThe Asset to Equity Ratio is the ratio of total assets divided by stockholders’ equity.

The asset/equity ratio indicates the relationship of the total assets of the firm to the part owned by shareholders (aka, owner’s equity). This ratio is an indicator of the company’s leverage (debt) used to finance the firm.

The importance and value of the company’s asset/equity ratio is dependent upon the industry, the company’s assets and sales, current economic conditions, and other factors. There is no ideal asset/equity ratio value but it is valuable in comparing to similar businesses. A relatively high ratio (indicating lots of assets and very little equity) may indicate the company has taken on substantial debt merely to remain its business. But a high asset/equity ratio can also point to a company that is wisely “trading on the equity.” In other words, there is a high asset/equity ratio because the return on borrowed capital exceeds the cost of that capital.

At some higher levels, however, the ratio can reach unsustainable levels, as the additional debt ratchets up interest costs and the deteriorating financial position puts the firm in jeopardy. By the same token, a low asset/equity ratio can indicate a strong firm that needs no debt, or an overly conservative company, foolishly foregoing business opportunities.

Strategies for Beginners

Trading Strategies

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Today, you can find many articles warning of an imminent market pull back. As a new investor, it is helpful to understand how the various indicators contribute to these forecasts so that you will be forewarned and can make appropriate alterations to your portfolio before a bottom drops out. Those who are unprepared often pay a large penalty.

Current Events

Lets first look at current events. There is a very strong correlation between these events and the near term direction of the market. This week, there were reports that the job market and service sectors are in worse shape than predicted. The Eurozone economy, which has dominated the financial press, is continuing to unravel. Debt, driven by the US government, as a percent of GDP is more than 10 times higher today than it was prior to the great collapse of the 20’s. Market fear from these events can quickly stall the economy. While our economy is so shaky, our government ignores the historical lessons of our prior recessions. Obama has just release new guidelines for federal programs that will 1) remove capital from the market, 2) encourage people with weak credit ratings back into home ownership and 3) increase business uncertainty, risk and fear. The economic stall can be associated with any random event with all these other issues bearing down.

Beside specific current events, we know that seasonality has an impact on specific stock sectors as well as the market in general. Our “Best Months to Buy” article reported that May, June, August, September and October are historically the worst months of the year to hold stock.
Technical Indicators

For many, technical indicators are hard to understand so are overlook. In fact, using these tools are quite easy as they are readily available on the web. We just need to understand what they mean. Lets look at what some of these indicators are saying about our current economy and the market.

As most of us know, the most popular market indexes are hitting record highs but with lower volume. As you may remember from our previous article, volume is the most important early warning indicator for predicting changes in demand and the direction of price.

Avid technical analysts use the MACD as one of the most accurate indicators. Today when you look at the MACD for the DOW, you will see that it is converging and heading toward a bearish crossover. This is a very strong technical indicator predicting a downturn in the market. If the two lines used for MACD continue in their path and cross over, you will find that the smart investors will quickly leave uneducated investors holding the bag.

Finally, there have been five distribution days over the last month. A distribution day is when the market has a big loss with large volume. When you have five distribution days, then these analysts specify that the market moves from a confirmed up trend to a confirmed down trend. Some stock picking companies use this one indicator as the sole tool in choosing market turns. To see a complete list of technical indicators.

In next week’s newsletter, I will write about how to adjust your portfolio when you have identified an upcoming down turn.

Advanced, Glossary, H-M, Technical Analysis

Moving Averages

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Moving Averages

Moving Averages are one of the most popular and important technical analysis tools. The ease of use and simple calculation make it a great tool to get information quickly. They also provide the basics for more advanced technical analysis tools like MACD and Bollinger Bands and can be useful for removing some of the “noise” from daily fluctuations in the market. In simple terms, the moving average is an average that compares the previous period over time. There are two types of moving averages: the Simple Moving Average (SMA) and the Exponential Moving Average (EMA) which puts more weight on the latest date. We will explore the differences more in depth later on.

Moving Average Technical Analysis

Moving Averages are lagging indicators and give an indication of the strength of a trend rather than predict movement in the asset or market. They are also useful for identifying support and resistance lines and can be used to look at a market reversal. As we will see below, the longer the period used for the SMA, the stronger the trend, hence a 200 day SMA provides a stronger indication of trend than a 10 day SMA.

Moving Averages give a lot of information at crossings between shorter and longer Moving Averages, the distance between the price and the moving average and provide support and resistance lines as well.

Below is a graph with a 50 day and 200 day SMA.

The first thing to point out is that the 50 day SMA follows the price much more closely than the 200 day SMA. Hence the longer the period of the SMA, the smoother and more static the line is. As an analogy the 10-day SMA is like a sports car that can turn quick and easily whereas the 200-day SMA is like a large truck that cannot change or turn quickly.

Take note of the points where price and SMA’s or EMA’s cross each other. If we start with the leftmost arrow (1), we can see that the price crosses the 50 day and 200 day multiple times. This is not a strong indication of trend, as the price can frequently give “false” warnings in day to day trading.

A much stronger indication is when a shorter period SMA crosses a longer period SMA. As we can see at the second arrow (2). The 50 day SMA crosses the 200 day SMA from the top (downward) which is a strong indication of a bear market.

On the other hand, the third arrow (3) has the 50 day SMA crossing the 200 day SMA from the bottom (upward) giving a strong indication of a bull market.

Another aspect we can see from moving averages is the support and resistance lines. Support lines are when the moving average is below the price and resistance lines are when the moving average is above the price. As we can see from the multiple small circles, the price rarely goes above or below the moving averages for long and even less frequently when it is a longer period. The other thing to notice is the large oval. The greater the distance between a moving average and the underlying price, the more we can expect a reversal of the current trend as we can see above.

!!! Note: These indicators can be useful to determine resistance, support, some reversals and trend strength. However, as you can see from the top left in the graph, this is not always the case. The 50 day SMA came very close to crossing the 200 day average but would not have indicated a very strong trend!

SMA vs EMA

As we saw earlier the EMA gives more weight to the current price which we will see in more detail in the calculation section.

You can see slight discrepancies above between the EMA and SMA. With a price that has more volatility however, you will see greater differences. We can also see that there the EMA tracks some big changes more closely, especially for the EMA that is 10 days as opposed to 50 days.

Moving Average Calculations

The Simple Moving Average calculation is far more straight forward than the Exponential Moving Average Calculation.

SMA calculation:

N Day SMA: Is the sum of N previous closing prices over N where N is the number of Days considered.

For example: 20 Day SMA is the sum of the closing prices of the 19 previous days(includes today’s closing) over 20.

If we have a 5 day SMA with prices as follows:

Jan 1st	12.5
Jan 2nd	13.7
Jan 3rd	14.5
Jan 4th	13.9
Jan 5th	16.8

Then the 5-Day SMA on the 5th of January is: (12.5+13.7+14.5+13.9+16.8)/5 = 14.28

!!! You always need the number of days data before you can calculate that day’s Average! So if you want the 200 day SMA for a particular day you need 200 days of data before that!

Mathematical Formula:

(Σ closing price from i-N to i) / N where i is the current day and N is the time period.

EMA calculation:

The EMA is a more complex calculation, though, as we have seen, just as easy to interpret.

EMA = (current Price * 2/(1+N)) + (Previous Day’s EMA * (1-2/(1+N))

The expression 2/(1+N) is called the weighting multiplier and will be higher for smaller periods of EMA. This means that more weight will be given to the last day’s price.

SMA VS EMA

Price	SMA-5	EMA-5
19	17	17
20	18	18
50	24.8	28.67
22	25.8	26.44
23	26.8	25.3

Recession is generally described as a slowdown of economic growth over a sustained period of time.

Advanced, Financial Ratios, Glossary, N-T

Quick Ratio

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Quick Ratio is the ratio that measures the ability of a firm to cover its current liabilities with their most liquid current assets.

Quick Ratio = (Current Assets – Inventory) / Current Liabilities

Glossary, N-T, Options

Put Option

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A Put Option gives the holder the right to sell the underlying stock or futures contract at a specified strike price.

Glossary, N-T

Pink Sheet

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Pink Sheets refer to the trading of stocks that are not listed on a major exchange or the OTCBB due to a lack of minimum listing requirements or filing financial statements with the SEC (Securities Exchange Commission)

Bonds, Glossary, N-T

Par Value

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Par Value is the amount that the issuer of a bond agrees to pay at the date of maturity.

Glossary, N-T, Options

Out of The Money

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Out-Of-The-Money refers to an option that is unfavourable to exercise. An example is a put option with a strike price lower than the underlying stock price, or a call option with a strike price higher than the underlying stock price.

Moving Averages

Moving Average Technical Analysis

SMA vs EMA

Moving Average Calculations

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