Schools out. What better education over summer to give your children than a primer on the basics of share investing? Could set them up for life.
The return on any stock is realized through annual dividends earnings and the net profit realized over the purchase price when the investor decides to stop holding the security. Stock prices change every day due to the forces of supply and demand. If market participants are optimistic about a company’s performance, more people would want to buy its stock and thus the price would move up. Conversely, if they have a negative outlook, they will want to sell it and the price would drop.
The most important factor that influences any stock’s price is the company’s earnings. Investors consider earnings a key benchmark while gauging a company’s operational performance. Listed companies report earnings every quarter and these figures are closely monitored by analysts and investors. A stock’s value is based on forecasted earnings and thus any unanticipated change in the released figures can cause sharp movements in its price thereby affecting the P/E multiple and Price to book value ratio.
Another factor that has an effect on pricing is the investor’s outlook regarding the company’s growth potential and general widespread euphoria for a sector/country. During the dotcom bubble, the market capitalization of many internet companies exceeded a billion US$ without the backing of profits. When the bubble burst, most of these valuations did not hold and the market crashed. Some of the prominent losers were Infospace (which plunged from US$1,305 per share in 2000 to US$22 per share in 2001) and The Learning Company (acquired for US$3.5 billion in 1999; sold for US$27.3 million in 2000).
Other factors that influence the expectations of an investor are various financial ratios such as:
Price earnings ratio: The price earnings ratio (P/E ratio) is the most widely used valuation ratio in investment community. First made popular by Benjamin Graham, he declared the ratio as one of the quickest and most accurate ways to make value comparisons.
Price to Book Ratio: The Price to Book Ratio is a measure of a company common stock price in relation to the book value of each share. The price to book ratio is a high level indicator of whether or not a company's stock price is undervalued or overvalued.
Dividend yield: The dividend yield is obtained by dividing the dividend by the share price and expressing it as a percentage. This measurement tells the investor what percentage return he can expect from his investment.
Debt ratio: Debt ratio indicates the proportion of company’s debt to its assets. The measure gives an idea to the leverage of the company along with the potential risks the might company face in terms of its debt-load.
Interest coverage ratio: The interest coverage ratio is a measure of the number of times a company could make the interest payments on its debt with its earnings before interest and taxes, also known as EBIT.
Return on equity: Return on equity indicates how much profit a company earned in comparison to the total amount of shareholder equity on the balance sheet.
That’s a start. Hope the education will continue under your own steam over the hot summer.
Alpesh B Patel
www.trading-champions.com
