Posts Tagged ‘Picking’
Picking Stocks – Stock Investment
Posted by admin in Common Stock on January 13th, 2010
Stock Forecasting?
If forecasting in the stock market is dangerous, how can an investor time his buying and selling of stock? The simplest answer is to ignore the price level, to buy stock whenever he has savings to invest, and not to sell unless he must. And he must also own fixed-dollar deposits because it opens an opportunity to buy stock at lower-than-average prices and to sell at higher than average, without forecasting.
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The Investment Ratio.
Momentarily ignoring the question of timing of stock purchases, let us suppose A has $1,000 of new savings to invest on the first day of each month. With half of this he buys common stock, and the other half he puts it into a savings deposit. His savings are always divided equally between stock and cash reserve. During the first year he deposits $6,000 in the savings bank and pays $6,000 for stock, buying 120 shares, an average of 10 shares a month, at an average price of $50 a share. (For simple illustration the expense of buying and selling stock, also the income on investments, are excluded here.)
Now let us look at A’s market or redemption values. On January 1st of the second year the current value of his savings deposit, disregarding interest, is the same as his cost. But the market value per share of his stock has dropped to $40, giving his 120 shares a value of $4,800, or $1,200 less than his savings deposit. With this drop in price, his usual $500 monthly purchase would pay for 12 shares, as compared to his previous average of 10 shares a month.
At this point A decides he wants the market value of his stock to equal his savings deposit, and that he should adjust his buying to accomplish this. So on January first he makes no savings deposit but puts all of his $1,000 monthly saving into stock, thus raising the total stock value to $5,800, as compared to $6,000 in the savings deposit. With the $1,000 he buys 25 shares, 2.5 times as many as his former monthly average. Later on, when a rise in price causes his stock value to exceed his savings deposit, he offsets this by putting all or most of his new savings into the savings deposit.
Action Plan.
Now let us expand A’s action into a plan. First, an investor selects a standard ratio that he will maintain between the market value of his common stock and his cash deposit. The idea can be applied to any ratio an investor prefers.
To maintain a stable lifestyle for the family, some additional reserve says $5,000 would be needed for personal emergencies outside the investing portfolio. On starting to save $1,000 a month, he might adopt a standard ratio of $800 stock to $200 fixed-dollar deposit, but not counting $5,000 in his emergency reserve. For the first 5 months all his savings go into this special reserve, thus completing his goal for emergencies. In the sixth month, observing his standard ratio, he puts $200 into cash deposit and $800 into stock.
Having chosen a standard ratio, he must not allow current stock-market conditions to persuade him to change the ratio. If he adopts one ratio when stock prices are dropping, and changes to another ratio when prices are rising, he is slipping into forecasting. A standard ratio has no chance of success unless, after an investor adopts it, he parks his emotions outside.
Buying under a standard ratio goes this way: When an investor has new savings available, before placing them he finds out what the current values are of his total stock and his total bank deposit, not counting the emergencies reserve. Then he puts his new savings into whichever one is low in value compared to his standard ratio, as A did with his $1,000 monthly savings.
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No New Saving Situation.
When an investor has little or no new savings, he can gain the benefit of the standard-ratio plan by applying the same ratio to both selling and buying stock. Suppose B’s annual spending is exactly equal to his income, so that he has no new savings, nor is he spending any capital. His standard ratio is 1 to 1, and the current value of his capital agrees with this; 2,000 shares of stock at $10 a share total $20,000, and $20,000 in a savings deposit.
Then the value of a share drops to $8, making his total stock value $16,000. To restore his values to agreement with his standard ratio, he withdraws $2,000 from savings deposit and buys 250 shares of stock. This cuts his reserve to $18,000, and also raises his current stock value to $18,000.
Next, the value per share rises to $10, the same as the original figure, and his 2,250 shares have a current value of $22,500. Again acting to restore his values to his standard ratio, he sells 225 shares of stock for $2,250, and adds this to his savings deposit. This leaves him with 2,025 shares of stock, valued at $20,250, and $20,250 in bank deposit, his total capital being $500 larger than at the start. (For accuracy, the expense of buying and selling should be subtracted from this gain.)
Stock Value Movement and Value Gap.
A switch of old capital between stock and bank deposit should not take place until stock value has moved far enough away from the standard ratio to justify the expense and trouble of changing. In the above example, B bought stock when his stock value was 20 per cent below his reserve value. And he did not sell stock until his stock value was 25 per cent above his bank deposit value. The desired gap can be provided automatically by setting up a standard ratio for selling stock that is different from the buying ratio.
Ratio System Requires Discipline.
It helps you decide when the share price moves down, how many shares to buy into your stock, drawing from your available bank deposit. It also prompts you during the stock soaring months, how many shares to sell in order to keep to your initially set ratio.
This Standard Ratio Investing System has to be followed with discipline in order to achieve winning goals. The buy low and sell high obviously comes into fruition here as you see your combined stock and bank deposit value grows over time.
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Against the Top Down Approach to Picking Stocks
Posted by admin in Preferred Stock on January 13th, 2010
If you have heard fund managers talk about the way they invest, you know a great many employ a top down approach. First, they decide how much of their portfolio to allocate to stocks and how much to allocate to bonds. At this point, they may also decide upon the relative mix of foreign and domestic securities. Next, they decide upon the industries to invest in. It is not until all these decisions have been made that they actually get down to analyzing any particular securities. If you think logically about this approach for a moment, you will recognize how truly foolish it is.
A stock’s earnings yield is the inverse of its P/E ratio. So, a stock with a P/E ratio of 25 has an earnings yield of 4%, while a stock with a P/E ratio of 8 has an earnings yield of 12.5%. In this way, a low P/E stock is comparable to a high – yield bond.
Now, if these low P/E stocks had very unstable earnings or carried a great deal of debt, the spread between the long bond yield and the earnings yield of these stocks might be justified. However, many low P/E stocks actually have more stable earnings than their high multiple kin. Some do employ a great deal of debt. Still, within recent memory, one could find a stock with an earnings yield of 8 – 12%, a dividend yield of 3- 5%, and literally no debt, despite some of the lowest bond yields in half a century. This situation could only come about if investors shopped for their bonds without also considering stocks. This makes about as much sense as shopping for a van without also considering a car or truck.
All investments are ultimately cash to cash operations. As such, they should be judged by a single measure: the discounted value of their future cash flows. For this reason, a top down approach to investing is nonsensical. Starting your search by first deciding upon the form of security or the industry is like a general manager deciding upon a left handed or right handed pitcher before evaluating each individual player. In both cases, the choice is not merely hasty; it’s false. Even if pitching left handed is inherently more effective, the general manager is not comparing apples and oranges; he’s comparing pitchers. Whatever inherent advantage or disadvantage exists in a pitcher’s handedness can be reduced to an ultimate value (e.g., run value). For this reason, a pitcher’s handedness is merely one factor (among many) to be considered, not a binding choice to be made. The same is true of the form of security. It is neither more necessary nor more logical for an investor to prefer all bonds over all stocks (or all retailers over all banks) than it is for a general manager to prefer all lefties over all righties. You needn’t determine whether stocks or bonds are attractive; you need only determine whether a particular stock or bond is attractive. Likewise, you needn’t determine whether “the market” is undervalued or overvalued; you need only determine that a particular stock is undervalued.
Clearly, the most prudent approach to investing is to evaluate each individual security in relation to all others, and only to consider the form of security insofar as it affects each individual evaluation. A top down approach to investing is an unnecessary hindrance. Some very smart investors have imposed it upon themselves and overcome it; but, there is no need for you to do the same.
Gambling Vs. Picking Stocks
Posted by admin in Preferred Stock on January 6th, 2010
Although some people may argue that investing in the stock market is the same as placing bets at the race tracks, these two activities are actually very much on polar ends. To clarify matters further, let us first define gambling; and then investing in the stock market.
Gambling For Profits
Some gamblers claim that they play the field out of fun, but that statement can be misleading. Exactly what the term “fun” is for most avid gamblers is when they make a killing at the race track, at the casino tables and even at the slot machines. In other words: gambling is fun when they win, but not much fun when they lose.
In a nutshell, gambling is when a person wagers something of value (money, material possession, service, etc.) on a particular event with hopes of taking home a profitable exchange, or at least a return of the original wager amount. If you dare a friend to jump a puddle for a dime, hoping that either he would not clear the puddle or he would not make the attempt, then you are already gambling even if the amount is pretty small.
The same is true when you put a $20 bill in a slot machine and pull the handle. You are hoping to get something out of your money, preferably something more than strained muscles from pulling down the machine handle much too often.
Investing In Stocks For Profit
People are also investing in the stock market to gain profits. Brokers and traders usually handle assets or securities. To make a very complicated financial market less complicated, let us just say that people who dabble in this kind of trade buy stuff while its price is at its lowest, hold it for a period of time, and then sell the stuff when its market price is several degrees higher. This is the way brokers or traders earn their keep.
Similarities Of Gambling And Investing In Stocks
Despite what many think, both gambling and investing in the stock market are legal activities at least in most countries. There are however, some forms of gambling that are illegal; but there are also some forms of trading that are illegal in nature. There are also committees for both activities overseeing the works like the gaming (or gambling) commission, and several types of financial regulatory boards.
These two activities are also fraught with risks, and usually, the riskier the venture, the greater projected profit should be. There is also that element of “loss” since we all know that many gamblers and financial investors lose more stakes than those who practice conservative business measures.
Differences Between Gambling And Investing In Stocks
Investing in stocks may be a risky venture, but there are always safe and conservative measures to work with in the trading arena. Some investors prefer speculative trading, which is probably the riskiest form of trade in the financial markets, but there is a greater population of investors who prefer quiet investments with growing yearly interest. A good example of that would be people who dabble in mutual funds.
Investing in mutual funds means putting down money on an erstwhile money-generating company while making sure that part and parcel of the money it earns go into something either environmentally or socially productive ventures.
You definitely cannot say the same for gambling, although many people might argue that a portion of the money does go to a good cause. Gaming commissions donate money to charitable institutions, but this is more for tax cut reasons.
Also, there are no conservative measures when it comes to gambling. Its either you win or you lose. Even in hedge betting where gamblers stake on different players in order to cover all bases, there is definitely no yearly interest growth to look forward to.