Stock Trading Blog

Can This Bull Market Keep Heading Higher?

bull and bear market

The stock market has continued its long bull run, up nearly 14 percent year-to-date. It’s the second longest bull market in history, which was born in March 2009 following the Great Recession. And it’s that longevity that has investors wondering – when will it end?

Despite setbacks, like the oil crash prompted by OPEC’s war on U.S. shale and the subsequent deal to cut production in order to lift prices again, the current bull market has continued on unfettered. But there are cracks showing that could bring about the start of a new bear market. Whether those cracks will widen this year or next is still debatable.

Obstacles in the Markets

Stocks have climbed without stumbling much so far this year. There hasn’t been any sign of a correction and any negative news seems to get absorbed by investors without blinking. But investor confidence may be misplaced.

One of the most often quoted indexes on Wall Street is the VIX Volatility Index, commonly referred to as the “fear gauge.” Anything over 20 is considered volatile, while anything under 15 is considered calm. Contrarian and value investors like to sell during calm markets and buy when volatility is high and other investors are panicking.

Right now, the VIX reads at around 10, with less than a handful of minor spikes above 15 earlier in the year. At first glance it might seem like this means everything is steady and calm in the markets. But really, all it says is that investors believe risks are low. Long-term low volatility can indicate a level of apathy in investors minds who aren’t correctly anticipating or pricing in real market risks. It’s a prelude to a possible correction.

One of the best indicators of an issue is the average multiple relative to earnings investors are paying for stocks. Right now, the average P/E of the S&P 500 is at 25.43. Considering the historical median is 14.67, it seems safe to say that stocks are currently overpriced. However, this statistic alone isn’t enough to condemn the market. From the late 90’s to the early 2000’s, the average P/E stayed above this level and, in 2008, multiples soared above 65 times earnings.

Finally, earnings are what drive stock prices. A recent report revealed that energy prices are expected to fall next year as demand drops – low demand equals lower growth expectations. And if earnings drop, stock values should fall as well. Keep an eye on whether stock values fall with lower earnings. That would make multiples even higher and stocks far more expensive relative to risk.

Despite evidence of an emerging bear market, investors don’t need to press the panic button just yet. History shows that stocks can continue going higher for years even with elevated multiples. While a correction is arguably overdue, it won’t necessarily mean that a long term bear market will take over. It could take several corrections before earnings become too low and multiples too high to support stock values.

 

 

Dividend Payers and Other Hedging Strategies

US dollar

Dividend paying stocks are usually popular choices for risk-tolerant and risk-adverse investors alike. For the risk-tolerant, dividend yielding stocks can help diversify against loss while providing extra income to boost returns. For the risk-adverse, the same stocks lower overall risk in the portfolio and provide a steady stream of income and returns, instead of chasing big gains and risking equally large losses.

Usually investors think of bonds and treasuries when a conservative portfolio is discussed instead of stocks. And when stocks are included, only dividend yielding ones are screened for. But dividends aren’t the only path conservative investors have when it comes to equities. There are plenty of other stock types to consider when building a defensive or conservative portfolio without having to turn to other assets, like bonds and treasuries.

Don’t count out stocks when it comes to building a defensive portfolio

While dividend payers are a no-brainer for investors that seek hedging strategies or defensive stocks, there are several other things to consider before making a decision. Things like having a large market capitalization, stock buyback programs and sector rotation planning should be included in any portfolio – defensive or not.

Having a large market cap is good for defensively-minded investors, because it usually means that the stock won’t react strongly to market movements. These types of companies tend to be global, making them diversified with their product or service, as well. Both conservative and risk-oriented investors use large cap stocks as portfolio anchors to build the rest of their stock picks around.

Stock buybacks are a great advantage for any investor because they mean the company is helping lift the stock price by generating positive buying activity in the stock. It also means management has shareholders’ best interests in mind and takes an active role in managing the stock price. When a stock starts to fall, having a stock repurchase program can often turn the tide and keep the stock from falling.

Finally, a strategy known as sector rotation can help hedge your portfolio by allowing the business cycle to guide your investments. This cycle is correlated with the economy with certain sectors under-performing or out-performing, depending on where the economy is in the cycle. By avoiding sectors that generally lag and investing in those that do well, you can effectively ride the economic wave and take out some of the guesswork.

Options are often considered separate from stocks in a portfolio, but many option strategies include holding equities as a part of the plan and can be very conservative. Covered calls for example can be a great way to hedge your portfolio if you already own the underlying equity. This allows you to profit upfront, thus lowering your investment base at the cost of selling at a higher price if the stock moves up that high before the expiration date.

 

 

 

3 Investment Rules to Live By

businessman

Successful investors know that due diligence and strategic planning are necessary to stay ahead of the curve. Over time, you may find that you’ve developed certain rules that help you invest better and make smarter decisions. If so, you might already know some or all of these three essential rules. If you don’t, you should consider adding them to your list.

Here are 3 simple rules that every successful investor swears by.

Brand Name Matters

The first rule is simple – brand name matters. The best-in-breed companies are best for a reason. There’s a similar saying in real estate, as well – don’t buy the best house if it’s in a bad neighborhood. Value investors are often guilty of ignoring this rule because they confuse undervalued companies with second-rate companies.

A strong brand name company or stock is a top pick for a number of reasons. They generally have a large market share, sell a product or service that is in demand and are owned by institutional investors. This makes them very competitive relative to their peers and will generally outperform them over time.

Don’t Be Afraid to Hold Cash

It’s a common misconception that holding a large amount of cash means you’re making a mistake and missing out on potential gains. While there might be a case to be made about opportunity cost, there’s also a case to be made for patience.

Consider a scenario in which an investor is 100 percent committed in the market with a portfolio of stocks and nothing in cash holdings. But then an opportunity arises in a stock that could result in big gains. The investor who has cash on stand-by can immediately jump in and purchase the stock, while the one who doesn’t have cash on hand will have to make a choice about what stock to sell, if any, and wait for the sale to go through before making a purchase.

Invest Like It’s For Someone Else

Investing is often a solitary activity. While that’s not a bad thing, it can lead to a certain kind of laziness that could spell big trouble for the undisciplined investor. That brings us to rule number three – invest like it’s for someone else.

You might buy a stock simply because it looks cheap and you like the company, but if you tried explaining to someone else that you bought a stock for them with that explanation, you’d be fired pretty quickly. If you can’t explain your reasoning for holding a stock and why it will go higher, then you shouldn’t own it.

Obeying the above three rules will almost certainly improve your investment performance, but it doesn’t stop there. Incorporating these into other lessons you’ve learned will help you make smarter investment decisions and increase your returns.

 

 

3 Industries that Might Not Be Around in a Decade

typewriter

Economic sectors might be one of the cornerstones of diversity, but they aren’t timeless. In fact, sectors are born and die over time as technology and consumer habits change. Investors need to be aware of industries and emerging trends that could mean the beginning or end of an industry, or else find themselves lagging behind in a dying business.

Long gone are the days of the seeing the milkman in your neighborhood making deliveries or talking to the switchboard operator when making a call. Those jobs were replaced by automation and other business innovations decades ago.

As an investor, having a long term investment horizon is usually the best advice, but it also means you need to be extra diligent when making your portfolio selections. Unlike stocks that dip down temporarily and eventually go higher, industries that face extinction don’t usually recover. You need to be careful and avoid investing in an industry that could be on its way out.

Endangered Industries

1. Transportation

IoT (Internet of Things) is a game-changing new technology that allows machines and programs to communicate and operate without the need for human interaction. That means energy grids that can order their own repairs, refrigerators that order food to be delivered when they start to run out and, yes, cars that drive themselves.

Automated vehicles won’t just improve safety and make your daily commute easier and more efficient, they also mean professional drivers may soon be out of work. Train engineers and even commercial pilots could be replaced by artificial intelligence within the next 10 years.

2. Coal

Most people think the political climate is responsible for the downfall of coal, but, once again, technology is the real culprit. Coal has been the power source of choice for more than a century because it was cheap, but recent innovations in photovoltiacs means that solar power is now on par with coal for price. With so many people looking at alternative energy and green business policies, an industry as polluting as coal won’t be able to stay competitive.

3. Cable

The cable industry has enjoyed many years of control, dictating what type of programs get made, while consumers were left with whatever was on TV at the right time. But the advent of companies like Netflix, Hulu and Amazon Prime means that cable won’t be able to compete with on-demand programming. While most packages now include some type of on-demand service or recording ability, cable’s popularity continues falling with more and more people switching to cheaper alternative entertainment packages instead.

Industries don’t just die out and leave nothing behind. When business models go bankrupt, other industries take notice of what worked and what didn’t.

Take the publishing industry for example. Printing books and magazines, and selling goods in a brick and mortar store is now a model for quick losses thanks to competitors like Amazon. But the business of the written word won’t just go away. Instead it’s being reinvented with online distribution channels and technology like the Nook that allows users to download hundreds of books onto one device.

Old business models and industries fade away and other more efficient ones rise up and take their place. Technology as an industry hasn’t been around more than a few decades, but is one of the fastest-growing sectors in the economy. There will likely be many more industries in danger of becoming extinct as technology advances through the 21st century.

 

 

How Interest Rates Affect the Market

stock market interest

The financial markets are fickle things that overreact to virtually any new information. Some movements are relatively easy to predict, such as when GDP data comes in higher or lower than expected. Others are more tricky.

The Federal Reserve, an institution designed to maximize employment and control inflation, has become more influential in the markets over the past decade or so, following its quantitative easing program. Investors keep careful watch on what the Fed does and says because it impacts interest rates. And those, in turn, affect almost every corner of the markets, from the value of the United States dollar to stock valuations to bond prices. But it’s not as intuitive as one might think.

The interest rate effect

Interest rates essentially exist for two reasons: the time value of money and inflation. The time value of money says that money now is worth more than money later. If someone loaned out $10,000, they would charge some type of interest rate for it. This makes sense because of the opportunity cost of not applying that money to something that could net a larger return.

Inflation is the bigger threat, though. When inflation is low, interest rates should also be low to encourage growth. Conversely when inflation is high, interest rates should be high in order to curb growth and bring down inflation. Because companies need loans to finance growth and investments, a lower interest rate means higher earnings and less costs due to interest expenses while high interest rates have the opposite effect.

You might think that when the Fed announces an interest rate hike, that it would have a deleterious effect on stocks. After all, higher rates mean more spent on interest and less money for profit and earnings. But in recent years, that hasn’t been the case. In fact, stocks rose in response to the Fed raising interest rates. The reason being that, after years of interest rates near zero, the Fed hiking rates meant a renewed sense of confidence in the economy – something investors felt was more positive than the slight negative of higher rates.

Interest rates always need to be looked at in context. When Herbert Hoover raised rates after the stock market crashed in the late 1920’s/ early 1930’s, he exacerbated the Great Depression. The lesson learned is that rates need to be adjusted only when it makes economic sense. Interestingly, the stock market seems to be able to absorb the impact of higher interest rates over time. At first there might be a drop in values as businesses and investors get used to the higher expense, but eventually the market balances out making overall interest rates irrelevant.

 

 

Strategies for Mitigating Geopolitical Risk

investing

Risk is a necessary evil in every portfolio – but that’s not necessarily a bad thing. Risk is why stocks can outperform safer, conservative investments like bonds and treasuries. The key is to diversify your holdings so that one single risk doesn’t pose too much of a threat to your overall portfolio.

Many investors believe that diversification begins and ends with simply buying a number of stocks in a different industry. While that might help protect against several forms of economic and industry risk, it doesn’t do much for macroeconomic concerns like geopolitical risk. To defend against this kind of threat, investors will need to have a thorough understanding of what geopolitical risk is and how they can prepare for it.

Welcome to the geopolitical arena

Globalization is when businesses operate on a global scale and not just within a specific region or country. You might think that the term only applies to large multinational corporations, like Apple or Exxon Mobil, but it affects every business in every industry around the world.

For example, imagine a small regional hardware goods retailer that doesn’t do business outside of the state. You might think it’s immune to geopolitical risk, but then a group of protesters overthrows the government in Bangladesh. Suddenly there’s a supply chain disruption problem where the company that manufactures the hardware goods makes exporting them difficult. Now the small regional store has no choice but to buy from an alternative, more expensive supplier and is forced to increase the price, lowering their returns.

While the above scenario might be somewhat far-fetched, geopolitical risk can affect almost anything, making it hard to plan for or predict. The best way to handle it is to keep abreast of what the political risks are. If there are tensions in the middle east, oil prices are likely vulnerable. European debt crises could mean a spike in United States treasury yields and falling bond prices.

Increased volatility from geopolitical risk can be a good thing for investors. Investors that sell out of the markets, especially in a sector that isn’t affected by the event, leave the door open to value seekers who can swoop in to buy at a discount. Interestingly, history has shown that geopolitical risks don’t have a long term impact on the markets.

The best strategy for a drop in stock values due to geopolitical risk is to buy into the dip. Even sectors that are directly impacted by the event don’t stay down once the event has ran its course. Investors generally over-react to the risks, causing a larger movement in prices than is warranted. In this case, contrarian investors may be the correct ones.

 

 

Getting Started in the Mining Industry

gold stock mining

While some investors love chasing the latest technological trend or favorite consumer product or service, others prefer investing in something more primal. These investors like companies whose business is easily understood – something solid. They want a product that has real value, no matter what.

Mining companies harvest metals and minerals essential for every industry, from manufacturing and construction to technology and transportation. They deal with commodities like gold, silver, copper, iron, molybdenum, uranium and more, elements that are largely responsible for our modern world.

Mining Stocks 101

The mining industry is somewhat unique in the world of business. Standard ratios like price-to-earnings don’t have as much relevancy, meaning that investors need to analyze mining stocks with other forms of data. That’s because mining companies carry large amounts of metals on their balance sheets, making assets far more important than earnings.

The cost of production is arguably a mining stock’s most important statistic. The lower the all-in sustaining cost of production, the lower prices for the mined metal can drop before the company becomes adversely affected. It also means margins are higher. For example, a gold miner with all-in costs of $500 is in a better financial position than a miner that has costs of $750. It also means the former company has more room for error if the price of gold drops. If gold dropped to $700 per ounce, the first company would still be profitable while the second would need to stop production until the price crossed over the break-even point.

Investors should also note the differences between a junior miner and a senior mining company. Junior miners are focused on exploration rather than production. That makes them far more volatile, since locating metals and minerals is a risky endeavor that doesn’t have any guarantees of success. Senior mining companies, however, operate mines and focus on production. That makes them more stable than junior miners.

There’s one last type of mining company – streaming. These types of mining companies have purchase agreements with other mining companies to buy some or all of the metals mined at a predetermined cost. That makes it more resistant to changes in commodity values and even more stable than traditional mining companies.

There’s a risk in the mining industry that doesn’t exist in most other industries – commodity risk. Because these companies deal with metals that are traded as commodities, price fluctuations can change the overall value of a mining stock. A drop in the value of gold means that margins for a gold miner are reduced. If it drops below the company’s cost to extract the metal, then it starts hemorrhaging money. Investors should keep a watchful eye on commodity values when owning a mining stock.

 

 

What A.I. Automation Means for Employment and Your Portfolio

self-driving car

There’s a lot of talk on Wall Street about the future of artificial intelligence and what it means for the economy. Predictions of robots taking jobs away and mass unemployment are contrasted with ideas of a paradise-like society where no one is left wanting for anything. Reality though, likely lies somewhere in between.

There are two sides to this story: investment opportunities and the impact on the workforce. Any new technology means there are investors clamoring for investment opportunities, looking for ways to play the trend early and trying to find where the best A.I. stocks are. On the other hand, widespread automation will certainly impact the workforce, the true extent of which no one really knows.

Investing in A.I.

Experts estimate that the artificial intelligence market will be worth more than $46 billion by 2020 – just three short years away. But the market is still in development with different companies tackling different aspects of the technology. If you want to get in on the ground floor, you need to know where to look.

The first group of companies, Facebook, Apple and Amazon, are all involved with a type of artificial intelligence. This is the technology that learns a users individual tastes and preferences and bases ads and recommendations accordingly. Also, interactive software like Alexa and Siri all part of the emerging field.

Driver-less cars seem to be the next trend in A.I. development, making Alphabet, Tesla, and most automakers a part of it. This type of intelligence is able to map out its surroundings and react to them in real time – a technology with applications in a number of various industries.

The best pure play on artificial intelligence is probably NVIDIA Corporation right now, though. The company designs the Drive PX 2 supercomputer used in driver-less cars and its powerful graphics processors are behind many of the latest A.I. projects in other companies.

The Automated Workforce

What artificial intelligence and automation will bring to the workforce is largely hypothetical at this point, but there are some serious concerns already. The advent of the driver-less car alone could have huge ramifications for a number of industries – most felt by truckers and the transportation industry. Commercial driving may no longer be done by humans in the next 20 or 30 years which means around 9 million people could be out of work within the next few decades. Ideas like the Universal Basic Income plan are already being brandied about by politicians and business leaders who see the difficulties that lie ahead.

The A.I. revolution is still very young, making it difficult to predict what the impact will be over the long term. There needs to be an existing infrastructure before A.I. can truly start being implemented on a widespread basis, meaning that investors can also look at stocks that specialize in this type of industry. Investors who want to get an edge on artificial intelligence should start small and bear in mind that the industry is likely to go through a number of large highs and lows before becoming established as a solid part of the economy.

 

 

 

Learning to Spot (and Avoid) Value Traps

financial stock numbers

Value investors pride themselves on their ability to locate undervalued, under-appreciated stocks with a lot of untapped upside potential. It takes due diligence to be able to identify the key characteristics of a value stock – low P/E, low PEG and minimal debt. Many also have little to no analyst coverage, a dividend payment and a market cap of less than $2 billion. These stocks usually have one other defining characteristic – they usually haven’t been outperforming the broader indexes.

Unlike growth investors who focus on fast-growing companies with a high P/E and a chart that looks like a 45 degree upward climb, value investors prefer patience. By knowing a stocks true intrinsic value, they can wait out impatient investors, temporary trends and anything else that doesn’t interfere with the stocks future potential. But it’s not as easy as screening for just a few key ratios. Many would-be value stocks are actually traps that can quickly sink any portfolio.

Triggering the Trap

A real value stock has the potential for outsized gains. What separates a successful value investor from a poor one is knowing why the stock hasn’t yet reached its potential. After all, if an investor looks at a stock and comes to the conclusion it’s actually worth 15 percent more than its currently trading for, there has to be a reason.

There needs to be a catalyst for a value stock to go higher. Maybe its a cyclical stock that’s simply out of favor at the moment, or it has a promising new product that hasn’t been released yet. Whatever the reason, investors should be able to explain exactly what it is that will push the value stock up to its intrinsic value. If the only reason to buy a stock is because it’s priced cheaply, you could be looking at a value trap.

Some stocks that have a low P/E ratio might not be undervalued – there could be a perfectly good reason why it trades at such a low multiple. It could be that there isn’t much room for growth, or it might be in a dying industry. Investors need to be careful not to associate “low P/E” with “value.”

Another big trap happens with the dividend payment. A high dividend yield might be attractive for investors, but the payout ratio is what will reveal the companies ability to continue paying it. A payout ratio of more than 100 percent means that the company is paying out more in dividends than it earns in income – an unsustainable operation.

One of the hardest things for value investors to learn is patience. Sometimes a stocks intrinsic value isn’t realized for more than a year, making it a strategy for those who have a long term investment horizon. Warren Buffett says that if you aren’t willing to hold a stock for at least 10 years, then it’s not worth owning. True value plays happen over time, not in the course of just a few weeks.

 

 

Everything You Need to Know About 10-K Statements

stock 10-k statement

A successful investor understands the value of due diligence. While technical traders follow patterns of momentum and volatility, those with long term winning track records use fundamental analysis. Understanding comparative ratios, earnings growth and other financial details are what helps an investor know the real value of any stock they want to invest in.

Information about a publicly traded company is freely available to investors. It can be found by pouring through financial statements, such as the balance sheet, income statement and cash flow statement. This information is updated quarterly along with a plethora of other financial information including risk assessments, loans, acquisitions and other things. Investors that want a leg up on the competition can find it all on the 10-K statement (10-Q for quarterly statements) – easily found on the U.S. Securities and Exchange Commission website.

Reading a 10-Q/K

The first thing you’ll notice when opening a 10-K statement is that they are usually highly detailed and sometimes over 80 pages long. There’s all kinds of information available, but most investors don’t know what’s important or what parts to pay attention to.

One of the first things to notice on a 10-K is the company’s explanation of business operations, how it actually makes its money and what markets it currently operates in. This part is doubly important for investors who aren’t completely sure what a company does. For technology companies in particular, this information can help shed light on what type of business a company does and how it actually earns income.

The next part of a 10-K covers risk assessments and other potential liabilities, such as lawsuits. Believe it or not, investors often jump into a stock without reading these critical pieces of information, like pending bankruptcies or risk exposures, that might otherwise change their opinion.

The financial statements are arguably the part that most investors are familiar with. This section includes the balance sheet, income statement and cash flow statement. From these documents, investors can see how much money a company is making, how much debt it has and much more. This is also where most investors get comparative ratios, as well.

Due to accounting rules, many potential liabilities or obligations must be listed on the financial statements. But they still need to be disclosed to investors. Things like operating leases, where the company pays out a certain amount each month in rent, won’t reflect the true nature of the liability on a balance sheet.

Other items can be found on a 10-K as well, including forward-looking estimates from management and notes from an independent auditor. Investors can look for certain red-flag keywords, like “ongoing concerns” that can tell investors to stay far away from that company.

Companies that aren’t incorporated in the United States generally don’t have a 10-K available with the SEC. Investors interested in foreign stocks should take extra precautions, as accounting rules and other financial details may be different than those required in the United States. Certain industries tend to have specific details that are critical for them, but not for others, like the amount of reserves for a mining company. Investors need to understand the specifics of the type of industry a stock operates in before making a final decision.

 

 

Including ETFs as Part of Your Stock Portfolio

bull and bear

An investment portfolio can take on many different forms. It might include stocks, bonds, currencies, precious metals, commodities, futures, mutual funds, ETFs and more. It might have just some of these asset types or it might include a little of everything.

Diversification is a term that gets passed around on Wall Street often, but seems to be misunderstood more often than not. The basic idea is to diversify assets so an investor isn’t overly exposed to one kind of risk over another. Some investors seem to think that means buying a lot of different things is the best way to accomplish diversification, but in reality, this strategy will dilute your portfolio’s total return potential.

One way to avoid diluting returns without giving up on diversification is by using investment vehicles that contain a portfolio of holdings like a mutual fund or ETF. And investors have already begun picking up on this idea with ETFs becoming more popular and more prolific each year.

Successfully incorporating ETF’s into a portfolio

There’s a trend in the last few years: investors leaving mutual funds and choosing ETFs as an alternative. Mutual fund outflows in 2016 hit $264.5 billion, while inflows to ETFs numbered $236.1 billion. It represents a shift in investor behavior. More people are choosing passively managed investments with lower fees than actively manged funds with higher fees. Higher fees that many believe aren’t warranted given the lack of performance from the industry.

Actively managed funds like mutual funds have under-performed broader indexes like the S&P 500 for years now – and with expense ratios near 1%, many feel like these types of managed accounts aren’t performing as advertised. ETFs generally have lower expense ratios than mutual funds and, despite passive management, have performed well against market averages. Meanwhile, 76% of mutual funds have lagged relative to their intended benchmark indexes.

The greatest appeal ETFs have to investors is the fact that they trade like stocks. Investors can buy and sell them with ease, unlike mutual funds, which trade just once per day. Thanks to the popularity of the industry, there are numerous options available, as well, from standard index-based ETFs to commodity-based ETFs and even leveraged ones.

While holding a portfolio made up entirely of ETFs is possible, the best allocation would be to hold just one or two in the mix to help shore up any portfolio weaknesses. If technology stocks seem too complicated as an investment, a tech-based ETF might be exactly what your portfolio needs to gain exposure to the sector without taking on too much risk.

Investors should note the difference between ETFs and ETNs (exchange-traded notes). While ETFs hold stock securities, ETNs are comprised of debt securities, albeit without the periodic payments. Investors who aren’t aware of the differences might see ETNs and ETFs as the same thing, but the risk and reward of debt securities are much different than that of stock securities. Investors will need to make sure what type of product they are interested in before committing.

 

 

Placing a Price Target on a Stock

business-man

Successful investing requires doing a certain amount of due diligence to avoid making costly mistakes. Pouring over financial statements, analyzing ratios and charts, and reviewing comparable statistics to other similar stocks takes time. But it’s all worthless unless you understand exactly how much a stock is actually worth.

Knowing when to buy a stock and when to sell it is the difference between good investors and great ones. Finding value is meaningless if you don’t know what the number actually is. Before buying, you need to have a number in mind to sell at – whether it’s 10%, 20%, or 50% higher. You need to know how to put a price target on stock.

Determining Value

A stock’s value comes from a number of different metrics working together. A company’s earnings are only part of the equation – the other part is the multiple investors have placed on the stock, commonly known as the price-to-earnings ratio (P/E). A stock trading at $20 per share with earnings of $1 per share would have a P/E of 20.

Earnings change over time, though, generally starting out fast when the company is smaller and younger and then slowing down and becoming more stable once the company reaches a certain size. Making EPS forecasts is important for placing a price target on a stock, but one mistake investors tend to make in this process is assuming an unrealistic growth rate. A small cap company that has been growing at an average of 25% annually might be impressive, but investors assuming this as a long term growth rate will likely be disappointed and over-estimate the future value of the stock.

New developments can change EPS assumptions, as well. A new product, acquisition, or technology can affect EPS guidelines, meaning that investors will likely need to change their price target the longer they hold a stock.

Finally, the market will place a valuation multiple on stock that needs to be taken into account when estimating the future price of a stock. Depending on the industry, it could be the price-to-earnings, price-to-sales, or price-to-book ratio. Some industries require looking at other metrics, such as mining stocks, which base their value off of the value of their total reserves.

While getting an accurate estimate of a stock’s true value is critical, there are many factors that can affect price other than earnings changes. The valuation multiple is arguably the most unstable part of price determination because it’s based off nothing more than assumptions and comparisons to similar companies. Investors can change assumptions based off various macro and micro-economic reasons, making it a difficult ratio to justify. Comparing it to past historical averages on the same company helps, but comparing it to the multiple placed on companies in a similar industry is the best way to find undervalued stocks, while simultaneously putting a price target on a stock.

 

 

How to Boost Profits Using Spread Options

businessman

Investors are always looking for a way to make their money go further. Investing in speculative high growth stocks can generate returns in excess of 100 percent or more over a couple of years. Those with an extremely high risk tolerance might play the futures market and gain leverage, as much as 200:1 in some cases, to increase returns. But there’s another way to boost returns without having to take on an exceptional level of risk.

As a general rule of thumb, one must take on more risk in order to increase possible returns. That means more volatility, more chance of under-performing other portfolios and more time spent analyzing the market and keeping track of current trends and issues. But option trading seems to be the exception to the rule. On one hand, higher risk seems obvious, but when looked at from a long-term time frame, certain option strategies can leverage your money to increase returns without having to take on exceptional risks.

Spread Options: Low Risk, High Gains

One of the biggest misconceptions investors have about options is that because they use leverage, they are inherently more risky than just investing in a stock. But in reality, there are numerous strategies that can actually reduce risk without giving up return potential. One strategy that accomplishes this goal is known as a spread option.

Spread options can be bullish or bearish, depending on which way you think a stock is going to go. Here’s how a basic bullish spread option is structured:

Let’s say you think XYZ stock is going to go higher, but you don’t want to commit a lot of money upfront in order to invest. If XYZ is trading at $50 per share, then you would need $5,000 in order to invest in it. Instead, you decide a bullish spread is the best way to go.

First, you purchase a call option at the same strike price or slightly higher than the stocks current value. Assume a 3 month call at $50 costs $500. Next, you sell a call 3 months out at a higher strike price – let’s say $60 per share. The call you sell nets you $150, making your total investment cost $350.

If the stock does nothing, the maximum amount you stand to lose is your initial investment of $350. The maximum gain happens if the stock climbs to $60 or more within 3 months. In that case, the total gain would be the difference between the strike prices – $1,000. That’s a possible profit of 285 percent on your original investment. A bear option spread works in the same manner, but with puts instead of calls.

Spread options can be a great way to act on potential opportunities without having to spend a lot of capital. The biggest downside, other than the possibility of losing your total investment, is if the stock actually does better than you expected. Taking from our original example, if the stock gains above $60 per share, that excess will essentially be lost, since you sold a call at that strike price.

If you believe a stock has a good chance of gaining quickly, it might be better to simply invest in the stock rather than use options.

 

 

Stock Trading 101: When to Cut Your Losses

stock market loss

There’s no worse feeling than selling a stock after it’s lost money – except when you hold on far past when you should have sold, as the stock drops more and more, making you question every trading decision you make from then on. Warren Buffet famously has just two rules he lives by – Rule #1: Never lose money. Rule #2: Never forget rule #1. After all, the whole purpose of investing is to end up with more money. If you’re just looking to preserve wealth, you might as well open up a savings account and forget about it.

But no matter how much research and due diligence you do on a stock, odds are that eventually you’ll find yourself invested in a loser. You might hold on at first, believing it’s simply a minor correction or mild profit-taking activity, but once a stock has lost 20 percent or more, panic starts to creep in. Knowing when to buy a stock is important, but knowing when to sell is just as critical in order to be successful in the markets.

Knowing when to let go

It’s one of the hardest lessons investors need to learn – when to sell a stock that’s lost money. Many traders attempt to recover from losses by chasing after it with more money. They convince themselves that the stock is cheaper now and more money being thrown at it will help mitigate the loss and bring down the break-even point.

There’s a certain logic to investing more in a loser. After all, if a stock drops 10 percent, you’ll need an 11.11 percent gain to break even. A 20 percent loss means you’ll need a rise of 25 percent to break even. But if you invested more once the stock drops in value, the gain doesn’t have to be so large to break-even on an investment.

The problem isn’t that it takes more of a gain to recover from a loss, though, it’s a refusal to accept the fact that a stock might just be a bad choice period. There’s nothing to say that a losing stock will recover. In some cases, a falling price might actually be a buying opportunity, but more often than not, a steady decline in value is a sign of something going wrong in the company.

The key to knowing whether to keep a loser or sell it comes from answering one question – have the reasons you bought the stock for changed? For example, if you bought a stock because it does business in China, but later spins off that segment, your reason for holding the stock no longer applies. However, macroeconomic conditions like a general correction due to poor GDP data don’t have anything to do with a single stock, so your reasons for owning the stock won’t change.

There’s a silver lining to selling a stock at a loss – you can take advantage of a strategy known as tax loss harvesting. The IRS allows you to offset up to $3000 in capital losses annually against your income and carry forward the excess into future tax years. You can use losses to offset gains so your tax liability won’t be as high. While it might not be an ideal strategy for long term success in the markets, it does help mitigate losses when they do occur.

 

 

 

 

How to Evaluate an IPO

evaluating an ipo

An IPO launch can be an exciting opportunity for investors who want to get in on the ground floor of a newly-made public company. Companies decide to go public in order to accumulate a massive influx of cash, which is then used for product development, capital investments and other things that help it grow larger.

Before the launch, though, there is relatively little information made available to investors about the company. They might have a good idea of what the business is and what the company direction will be, but most of the information comes from media coverage. Because it’s brand new, there isn’t a track record to analyze or ratios to compare. Even details like financial statements aren’t readily available, making the initial price difficult to judge as to whether or not its fairly valued or overpriced.

From IPO to your portfolio

Most investors have little knowledge as to how an IPO is actually priced. In practice, the initial pricing generally follows the basic rules of supply and demand. If demand is high for a particular IPO, the price goes up, since the number of shares being issued stays the same. Some industries, like technology tend to garner higher premiums for IPOs due to the interest of investors, while other times demand changes depending on what industry is popular at the time.

Multiples for the IPO pricing are based off competitors helping investors pinpoint whether a stock is overpriced or not. For example, if investors are willing to pay 20 times earnings for a software developer, then an IPO price will be set with this as a guideline.

But more often than not, IPOs are mostly priced based on their marketability rather than fundamental numbers. The idea of what the company is capable of doing or might do can overpower the reality of its current financial situation simply because it is new.

Sometimes though, investors won’ have much to go on other than market opinion. When Google first went public, the IPO price quickly jumped to levels that some analysts felt were unsustainable. But the stock price kept steadily climbing until it became a tech staple of almost any portfolio. Twitter, on the other hand, debuted at $40 per share and quickly rose to nearly $70 before correcting downward, eventually settling at the $15 range.

 

Investing in an IPO is risky considering the lack of information available. Many times, prices get hyper-inflated on pure speculation, only to fall by 50 percent or more less than a month later. Due diligence is doubly important in these kinds of offerings, but even this isn’t always a good predictor of future movement. Unless you’re willing and able to take the risk, it’s usually best to wait a while before jumping into a newly issued stock to see how it settles after the initial hype is over.