Securities For Beginners

Thursday, February 02, 2006

A rundown on dividends

First of all: What are dividends?
Well, it's pretty simple: Dividends are a portion of a company's profit paid to the shareholders - who are the owners of a company - in order to let them participate in the company's (financial) success.

Here's a rundown on dividend information provided by most stocktables:

Dividend paid
The dividend paid to the shareholders in the last year - most often expressed as dollar amount paid per share. Nothing exciting about this term, it only tells you wether there was paid a dividend at all or not (for example because the company didn't generate a profit or the profit is reinvested in order to generate growth). Most of the big and stable companies pay dividends whereas fast-growing companies often reinvest the profits in order to keep the company growing.

Dividend yield
The dividend yield is much more interesting for the average investor than the mentioned absolute amount paid: It shows you the dividend per share in relation to the stock's price. Calculation is very easy:
Dividend yield = Annual dividend per share / Current stock price

High dividend yields are always welcome because they provide an income stream even if the stock price isn't developing very well.

Dividend payout ratio
The actually paid dividends in relation to the company's profit. There are two different ways to calculate the payout ratio although there are equivalent (so it doesn't matter which one you choose):
Payout ratio = Dividend per Share / Earnings per share

or

Payout ratio = Dividends / Net income

The payout ratio gives you a rough idea of what the company is doing with the profits: Keeping it in the company or paying it to the shareholders?

Example
Company X:
Stock price: $40
Earning per share: $4
Dividend per share: $2

Divdend yield: 0.05 (2 / 40) or 5%
Payout ratio: 0.5 (2 / 4) or 50%

Wednesday, February 01, 2006

Bonds 2006

Have you thought about investing in bonds? Then 2006 might be the year for you to start. According to Timothy Middleton, bond funds are going to be a good choice this year - maybe "double-digit good". This expectation is based on the assumption that interest rates will be lower and therefore bond prices are going to rise.

Read the full story:
MSN Money: Up next: A banner year for bonds

Related Posts:
Bond types explained (overview)

Monday, January 30, 2006

Bond types explained (Overview)

Convertible Bonds:

Convertible Bonds are corporate bonds that can be converted into common stock of the issuing company. As a result, convertible bonds are usually offered with a lower yield. Investors may like convertible bonds because of the mixture of a bond's constant income stream combined with the chance to participate in a rising share price. On the other hand, there's always the chance that the share price takes a downturn and the bond's holder is stuck with the low coupon rate, because it's unattractive to convert the bond into shares.

Zero-Coupon Bonds:

Zero-Coupon bonds come with no interest rates to be paid by the company. Sounds strange? Well, here's the clue: They're sold with a considerable discount to par value, but in the end the whole par value is paid to the bond owner.

Example:
Coupon: 0
Par Value: $1000
Years to maturity: 5
Bond's price: $800
In this example you pay $800 now and will receive $1000 in five years, but won't receive any interest payments in the meantime.

Callable Bonds:

Issuing callable bonds allows the company to redeem the bonds before maturity. In return a premium is paid to the bond holders when the company uses the call option to compensate the future interesting rates that won't be paid due to the call. The call option is often used when interest rates decline and therefore the company has the opportunity to restructure its debts to better (i.e. "cheaper") conditions.

Bonds with floating interest rates:

Some bonds come with flexible interest rates. The actual interest rate paid by the issuer depends on some index, for example the short-term Treasury bills or the EURIBOR in Europe. Usually the prices of normal bonds decline when market interest rates raise, but due to the constant adjustment of the interest rates the volatiliy of bonds with floating interest rates is lower compared to normal bonds.

Related Post:
InvestorGeeks.com on Bonds

Friday, January 27, 2006

Terms Explained - Price/Earnings Growth (PEG) Ratio

After I already explained the P/E ratio, this time I want to explain another ratio that is directly linked to the P/E ratio: The Price/Earnings Growth ratio (PEG).

Many investors consider the P/E ratio to be inaccurate to judge wether a stock is overvalued by the market. The problem with the P/E ratio is that it shows you the premium investors are willing to pay in return to an expected growth of the company and its stock's price. It doesn't show you wether this premium is (too?) high or low compared to other companies in the same sector. To get this information you will need to take a look at the PEG ratio.

The PEG is based on the P/E ratio and the expected growth of a company's earnings and is calculated by dividing the P/E ratio by the expected growth:
PEG = P/E ratio / Expected Growth

Example:
Company X
P/E ratio: 20
Expected growth: 10%
Company X's PEG = 20 / 10 = 2

Like with the P/E the companies with lower PEG ratios are supposed to be more attractive than those with higher PEG ratios and there are also differences in the PEG levels depending on the industrie you are looking at.

Although the PEG is a great way to judge a stock's value, it has its own traps you need to consider when using it. The main problem is the expected growth you need to know in order to calculate the PEG. And there it is: It's an expectation, not a given fact that the company will achieve this growth rate. But a lower actual growth rate means a higher PEG and in consequence a less attractive stock - unfortunately you will see this after you bought the stock, i.e. when it's too late to change your decision. For this reason investors are sometimes advised to shave 15% from any growth estimates issued by the analysts to create some kind of protection against analysts' errors.

Further information:

Investopedia.com: Move Over P/E, Make Way For The PEG
Yahoo! Finance: Price/Earnings Growth ratio

Wednesday, January 04, 2006

Terms Explained - Cash Flow

The cash flow statement in a company's financial statement shows you the inflow and outflow of money. The difference between cash flow and income is that the net income is heavily influenced by depreciation, amortization and other non-cash items. Sometimes a company announces a loss although they earned a lot of money throughout the year. Investors now wonder wether buying the stock was a fault or the loss is the result of one-time effects that only affect the financial statement without affecting the company's economical health in general.

To answer this question you can take a look at the cash flow statement. The change of cash flow compared to the last year tells you wether the situation remained (nearly) unchanged, became better or worse. The higher the cash flow the better, beacause it means the company earned a lot of money! Since a company needs cash to pay its bills, employees and so on it's in great danger of bankruptcy when it's unable to generate enough cash throughout the year. To show the real amount of money earned the cash flow is calculated by adding depreciation and amortization to the net income (this is the most simple type of cash flow, there are other types that require more items to be included).

Due to the many ways a company can change its economic appearance by using the various accounting instruments the net income doesn't tell you that much - except you want to know wether there is a chance to get a dividend this year. The cash flow however can't be manipulated by accounting tricks, so it is much more important for the investor. Don't get fooled by the income - it's worth nothing without cash. As you can see, there isn't that much to say about cash flow (at least at the beginning), you just have to know the difference between cash flow and net income and the importance of this figures.

Link:
Investopedia: The Essentials Of Cash Flow
Investopedia: Operating Cash Flow: Better Than Net Income?

Thursday, December 22, 2005

InvestorGeeks.com on Bonds

This week Chris posted a nice article on bonds on InvestorGeeks. In my opinion, no investor should exclude bonds from his portfolio, because they are a secure way to create a regular income stream. Well, actually it isn't completely safe, as the Argentinian bonds showed in the past. But since rating agencies like Standard & Poor's publish bond ratings the risk can be seen as easily comprehensible compared to stocks - as long as you stay informed.

Chris mentions the yield to maturity formula to calculate a bond's actual rate of return. This formula gives you the exact rate of return but is very complicated. A less complicated formula is:

r = (c*B + (B-P)/n) / P

with

c = coupon rate
B = par value
P = purchase price
n = years to maturity

Note: This formula is less exact than the YTM formula, but it gives you a basic idea on the bond's rate of return. The actual YTM is below the above formula's result. Let's compare them with an example:

c = 6%
B = $1000
P = $980
n = 8 years

Simple formula: r = 0.0638 = 6.38%
Exact YTM: r = 0.0633 = 6.33%

You see: There is a little difference, but you get a first impression on the bond's rate of return.

Links:

Moneychimp: YTM
Fool.com: Investing basics: Bonds

Tuesday, December 20, 2005

Introduction to College Saving

Please, be the next Einstein

The Motley Fool provides an introduction to Saving for your Child's College Fees. It starts rather disencouraging:
You're not going to like what you're about to read, but you probably suspect as much. You probably have a sense of looming unpleasantness, the kind of feeling you get right before you open a container of leftovers that has been in the fridge for a few months. But it's time to face reality, Fool.

But trust me, it's getting better as you read further. The statistics provided in the article will you give you some hope that if your "pride and joy" is just a little brighter than Forrst Gump he might recieve financial aid in some way.
In my opinion, the most valuable advice is hidden at the end of the article: Do as much as you can to save money for your child's education, no matter what time it is you realize that there is something missing you should have taken care of long ago...

Also worth looking at:
MSNBC.com: What's the best way to save for college?


Disclaimer
The information on this site is provided for general information purposes only. Accuracy of the information cannot be guaranteed, no investment decisions should be made based on this information. Under no circumstances does this information represent a recommendation to buy or sell stocks, bonds or any other securities.