Where to Invest |Asset Allocation |Portfolio diversification

Where to Invest? Learn asset allocation basics, and tailor to your investment profile. Decisions you make here will have by far the greatest impact on your investment portfolio’s performance.

Contents
  1. Where to invest: Asset allocation decisions
    1. Historical Returns
    2. Market risks
    3. Inflation risk
    4. Your Investment Profile
    5. Very good intro

How to Invest |Return requirements |Risk tolerance |Your Investment profile

How to Invest? Devise your investment strategy. Find out how your investment profile plays a crucial role in helping you meet your investment goals without exceeding your tolerance for risk. Continue reading “How to Invest |Return requirements |Risk tolerance |Your Investment profile”

How to Invest |Understand Return and Risk |Risk Return analysis

How to Invest? First, understand basics of return and risk, with the trade-offs associated with each investment asset class. Learn to use diversification as a means of mitigating these risks.

Contents
  1. How to invest: the basic principles
    1. First things first
    2. Understanding Return and Risk
    3. The risk return trade-off
    4. Diversification: Mitigating Risks
    5. Time Diversification
    6. How to invest: is the foundation strong?

Why Invest | Get your Money to make more Money

Why Invest? Get your money to make more money and build long-term wealth. In the process you beat inflation, achieve financial goals, and provide for a comfortable retirement.

Contents
  1. Why Invest at all?
    1. Time Value of Money
    2. Compounding at different rates
    3. The Thumb Rule of 72
    4. Other Why Invest considerations
    5. Different Investment Options
    6. Wealth Creation studies in India

Stock Valuation | Learn how to value a stock

Learn stock valuation techniques – Pay close attention to the price you pay for a stock and you minimize your speculative risk. Focus instead on investment returns.

Contents
  1. Stock Valuation -the basics
  2. Impact of Investment Returns vs. Speculative Returns
    1. Investment Return Vs. Speculative Return
  3. Paying Up Rarely Pays off
  4. Using Price multiples wisely
    1. Price-to-Sales
    2. Price-to-Book
    3. Price-to-Earnings
    4. P/E drawbacks
    5. Price-to-Earnings Growth (PEG)
    6. Say Yes to Yield

Stock Analysis | Learn to analyse a stock in-depth

Learning stock analysis can be a daunting task for newbie investors. Here’s a complete step by step, do-it-yourself template for conducting in-depth stock analysis

Contents
  1. Analysing a Company- stock analysis basics, step-by-step
  2. Growth
    1. Sources of Growth
    2. Quality of Growth
  3. Profitability
    1. Return on Assets (ROA)
    2. Return on Equity (ROE)
    3. Free Cash Flow
    4. Profitability Matrix
    5. Return on Invested Capital (ROIC)
  4. Financial Health
    1. Financial Leverage
    2. Debt to Equity
    3. Interest Coverage
    4. Current Ratio
    5. Quick Ratio
  5. The Bear Case
  6. The Management
    1. Character
    2. Thank you.

Understanding Cash Return ratio

The best yield-based valuation measure is a relatively little-known metric called Cash Return ratio. In many ways it’s actually a more useful tool than the P/E.

Contents
  1. Cash Return ratio
    1. Cash Return Formula

 

Cash Return ratio

The best yield-based valuation measure is a relatively little-know metric called Cash Return ratio. In many ways it’s actually a more useful tool than the P/E. To calculate cash return, divide free cash flow by enterprise value.

 

Cash Return Formula


 Cash Return = Free Cash Flow/Enterprise Value = Free Cash Flow/(Market Cap + debt – Cash)


The goal of Cash Return is to measure how efficiently the business is using its capital –both equity and debt-to generate free cash flow. Essentially cash return tells you how much free cash flow a company generates as a percentage of how much it would cost to buy the whole shebang, including the debt burden.

The best yield-based valuation measure is a relatively little-know metric called Cash Return ratio. In many ways it’s actually a more useful tool than the P/E. To calculate cash return, divide free cash flow by enterprise value.

Cash Return is a great first step to finding cash cows trading at reasonable prices.

You may also like to learn more on yield-based and other valuation measures, as below.

Understanding Earnings Yield

The nice thing about Earnings Yield, as opposed to P/E, is that we can compare it with alternative investments such as fixed deposits, to see what kind of a return we can expect from an investment.

Contents
  1. Earnings Yield
    1. Earnings Yield Formula

 

Earnings Yield

The first yield based measure is what is called the Earnings Yield. In addition to multiple-based measures, you can also use yield-based measures to value stocks. If we invert the P/E and divide a firm’s earnings per share by its market price, we get an earnings-yield. If a stock sells for Rs. 200 per share and has Rs.10 in earnings, it has a P/E of 20 (20/1) but an earnings-yield of 5% (1/20).

 

Earnings Yield Formula


Earnings Yield = Earnings per share / current market price


The nice thing about yields, as opposed to P/Es, is that we can compare them with alternative investments such as fixed deposits, to see what kind of a return we can expect from each investment. (The difference is that earnings generally grow over time, whereas fixed deposit payments are fixed).

A stock with a P/E of 20 would have a yield of 5 percent which is worse than the current bank FD rate of 8%. A stock with a P/E of 10, however, will have a yield of 10% which is better than the FD rates. Thus I might be induced to take the additional risk.

You may also like to learn more on yield-based and other valuation measures, as below.

Understanding Price to Sales ratio

The Price to Sales ratio (P/S) is useful for quickly valuing companies with highly variable earnings, by comparing the current P/S ratio with historical P/S ratios

Contents
  1. Price to Sales ratio
    1. Price to Sales Formula

 

Price to Sales ratio

The most basic ratio of all is the Price to Sales ratio, which is the current price of the stock divided by sales per share. The nice thing about the P/S ratio is that sales are typically cleaner than reported earnings because companies that use accounting tricks usually seek to boost earnings. In addition sales are not as volatile as earnings –one time charges can depress earnings temporarily, and the bottom line of economically cyclical companies can vary significantly from year to year.

Price to Sales Formula


Price to Sales = Current stock price /Sales per share


This relative smoothness of sales makes the P/S ratio useful for quickly valuing companies with highly variable earnings, by comparing the current P/S ratio with historical P/S ratios.

However the P/S ratio has one big flaw. Sales may be worth a little or a lot, depending on a company’s profitability. If a company is posting billions , but it is losing money on every transaction, we would have a hard time pinning an appropriate P/S ratio, because we have no idea what level (if any) profits the company will generate.

Therefore, although the P/S ratio might be useful if you are looking at a firm with highly variable earnings –because you can compare today’s P/S with a historical P/S ratio – it’s not something you want to rely on very much. In particular don’t compare companies in different industries on a price-to-sales basis, unless the two industries have very similar levels of profitability.

You may also like to learn more on other valuation measures, as below.

Understanding Price to Book ratio

Although Price to book ratio (P/B) still has some utility today, the world has changed since Ben Graham’s day. Find out how to use P/B as a valuation measure for today’s markets.

Contents
  1. Price to Book ratio
    1. Price to Book Formula
    2. Price to Book & Return on Equity
    3. Price to Book – valuing Financial Services firms

 

Price to Book ratio

Another common valuation measure is price to book ratio (P/B), which compares a stock’s market value with the book value (also known as shareholder’s equity or net worth) on the company’s most recent balance sheet. The idea here is that future earnings or cash flows are ephemeral, and all we can really count on is the net value of a firm’s tangible assets in the here-and-now. Legendary value investor Benjamin Graham, one of Warren Buffet’s mentors, was a big advocate of book value and P/B in valuing stocks.

Price to Book Formula


 Price to Book = Current Market Price/Book Value per share


Although price to book ratio still has some utility today, the world has changed since Ben Graham’s day. When the market was dominated by capital-intensive firms that owned factories, land, rail track, and inventory –all of which had some objective tangible worth – it made sense to value firms based on their accounting book value. But now many companies are creating wealth through intangible assets such as processes, brand names, and databases most of which are not directly included in book value.

For service firms in particular Price to book ratio has little meaning. If you used P/B to value eBay, for example, you wouldn’t be according a shred of worth to the firm’s dominant market position, which is the single biggest factor that has made the firm so successful. Price-to-book may also lead you astray for a manufacturing firm such as 3M, which derives much of its value form its brand name and innovative products, not from the size of its factories or the quantity of its inventory.

Another item to be wary of when using P/B to value stocks is goodwill, which can inflate book value to the point that even the most expensive firm looks like a value. When one company buys another, the difference between the target firm’s tangible book value and the purchase price is called goodwill, and its supposed to represent the value of all the intangible assets –smart employees, strong customer relationships, efficient internal processes –that made the target firm worth buying. Be highly skeptical of firms for which goodwill makes up a sizeable portion of their book value.

Price to Book & Return on Equity

Price to book ratio is also tied to Return on Equity (equal to net income divided by book value) in the same way that price-to-sales is tied to net margin (equal to net income divided by sales) . Given two companies that are otherwise equal, the one with a higher ROE will have a higher P/B ratio. The reason is clear – the firm that can compound book equity at a much higher rate is worth far more because book value will increase more quickly.

Therefore when you are looking at P/B, make sure you relate it to ROE.

A firm with low P/B relative to its peers or to the market and a high ROE might be a potential bargain, but you will want to do some digging before making that assessment based solely on the P/B.

Price to Book – valuing Financial Services firms

Although P/B isn’t very useful for service firms, its very good for valuing financial services firms because most financial firms have considerable liquid assets on their balance sheets. The nice thing about financial firms is that many of the assets included in their book value are marked-to-market –in other words they are revalued every quarter to reflect shifts in the marketplace, which means that book value is reasonably current. (A factory or a piece of land by contrast, is recorded on the balance sheet at whatever value the firm paid for it, which is often very different form the asset’s current value). As long as you make sure that the firm does not have a large number of bad loans on its books, P/B can be a solid way to screen for undervalued financial firms.

You may also like to learn more on other valuation measures, as below.