Learn the stock market in 7 easy steps. Get spreadsheets & eBook with your free subscription!

HEY! DID YOU KNOW…

 

  • The median age in the U.S. is 36.8
  • The median income in the U.S. is $51,939
  • The average 401k match is $1 for $1 up to 6%

A 36.8 year old investing 10% of their $51,939 income with a $3,116.34 match:
With just average stock market returns of 10% would have $1,114,479.31 by retirement.

Join 7,200+ other readers who have learned how anyone, even beginners, can easily make this desire a reality. Download the free ebook: 7 Steps to Understanding the Stock Market.

The Enterprise Value Formula and What It Tells You

The enterprise value (EV) is the best metric if you want to gauge the real value of a company. Unlike market cap, which is the value of the company based on the shares outstanding, the enterprise value takes into account the market cap., the market value of debt, minority interests, preferred shares (if any), and the cash available. Therefore, it is more accurate.

corporation building to represent enterprise value

Breaking Down the Enterprise Value Formula

The enterprise value formula consists of five separate components:

  • Market cap. (Equity value): the value of the company based on its current stock price and the number of shares outstanding. To be accurate, you need to take the average number of shares outstanding, i.e. the shares at the beginning of the year and the shares at the end of the year and divided them by 2.
  • Market value of debt: this is the hardest component to obtain from a company’s balance sheet because most companies have bank debt, which pertains to their book value and not to their market value. Therefore, you need to calculate the market value of debt using the formula below:

Market value of debt = E ((1-(1/ (1 + R) ^Y))/R) + T/ (1 + R) ^Y

Where:

  • E = annual interest expense (it is on the income statement)
  • R = cost of debt (total interest / total debt)
  • T = total debt
  • Y = average maturity of debt (in years)

[click to continue…]

You Should Do Regular Monthly Maintenance on Your Portfolio

This article will explain why you should do maintenance on your investment portfolio, and how often to do it. Then it shares how I personally do this and my recommendations if you want to do the same.

portfolio maintenance

Last month during the holidays, I spent some of the weekend at the mall for some Christmas shopping. People watching is fun, even when you’re in a hurry. Then I realized something.

Other than the obvious necessities: food, clothing, shelter; there’s necessities that keep us as human beings sane.

Think about what you did in the morning. At some point you probably brushed your teeth, took a shower, maybe had a cup of coffee, sat in traffic, etc. I’m willing to bet that many of the things you did this morning– you do the same way and in the same order every day.

Without knowing it, you rely on rituals like these to get you through the day. They keep us comfortable and give us a predictable result.

The same applies when you think about the reason for holidays. Forget the consumer-driven side for a moment and just imagine if we never had a holiday. How would we differentiate anything worthwhile? The weeks would just drag on into a never ending blur. This is why humans crave rituals.

Rituals give us a sense of belonging. It’s a shared human experience. Just like that feeling of the weekend starting or the bliss of falling asleep after a great day.

If you don’t have a ritual with your investing, you risk failure on a greater scale.

My investing ritual takes about 15 minutes a month. Near the beginning of the month, I simply open up the spreadsheet that tracks my portfolio and update the ticker prices. Any dividends that were paid this month are also added into a dividend column that contributes to the return %.

This ritual keeps me in a monitor state over my investments without having to fret everyday. I can just shut off the noise and re-evaluate things in a calm and quiet state.  [click to continue…]

Examining Small Caps for Speculators

If you are a stock speculator, you believe you can outperform the market and markets are not efficient.  Regarding the subject of market efficiency, I am not a proponent of the efficient market hypothesis at the small-cap level because there simply isn’t the same number of investors looking at what the company is doing and that leaves the door open for mispricing of companies.

Trend followers like John W. Henry, which I discussed in my article trend following for beginners, place more importance on a study of market price rather than fundamentals.

small caps

My strategy for speculating on small cap stocks for the short-term combines trend-following and fundamental analysis. I use fundamental analysis to try and understand the forces of the market in order to filter out false moves.

My long-term speculations on small caps are primarily contrarian and based on fundamental analysis – meaning that I want to see a turn-around taking place with the company.  There must be some sort of impetus for the turnaround – a new product, new legislation opening up a new market, political trends etc. I like turnaround situations a lot because the share prices are usually significantly depressed, presenting an opportunity for a great upside.

Researching a company’s financial strength going into the turnaround should be an important factor in your strategy.  If the company is sufficiently funded, then the propensity for dilution diminishes, which is a key factor in generating high returns.

I’ve invested in a lot of turn-around companies that had some great news, but the companies were often financially weak, and thus some potential upside was dampened by stock offerings or convertible debentures.  In these aforementioned cases, I would typically sell once the price begins to stagnate and the volume begins to diminish.

When a company wasn’t needing outside financial help, I found I could hold on to their stocks and let them develop a bit.  New issue small caps can also be interesting, but are in many cases fueled by the initial hype of the IPO and everyone wanting a “piece of the action”, which is followed by a sharp drop.  Buyer beware.

What is a small cap?  According to Wikipeida.com, “A small cap company typically has under $1 billion under control and are hence considered small companies. Small companies generally are not able to secure the best (prime) borrowing rates and wield reduced power, including a smaller market share. Being small, they are also less financially stable than larger companies, and are more likely to become bankrupt. However, they do generally have more growth potential and over time have greater but more volatile expected returns.”

The small-firm effect, originated by Rolf Banz in 1981 is one of the most cited refutations of the efficient market hypothesis.  He found that by dividing all NYSE stocks into quintiles according to firm size, the average annual return of firms in the smallest quintile was 19% greater than the average return of firms in the largest quintile. (“The Relationship between Return and Market Value of common Stocks.  Journal of financial Economics (March 1981)

There is some disagreement about what exactly causes such a divergence in returns.  Some researchers say that it is due to the January effect which shows up more dramatically with small stocks vis-à-vis larger stocks, because of the inherent volatility of small stocks.  Furthermore, Marc R. Reinganum (1983) found that within size class, firms that had declined more severely in price were usually small firms and had larger January returns.  (“The Anomalous Stock Market Behavior of Small Firms in January:  Empiracal Tests for Tax-Loss Effects”  June 1983.

The January effect is tied to tax loss selling at the end of the year.  The rationale for the January effect is that many people sell stocks that have declined in price during the previous months to realize their capital losses before the end of the tax year, and wait until the next year to reinvest those funds.

Variability over time of the small firm effect has been noted by P. Brown, A Kleindon and T. Marsh (1983).  However Reinganum (1992) conducted an interesting study on the predictability of relative performance of small cap verses large cap stocks, which showed that variability in the small stock effect is not entirely random.

Reinganum’s evidence suggests that the relative performance of small versus large cap stocks can be predicted at longer-run investment horizons such as five years, and that the small firm effect tends to reverse itself.  In other words, following a five year period where large cap stocks outperform small cap stocks, the relative performance is reversed with the small caps outperforming the large caps.

A word of caution: after researching various academic studies, there does seem to be a great degree of conflicting information regarding a wide range of topics. A study in the Journal of Finance will be printed declaring a particular finding, and then a few years later another study will be released showing that the results from the previous study has been reversed.  So by the time you start to implement the findings of the first study, they become obsolete.

When I read academic studies on finance, I am often reminded of the studies conducted of various foods and how it affects our health or propensity to gain or lose weight.  One moment a certain food or diet is the panacea, and the next thing we hear is the opposite.

Regardless, it is still worthwhile to research academic studies and make our own decisions based on the presented data  – it at least gets your mind working.  Victor Niederhoffer, a well-known speculator has written a few interesting books on stock speculation and speaks of the principle of ever-changing cycles that may be worth looking into if you would like to learn some interesting insights into the subject.

Small caps are probably my favorite type of stocks to speculate on because there is typically more volatility and upside.  I think it is important to have some “fun money” in your portfolio – It doesn’t have to be a large percentage – but it will keep your mind active.  Buy and hold can be boring and also rewarding after many years, however a little speculation makes you feel alive.   Good luck and happy hunting! – Dave Reiner

Free Cash Flow (FCF) Yield – Why the Fuss About it?

Free cash flow is one of the most important indicators of a firm’s operating performance. Companies that can generate strong cash flows are widely viewed as being solvent because they can meet their obligations in due time as well as pay dividends, invest in business expansion or develop a new product. Given that the free cash flow is related to the operating cash flow, firms that record gains from their core operations simply do their job well.

aapl cash example

Calculating a firm’s free cash flow

If you are already familiar with the free cash flow model (FCF), you know that the free cash flow considers the earnings before interest and taxes (EBIT), depreciation, amortization, changes in net working capital, and changes in capital expenditure

The net working capital is the difference between a firm’s current assets and current liabilities, and it is used to determine the firm’s ability to cover its short-term obligations. A negative or a declining working capital raises concerns about the firm’s solvency because it suggests that the firm is not collecting its receivables in due time because it has a loose collection policy with a high average collection period. Hence, a declining working capital for many quarters indicates a potential liquidity problem.

The capital expenditure (CapEx) is the difference between changes in total assets and changes in total liabilities. Note that industries like the airlines, telecom, and utilities, among others, are more capital-intensive and as such, they require a higher amount of capital to run their operations.

Let’s assume that you are an APPLE (NASDAQ: AAPL) investor, and you want to calculate the free cash flow for the period 2012 – 2016. You can find information about the depreciation, amortization, changes in the working capital and changes in the CapEx in the firm’s cash flow statement.  [click to continue…]

Comparing the Bull and Bear Market

In a nutshell, a bull is seen as someone who is optimistic and believes that stocks will rally. This is a bullish outlook. On the contrary, a bear is an investor who is pessimistic and believes stocks will decline in value. They are said to have a bearish outlook.

bull and bear

[This is a guest contribution from Vinayak Maheswaran]

Things to do in a Bear Market

A bear market alludes to a fall in stock prices of at least 15-20 percent, together with negative sentiment underlying the market. Stock investors are very wary of these periods.

An economic slowdown calls for a realistic mindset. If you looked through business cycles, you would have gathered that the stock market can go for years in negative territory. During a bear market, one easy way to limit losses is to play dead. Stay calm and don’t make sudden moves. Invest in money market securities and leave a large part of your portfolio in cash. Cash holds value and will earn interest in a bear market while stocks dive south. Plus, when the right buying opportunity comes along, you’ll have enough cash to make some moves.

Bear markets provide opportunities for investors to pick up value stocks. Try to go in with an idea of what you need. Stocks are underpriced in a bear market and have often declined in value for some time. Value investors are on the lookout for stocks at this time and they come at attractive valuations. Real bargains come up during a bear market. [click to continue…]