The Basics a Newbie Should Know

What are STOCKS?

Stocks are shares of ownership in a company. When you buy stocks of a publicly listed company, you become a stockholder or shareholder of a company. In other words, you become a part-owner of that company.

As a part-owner, you participate in the company’s growth and future profits. Conversely, you may also lose if the company suffers a loss or performs below market expectations.

The number of stocks you acquire will determine how big or small your ownership is. As you acquire more stocks, your ownership stake in the company becomes greater.

How Do You Make Your Money Grow in Stocks?

There are two ways to make your money grow in the stock market:

1. Through an increase in stock price or capital appreciation

Capital appreciation is an increase in the market price of your stock.  It is the difference between the amount you paid when buying shares and the current market price of the stock. However, if the company does not perform as expected, the stock price may go down below your purchase price.

You cannot really earn from stock price appreciation unless you sell your shares. Otherwise it is only a book value gain, which means it is not yet converted to cash, and current price may change depending on market forces.

For example, if you buy a share of stock at Php100.00, and it rises to Php110.00, your capital appreciation or gain is Php10.00.  Keep in mind that you only realize your gain of Php10.00 minus applicable charges, if you sell at Php110.00.  If you choose to hold it and it further increases to Php150.00, your capital gain would be Php50.00. However, if your stock decreases to Php100.00, and you decide to sell it at that price, then your capital gain is zero.

2. Through dividends declared by the company

Dividends are paid out to shareholders, representing earnings of the company that are not going to be reinvested in their business.  There are two types of dividends: cash and stock dividends.

A cash dividend represents earnings declared by the company for every share of stock. So, if the company declares a dividend of 25 centavos per share, a stockholder with 10,000 shares will receive a cash dividend of (Php2,500.00 minus tax of 10% for individual Filipino investors)(Php0.25 x 10,000) in cash.

Stock dividends are additional shares given to shareholders at no cost. If the company declares a 25 percent stock dividend, a stockholder with 10,000 shares will be entitled to an additional 2,500 shares of stock.  These shares can be sold anytime after the shares have been issued.

The Trading Schedule

In the Philippines, the only operating stock exchange is the PSE.

The PSE has two (2) trading floors in Ayala Center, Makati City and Ortigas Center, Pasig City—where trading participants trade daily from 9:30 a.m. to 1:00 p.m. except Saturdays, Sundays, legal holidays and days when the Central Bank Clearing Office is closed.

Effective January 02, 2012, trading hours are from 9:30 a.m. to 3:30 p.m., the morning session is from 9:30 a.m. to noon, while the afternoon session starts at 1:30 p.m. until 3:30 p.m. Note that you can start placing your orders 30 minutes before the market opens or at 9:00 a.m.

The PSE has extended the trading hours beginning this October, in a bid to attract more investors and prepare for cross-border trading with neighboring Southeast Asian nations.

Investors may post a buy or sell order even after the trading period. However, this order will only be entered and matched through the PSE’s new trading system known as the PSEtrade, the next trading day.

More on: http://www.pseacademy.com.ph/LM/p0/investors~reading/l-beg/k-all/Beginner.html

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When to Sell a Stock

I came across a good article by Geoff Gannon in gurufocus.com. You can also visit his wonderful blog: http://gannonandhoangoninvesting.com/

Geoff Gannon is a value investor whose influence, I presume, is more on Warren Buffett.

 

“Hi Gannon,

1) For a layman, when should one sell a stock?

For when to buy stocks there are so many formulas and screens: AAII screens, CANSLIM, Stockopedia, etc.

When to sell a stock is complicated.

A) Benjamin Graham said when the stock appreciates 50%, or two years

B) Magic Formula says rebalance with highest earning yield and highest ROI at the end of year.

C) Warren Buffett said never.

If I don’t watch my stocks for a year, if the fundamentals deteriorate in this year I might lose (fundamentals change every quarter). I asked this question to Validea and AAII. They said rebalance every month.

For the Benjamin Graham screen, rebalancing every month is not following what he said. For the Warren Buffett screen, rebalancing every month is not following what he said.

What is the simplest time and condition for a non-techie to sell a stock?”

Sell when your original idea has played out. Or when your original idea has been undercut. Never sell a live idea unless you need the cash to buy a better idea.

Never sell a live idea just because it’s been a long pregnancy. If you bought a stock a year ago because you had a good, valid idea and that idea is as good and valid today – but the stock price is no higher – that doesn’t matter.

The gods of finance do not reward patience. Nor do they punish it. They are indifferent. The world doesn’t care. It doesn’t care if you are getting bored. The lack of action that’s making you itch to sell is inside of you. The guy who buys your shares from you isn’t going to feel that itch. For him, it’s a new stock. The mental process reboots.

Don’t let that happen. Don’t sell a real thing from the outside world – a stock that might have a lot of value – just to scratch some mental itch. When deciding to sell a stock – it shouldn’t matter whether you bought it a day ago or a year ago.

So don’t relive your experience of owning the stock. Relive your experience of buying the stock. When you think about selling a stock – start by restating your reason for buying the stock. Then forget the time that has passed. That time is gone. All that matters is your past idea and the present reality.

The key to selling is knowing why you bought. If you don’t know why you bought – you can’t know when to sell. So, if you want a formula for selling – you need a formula for buying. If you trust the formula for buying – like Validea or AAII – then trust them for selling. I don’t trust them. I do my own buying and selling for my own reasons. And for the rest of this article, I’m going to talk to people who do that too.

I’m going to use something a blogger wrote as an example. Why? Because bloggers do the work all investors do. They just do it on paper. We can see their thoughts. And we can revisit their reasons for buying something.

In October, the blogger who writes Student of Value talked about National Western Life Insurance (NWLI).

At the time he wrote the post, he did not own the stock. It was “on his radar.” But since he was thinking about buying the stock – his post works just as well as what someone who did buy that stock might have been thinking.

Here’s what he said about the company’s value:

“National Western is selling for 40% (of) book. Life insurers at the start of the year were selling for 0.7x book on average, according to Damodaran’s data. Based on my analysis so far, I would think National Western is better than average. On top of this, the average is currently depressed. Assuming only the first part gets adjusted and the company trades up to par with the average life insurer equals a 75% price increase.”

We can boil down his argument into two ideas: 1) National Western is an above average life insurer. 2) National Western trades for a lower price-to-book ratio than an average life insurer.

This is the gap he wants to close. This is his idea. And it’s a live idea as long as nothing happens to ruin his reasoning. If he realizes NWLI is not an above average life insurer – then his idea may be ruined.

If the average life insurer falls in price while NWLI rises – that may kill his idea. But that’s the point. He wants the idea to die by seeing that gap close. Once that happens, the idea will be dead. And the stock should be sold. Hopefully, at a profit.

Something like a 40% drop in all stock prices – including the price-to-book ratio of the average life insurer – could kill his idea without a profit. That would close the gap without NWLI going up in price.

When he wrote this article, NWLI was trading for 40% of book value. So, he saw 75% upside. Or we could flip that and say he saw a 43% margin of safety. That’s because the multiple paid for the average life insurer could fall from 70% of book value to 40% of book value (a 43% multiple contraction) and NWLI would still be cheap. It would still be a better than average life insurer trading for the price of an average life insurer.

So, when should this blogger sell NWLI? When it rises 75% to 0.7 times book value. Not exactly. He didn’t say 0.7 times book value was some magic number. It wasn’t a target set in stone. It was just the price an average life insurer was trading for. So, it’s not right to say he should sell at 70% of book value. Instead, he should think about selling when NWLI – which he thinks is an above average life insurer – trades for the same price-to-book ratio as an average life insurer.

Maybe NWLI will rise 75% and other insurers will rise 30%. Maybe the average price-to-book ratio for a life insurer will be 0.9 times book value at some point. At that point, maybe he should keep NWLI even if it trades at 0.7 times book value.

Why?

Because we have to keep his reason for buying in mind. His reason for buying was that NWLI is an above average life insurer. If he is right about that, then NWLI should not trade for less than the average life insurer does.

So, when should he sell NWLI?

He should sell NWLI when his idea plays out. His idea was that he was buying an above average life insurer for less than the market was paying for an average life insurer. As long as that’s a live idea – he can stay in the stock. Once that idea is dead – he should think about selling.

But that’s just the upside idea. Student of Value is a good blog. And like any good blog it doesn’t just look at the upside. It looks at the downside.

What is the risk in NWLI? What’s the downside idea?

Here’s what he said about that:

I came across news from late 2011 of Brazilian insurance regulator attempting to impose a $6 billion fine on the company. National Western has been laconic in its disclosure… From what I read, the claim is most likely just flexing muscles on behalf of the regulator. The amount seems highly incredible at 5x the company’s capital. If the threat were credible, it certainly would have affected both the stock price and A.M. Best’s financial strength rating of A (Excellent) with a stable outlook, reiterated on May 31, 2012. Yet, Brazil is National Western’s largest foreign market – about the annual size (by premiums and contract revenues) of the next 3 largest markets… Even if there is no big effect on the company, the fact that management hasn’t been more open about a seemingly big issue in its largest foreign market undermines the confidence I had in it.”

So here we have another reason why he might sell. He might sell because the risk played out the wrong way. He might sell because something changed that made him believe the Brazilian threat was real. Or because he lost trust in the CEO because of how he handled this problem.

The key to selling is to always go back to your original idea. Why did you buy the stock? What upside did you see? What downside did you see? Has the upside played out? Has the downside played out?

No. Then has the upside changed? Has the downside changed?

No. Then you should stick with the stock.

If the price-to-book ratio of the average life insurer fell from 0.7 to 0.4 while NWLI’s stock price stayed the same – maybe he should sell. It might feel like a defeat. But so what? His idea was an above-average life insurer selling for less than the average life insurer. His idea was not that all life insurers are undervalued. It was that this life insurer is undervalued compared to the others.

Before you buy a stock, do what Warren Buffett suggests: Sit down with a pen and paper and say, “I am buying shares of this company because…” Then put that idea in a drawer. And whenever you reconsider the stock – read that idea back to yourself. Is it still a live idea? Have you given it time to play out?

If you’ve squeezed all the life out of an idea – either because price rose or value dropped – then sell it. But if there’s still juice left in the idea – just hang on. Be patient. Never sell a stock for lack of action.

There is one exception. You can always sell one stock to buy another. That’s different. When that happens, you just compare the stocks. And you go with the one you are most comfortable with.

Now that we know the key to selling a stock is revisiting why you bought it – let’s think again about what Buffett and Ben Graham said about selling stocks.

Ben Graham said you should sell a stock when it rose 50%. It’s easy to see why. Graham said you should buy a stock at two-thirds of its net current asset value. If you buy a stock at two-thirds of NCAV and it rises 50% – you now have a stock that is trading around its net current asset value. That’s still cheap. And Graham knew it. But once you got beyond net current asset value – you would need to know more about the business to know if the stock was cheap. That wasn’t Graham’s style. So he said you should sell after a 50% rise.

Buffett said the best time to sell a stock is never. Or, at least he said something – “our favorite holding period is forever” – that means roughly the same thing. Buffett focuses on quality. He wants to pick as close to the perfect business as possible. Once you own a chunk of a perfect business – you don’t want to sell it. So he doesn’t. But if he picked wrong – he should sell.

These guys had different specific ideas about selling. But their general principle was the same. Don’t try to guess about things you don’t know. Keep a stock as long as it stays in your comfort zone. Once it ventures into the unknown – outside of your area of focus – let it go.

Once your original idea plays out – sell the stock.

Buffett’s original idea in something like Coca-Cola (KO) is that it’s a great business that will stay a great business. As long as it stays a great business – he sticks with the stock.

Ben Graham’s upside idea for a net-net is that it’s cheap. It’s cheap no matter how bad the business is. As long as the net-net is safe it is cheap. It doesn’t need any growth prospects. He didn’t worry about whether it was worth 5 or 10 or 15 or 20 times earnings. He worried about whether it was worth more alive than dead. Once the stock rose above its net current asset value – he couldn’t be completely sure it was still trading for less than it was worth. So he would sell the stock.

You mentioned Graham saying you should sell stocks after two years. I’ve looked at Graham-Newman’s holdings by year – and haven’t seen any evidence he actually did this. Fear of getting stuck in a net-net was often the biggest complaint Graham got. I think this is something he suggested amateur investors could do. It’s not something he did in his own fund.

Here’s my advice. If you don’t know when to sell a stock – the problem is that you don’t know why you bought it. You don’t really know what the idea was you had in mind. And you don’t know if that’s still a live idea. So you can’t tell the difference between clinging to a dead idea and just waiting.

Always err on the side of waiting too long. Few investors wait too long. A lot of folks I know sell too soon. For example, I know plenty of people who pick good net-nets and then don’t stick with them. They do good work. And they don’t make money from it.

Selling can’t fix a bad idea. But it can kill a good idea.

The one instance where I am always in favor of selling this second is when you know you misjudged the risk of catastrophic loss. If you totally misjudged a company’s risk of default, fraud, etc., go ahead and sell the stock right now.

Otherwise, revisit your original idea. And then decide whether it’s played out fully or not. There’s no rule that says you should hold a stock for seven weeks, seven months, or seven years. It all depends on why you bought it.

If you bought the stock to flip it at a higher P/E – and it’s seven weeks later and the stock is up 25% – I can’t blame you for selling so soon. But if you bought the stock because you loved the competitive position and the constant buybacks and the rising dividend – and you’re selling it within a year – I don’t think you’ve let your original idea play out.

So unless you buy stocks using nothing but a formula, you won’t be able to sell stocks using nothing but a formula. You’ll need to revisit your original idea.

Time Value of Money

The time value of money principle must first be grasped in order to have a solid foundation in finance. Time value of money can be calculated as:

  1. Present value – Current worth of a future sum of cash given a specified rate of return.

Present Value = Future value x [1 / (1 + interest)]^time

  1. Future value – Future value is the value of an asset or cash at a specified date in the future.

Future Value = Present value x (1 + interest)^time

Example:

Assuming that a bank pays an interest of 10%, if I deposit P100 now, how much will it be next year? Answer is: P110 [P 100 x (1 + .10)].

P110 is the future value of your 100 pesos deposited now in the bank that pays 10% interest.

Assuming that current interest to borrow cash is 10%, if Jose approached you and offered you P110 after 1 year, how much will you give him today for a future value of P110?

Answer is: P100 [P110 x (1/1.10)]

P100 is the present value of 110 pesos to be received in the future.

To further illustrate:

The Present value simply discounts the future interest income to be earned hence the term ‘discounted’ in Discounted Cash Flow (DCF) Method of valuation.

There are only three approaches to valuation: Relative valuation, Contingent claim valuation and DCF valuation.

Everything A Beginner Stock Investor Needs To Know!

There is so much you need to learn in stock investing and the first question that would come to your mind would probably be: WHERE DO I BEGIN?

Luckily, there are plenty of helpful website available in the net.

For beginners, please visit this website:

http://www.pseacademy.com.ph/LM/p0/investors~reading/l-beg/k-all/Beginner.html
And shoot all your questions in this blog or in “Newbie Corner by michelli.”

Happy investing!:)

Financial Literacy

We all know the importance of financial literacy. I can still remember years ago when I do not know where to start learning it. I do not know anybody who can offer me that information. What I did was surf the net and just look for anything that has something to do with finance. If you are like me, let me cut short your trouble in finding it.

Please visit this blogger’s illustration of what you need to learn in achieving financial literacy.

7 Pillars of Financial Literacy

Introduction to stock market investing

Hello reader! You probably have an idea how profitable it is to invest in the stock market but investing in stocks is not an activity where you could be a millionaire overnight.

Some common misconception in stock investing are:

  1. The time horizon in stock investing.
  2. Stock market is unpredictable! I could lose all my money!
  3. You need to be rich, super intelligent and spend a lot of time in stock investing.

Time horizon in stock investing

One critical mistake that most people do is treating the stock market as a slot machine or any form of gambling; they invest in the hopes of doubling their money in a short time such as 6 months or even 2 weeks after they invested. Although some would claim making money using this method (and we here respect that) conservative individual investors should not invest their money which they would need in the next three years.

The stock market may fall more than 40% from their current value. Just this 2008, JFC fell from P50 on September 2008 to as low as P35 by the end of November, a decline of 30%. Should you panicked and sold your shares at a loss you could have missed it bouncing up to P70 by June 2010 making a substantial gain of 40% should you purchased it P50 per share.

Stock market is unpredictable! I could lose all my money!

Yes stock market is unpredictable and I believe that no one can predict where the market would be going in the next few days. But hey! We are not to predict the whole stock market! We are only to worry about the stocks we invested in. With the basic fundamentals (to be discussed on a later date) your investment should be doing good and the risk involved would only be minimal.

You need to be rich, super intelligent and spend a lot of time in stock investing.

How well you invest in stocks will depend on many factors and none of them depends on whether you are rich, super intelligent, or with fancy software. It depends solely on what you already know. If you love fast food and your nephew Juanny craves for Jollibee; who could be in a better position to predict the rapid growth of Jollibee foods corporation (JFC) but you. You love the chocolate coated Pretzels, the healthy snack Nova, and the refreshing taste of C2; who would be in a better position to analyze (URC) but you. You could have reaped substantial gains should you acknowledged that you experience their products first hand. JFC more than quadrupled its value from P20 on April of 2004 to its current price as of this writing of P88 and URC more than quintuple its value from 8 pesos on January 2009 to about P47 as of this writing.

Happy investing!

Why do people buy stocks?

Everyday millions of stock/shares are traded in the PSE (Philippines Stock Exchange) but a question would arise, why do they do that?

An individual can participate in the stock market in three ways by, investing (investor)speculating (speculator), and trading(trader).

Let’s start with trading, an individual trading is called a trader, a trader attempts to take advantage of a small price increase that would occur in a day. A trader treats stocks as a mere paper that transfers from one hand to another. A trader holds shares for a short time like a week, days, or even less than a day.

speculator is an individual taking great risks for a potentially great reward. The difference between a speculator and an investor has been a thin line. Mr. Benjamin Graham, the dean of security analysis and author of the famous books like Security Analysis and The Intelligent Investor, defines a speculator in his book the Security Analysis, to paraphrase, as an individual having an investment operation not meeting the requirements of thorough analysis to promise safety of principal and adequate return. A good example would be to buy a company with no history of gain (speculating for a turnaround).

The third and last alternative is investing, the investor is an individual who had done thorough analysis in the company he/she is investing in and treating ownership of shares as being part owner of a company. An investor’s time frame is usually a few years or more.

The three types of individual above determine the prices of the market every day. They may bid (price they are willing to buy) high on shares that they are optimistic about or sell shares they think is unfavorable.

I do not claim or say that one of the three types of participant in the market is the best as each has their own advantages and disadvantages. No matter how they participate in the market, their purpose is to profit from the increase in the market value of their shares, from the dividend declared (cash distribution to share holders) or both.