Finance Concepts

Should I invest in stocks now?

Nitin Garg

Well, this is the thought I’m trying to answer myself now-a-days, looking at the mirror every morning

First question: Why is the economy slowing down? Well, my one line answer to it – it’s the fear among people that’s slowing down the economy, rather than the virus itself. I’m not going to write about these things and “hows” and “whys” related to it (there are ample amount of media articles floating in the internet), but I’ll come straight to the point

Should I invest in stocks now? How should I invest?

In my opinion, this is the right time to review my investment portfolio and evaluate the stocks I always wanted to invest in

  1. I’ll choose stocks across sectors. Warren Buffet says, “One should never put all one’s eggs in one basket”. This is a golden rule now. I’ll read about the sector(s) before I invest in it. I should be able to gauge “Why would this sector do well?” I always choose that sector which is going to grow for the next 5 years. (i) Research reports, (ii) Analyst reports, (iii) investors say about the sector, (iv) what Mutual Fund Managers are investing in, etc. can be a good start to understand the chosen sector
  2. Large-cap stocks / blue chip companies across sectors are the ones for me now. I’ve been eyeing such stocks for a long time, but didn’t invest in them because they were expensive. Now is the time these stocks gives me the opportunity to earn profits
  3. If I’m fearful of losing money, I’d invest in staggered fashion. For example, if I want to invest INR 1,00,000 in a banking stock, for example, I’d invest in it in a equated installment, say INR 25,000, over a four-month period, or INR 12,500 every 15 days till I reach INR 1,00,000. In this way, I invest through the ups and downs of the stock market
  4. I keep a “sell” target before I buy a stock. I hold the stock for a period and book profits once it reaches its target price. I keep a variation of 15% in the absolute price
  5. I’d start small, if I’m new to an industry. To make a safe bet, I’ll capitalize on the expertise of a Mutual Fund Manager, who invest in my chosen sector, and see how the return came up for him/her in the last 5 years. I’ll, then, try my hands on the direct equity route
  6. I invest in a stock for at least 3 years. Equity is not for short-term investment (one year or less), nor is it for parking the money
  7. I do not borrow money from individuals or financial institution(s) to invest in stocks. While sophisticated investors do so, I recommend retail investors to stay away from such a strategy, even if there is substantial upside in stocks. I’d liquidate my term deposits and invests in stocks

In a nutshell, I’m holding cash to explore how the market volatility turns up. I know many Fund Managers who are waiting to see how low the stock markets go, so that they can buy good stocks at cheaper price. If you are a first time investor in direct equity, taking the expertise of a good fund manager, by investing through 100% equity mutual funds, is a great way to learn the fundamentals of equity investing and achieve long-term capital appreciation.

Warren Buffet says, “Fearful when others are greedy and greedy when others are fearful.” This is the time to realize this statement. Fingers crossed!

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What is Enterprise Value? How do you calculate it?

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EVEnterprise Value (EV) or Firm Value is an economic measure that indicates the total value of a company. It measures how much an acquirer needs to pay to buy a company. It’s one of the fundamental metrics used in business valuation and portfolio analysis.

Enterprise Value is considered to be more comprehensive and accurate than market capitalization while valuing a business. It takes into account not only the equity value of the company, but also its debt, cash and minority interest. Market capitalization, on the other hand, includes only common equity (leaving out important factors like company’s debt and its cash reserves.)

Calculating Enterprise Value of a firm

Simply put, Enterprise Value is the sum of market capitalization and net debt of a company. Mathematically,

Enterprise Value = Market Capitalization + Debt + Preferred Stock + Minority Interest + Pension Liabilities and other debt-deemed provisions – Cash and cash equivalents – “Extra Assets” – Investments

Where,

  • Market Capitalization is the price of each share  x   number of common shares outstanding. So, if a company has 100 common shares outstanding with each share selling at $10, its market capitalization will be $1,000.

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Hybrid Security: Convertible Bonds and Convertible Preferred

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HybridAs the name suggests, the convertible bonds and convertible preferred (or convertibles, in short) are securities that offer the holder the option of converting them into or exchanging with a predetermined number of common shares in the issuing company. They are hybrid securities that demonstrated the features of both equity and bond. Convertibles are issued by a company (also referred to as borrower) when a lower interest rate or dividend is desired and the issuer is willing to suffer the potential dilution of the investor converting the hybrid into common equity of the issuing company. Also, refer my article Equity: Common Stock, Preferred Stock and Convertible Preferred here.

Historically, the interest rates or dividend rates on convertibles have been lower than that of a similar non-convertible debt. The investor funds the company with the believe that the value of the underlying stock, into which the debt will convert, will grow over a period of time to an amount that exceeds a market rate of return for the instrument. In other words, the investor receives the potential upside of the conversion into common equity while protecting the downside with cash flow from the interest payments and the return of principal amount at maturity. However, if the stock delivers an under performance, the conversion does not make sense and the investor is stuck with a sub-par bond rate.

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Equity: Common Stock, Preferred Stock and Participating Preferred

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stockA company’s equity capital is represented by common stock or preferred stock. A company can be capitalized with only common stock, but usually preferred stock is issued along with common stock. Both common and preferred stocks are entitled to receiving dividends, but where both of them are outstanding, preferred stock holders enjoy priority. Let’s understand the concept in detail.

Common Stock

Common stock is a type of equity security that represents an ownership in a company. It can be classified into voting shares and non-voting shares. The holder of a voting stock carries a voting right to elect Directors of the company and to vote company’s fundamental corporate activities (including M&A) and policies. A non-voting stock, on the other hand, has all the financial rights of the common stock, but is devoid of the power to choose directors or veto corporate transactions.

During liquidation, the common shareholders are entitled to receive residual claim on the company’s assets that is, they stand at the last behind all the corporate creditors and preferred shareholders for receiving the payment. When a company is forced into bankruptcy because of its inability to pay its obligations (debts), the common shareholders receive nothing. So, their returns are uncertain, contingent to earnings, company reinvestment, market efficiency and stock sale. Since their investment risk is high, common stockholders enjoy higher returns (with higher capital appreciation) compared to preferred stockholders when the company does well.

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What is Diluted EPS? How is it calculated?

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This article is Part2 of my previous article on Earnings Per Share. In this article, I’ll discuss Diluted EPS along with different methods to calculate it. You may want to review Part1 of this article on Basic EPS here.

Part2: Diluted Earnings Per Share (Diluted EPS)

Diluted EPS is one which is calculated after all the convertible securities are converted into common stock. If a company has convertible securities (that is, if the company has complex capital structure), its basic EPS is greater than diluted EPS. And, if a company has a simple capital structure, its basic EPS is equal to diluted EPS.

Calculating diluted EPS

There are three scenarios that arises while calculating diluted EPS: (1) Convertible Preferred Stock, (2) Convertible Debt, and (3) Employee Stock Options. Let’s discuss them in detail.

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What is Earnings Per Share? How is it calculated?

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Earnings Per Share (EPS), an input to Price/Earnings (P/E) ratio, allows the shareholder to calculate his/her share of the company’s earnings. EPS can be classified into two – Basic and Diluted. Calculation of EPS requires that we have information on the company’s capital structure – simplex or complex.

A company is said to have complex capital structure when its securities (like convertible bonds, convertible preferred stock, employee stock options, etc) are convertible into common stock, and a company with no such convertible securities is said to have a simple capital structure. The distinction between the two is important while calculating EPS because any potential convertible securities can dilute (i.e., decrease) it. That’s why accounting standards like IFRS require public companies to disclose both basic and diluted EPS on the income statement.

In this article – Part1, I’ll discuss Basic EPS and in Part2, I’ll cover Diluted EPS.

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What is cross-sectional analysis?

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Cross-sectional analysis (also known as relative analysis) is a comparison of a particular metric (available in any of the financial statements) of one company with the corresponding metric of another company within the same industry, or against the industry in which it operates in. The objective of such a study is to understand and derive the relationship between the two despite being different significantly in size, or operating in two different currencies. This type of analysis is generally used to measure a company’s performance, efficiency and effectiveness against its competitors and industry benchmarks.

For example, Company A has 15% of its total assets as cash, whereas Company B has 40% of its total assets as cash. Even though the size of both the companies are different (and also assume they are operating in two different countries with different currencies), they are similar companies operating within the same industry, but Company B is more liquid. The reasons for such liquidity can be to acquire a target or to make an investment in property, plant and equipment for operational efficiency.

Generally, analysts and investors (individual and institutional) take into account various financial ratios to compare companies. Leverage ratio, profitability ratio, liquidity ratio and solvency ratio are the most frequently used ones to judge a company’s performance.