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Stock trading has retained its appeal for new and experienced investors alike. Like all investments, trading involves some form of risk, stocks can be traded easily and lucratively once you understand how they work. Investing in stocks also offers a sense of ownership that comes with certain benefits for shareholders. Stock CFDs or CFDs in general, however, have certain advantages over stocks that are also worth exploring.
We’ve recently defined stocks in our ‘ETF vs Stock: What’s the Difference?’ article, so there’s no reason to go into it too deeply. But in sum, a stock is simply a form of equity broken down into shares, each of which represents your ownership in a company. For example, anyone who owns shares of Apple is technically a part-owner of the tech giant. How much of that company you own depends on how many shares you’ve purchased and currently hold.
On the other hand, a contract for difference (CFD) is a derivative product. In finance, a derivative is a contract that derives its value from the performance of an underlying entity or asset. The key difference between stock and contract for difference is explained in a guide to CFD trading by Plus500. In buying and selling CFD positions, there is no need to own the underlying asset. This means that you can’t go around boasting that you own shares of a company like Apple Inc., because a CFD doesn’t afford you that right. Instead, what you have is an agreement between yourself and a CFD provider, wherein you make predictions regarding how the value of the underlying asset (such as shares of stocks) changes over time. An increase or decrease within this period will result in gains or losses for a CFD holder.
Unlike stock trading, which looks at buying and selling prices, signing a CFD involves an entry price and an exit price. The entry price is the value of the underlying asset at the time the contract is signed, while the exit price is the estimated value of the underlying asset in the future.
In CFD trading, you can take two positions: the long position and the short position. A long position predicts that the value of the underlying asset will increase, which is indicated by a higher exit price and a lower entry price. In this case, the CFD provider will pay the difference. If the opposite happens, then the investor would have to pay the difference.
Conversely, short positions predict that the value of the underlying asset will decrease, so you’re betting against it. As a result, the exit price is lower than the entry price. If the value decreases, the CFD provider pays the difference. However, if the value increases, the investor pays the difference. Loss or gain depends on the asset’s price action in relation to the contract.
Unlike stock trading, CFDs come with leverage. This essentially means that the CFD provider can give you more capital than is currently in your trading account so you have more to trade with. However, this also means bigger losses when your speculations about the market go wrong.
The long and short positions are also lacking in stock trading. The Street’s feature on common investing mistakes points out that stock traders often become overzealous and believe that a company’s value will not decrease — especially if it’s currently doing well. Trading CFDs, however, allows you to take an alternative position, while also giving you access to a wider range of markets on top of stocks, like forex, commodities, and bonds.
However, FX Street’s list of common errors CFD traders highlights how research-intensive it truly is. Other than making market predictions, you also have to calculate the risks involved in trading CFDs, especially if you’re using leverage, which tends to magnify your gains and losses. This means that trading CFDs is not ideal for new investors, as it requires a lot more work than stock trading.
You’ve probably heard the terms before on CNBC but, if you’re a new investor, you might not know what they mean. However, Wall Street didn’t pull these terms out of thin air. In fact, they make perfect sense when you put them in context with their history. Bulls and bears have been battling it out on Wall Street for over a hundred years. To understand the stock market, you have to understand that it all comes down to bulls vs bears.
The stock market, bears are sellers. They believe assets are going down in prices, so they’re selling the stocks in order to make a profit. Often times bears use shorts in order to generate profits from falling asset prices. Bearish is used to describe a negative perspective on asset prices.
Bear has been used to describe a negative outlook on asset prices since the 18th century. The usage originated in the early 1700s around the bearskin trade. In those days, trappers gathered bearskins and sold them to a middleman. The middleman usually had them sold before he even received them, so it was in his best interest if bearskin prices went down. Then, he could afford to buy more bearskins with his cash on hand and generate more profits. These middlemen were commonly referred to as bearskin jobbers and the usage gradually shortened to ‘bears’ over the years. The term stuck to describe a negative outlook on asset prices.
Shorting is very similar to the aforementioned bearskin business. First, short-sellers enter an agreement to borrow shares, usually from their broker, for an agreed-upon price. They immediately take those shares and sell them on the open market. Now, they have cash in hand but they still have to repay their broker for the shares they borrowed. If asset prices go down, they can buy back the shares for less then they paid and keep the price difference.
For example, I’m a short-seller and I borrow 10 shares of Stock A for $10 per share. Now I have $100 but I have to return 10 shares of Stock A to my broker. If Stock A goes down to $8 per share, I can buy 10 shares on the open market for $80. Then, I return the 10 shares of Stock A to my broker and I’m left with $20 in profits.
Unfortunately, short-sellers are on the hook for unlimited losses if asset prices go the other way. You can actually lose more money on a short than you put into the trade. Once you short shares, you have to pay your broker back with shares. You can’t say, “nevermind, here’s your money back.” Your broker will only accept shares so – if Google suddenly buys out Stock A and share prices sky-rocket to $100 per share – you’re on the hook for a huge loss. You would have to buy back 10 shares at $100 each for a total of $1,000 dollars. Wham, you just lost $900 on a $100-trade. Only experienced traders should mess around with shorts.
In a bear market, asset prices are heading lower. Short sellers and bears want the market to go down, so things are going their way when the market is declining. Specifically, a bear market occurs when asset prices fall by 20% or more. If you ever hear someone say “bear market territory”, they’re probably referring to the 20% benchmark.
A sell-off happens when a large volume of stocks or other assets are sold within a short period. Major sell-offs significantly push down asset prices. For bears, sell-off is a good thing as they can profit from the resulting price decline of an asset since they take short positions.
Put options represent a contract that gives the holder the right to sell a round lot of shares at an agreed-upon price. Usually, put options indicate a bearish perspective on the underlying asset. If share prices go down, put values usually go up. Since it’s an option contract, there is no obligation to actually convert on the contract. Unlike shorts, potential losses can’t exceed the price of your position.
If you buy $10 puts for $1 apiece, you have the option to sell 100 shares for $10 each. If share prices go down to $8, you can convert your option into shares for $800 and sell them for the agreed-upon strike price of $10 each. You would net a $200 profit on this trade.
Alternatively, you could sell your put contracts on the open market and collect the contract premium. If share prices went down to $8, the price of $10 puts might go up to $3 each. Then, you can just sell your put contracts for a total of $300. In this scenario, you paid $100 for the lot, so you’d collect a $200 profit.
Like any other option, put options have an expiration date. They also suffer from time decay, so prices tend to go down as the expiration date draws closer. All options become worthless after their expiration date, so traders need to sell them or convert them beforehand or they’re beat for their profits.
Bull eventually evolved to describe the opposite end of the bearish perspective. Bulls believe asset prices will go up and they’re optimistic about the market’s general outlook. Bullish traders buy stocks with the belief that they’ll be worth more in the future. Then, they can sell them for more than they paid in order to generate a profit.
The ‘bear’ term appropriately evolved from an actual historical market phenomenon, but the origins of ‘bull’ are more figurative. This term came around after ‘bear’ came into common usage. Many experts believe that it became popular because the bull was widely regarded as the bull’s arch-nemesis in the 18th century. This perception may have originated from the practice of bull-and-bear fights, a popular blood sport that pitted the two animals against each other in a blood sport.
Longs are the bullish equivalent of shorts. They describe traditionally buying an asset and holding it to sell for a profit at a later date. This is the usual approach for beginners and it involves fewer complexities than shorting. Simply buy the stocks you think will go up and sell them for a profit when prices increase. When you buy any type of stock or other assets, you are in a long position. Sometimes, traders will simply say, “Right now I’m long Stock A”, meaning they’re holding shares of Stock A or options that will appreciate in value if Stock A goes up.
In a bull market, the prices of stocks or other assets are increasing and investors are optimistic about the future. Bull markets can last for months, years, or even decades. The stock market is currently in a long-term bull market that began in 2009, over ten years ago. This is an unusual case because it’s the longest-running bull market ever recorded, but it shows that there is no limit to how long a bull market can run.
A short squeeze is a situation whereby a heavily shorted stock, cryptocurrency, or commodity, surges significantly higher. This is a bullish situation as it forces the short sellers to close out their positions, leading to further upward pressure for the asset.
Short sellers are squeezed out of positions and in most cases, they lose. A short squeeze usually occurs because of some positive developments that indicate the price of an asset is set to go on a Bull Run.
A call option is a financial contract that gives an investor the right to buy a stock, commodity, or any other asset at a set price within a specific time. However, the call option holder has no obligation to purchase the options.
When shares go up above the strike price, the option holders can “call” the shares for a profit. Conversely, they can sell the actual call option to another investor and generate profits on the face value of the call option.
Bullish vs bearish is the setting for all price movements. The battle between these sides dictates the market. When bears outnumber bulls, share prices go down. When bulls outnumber bears, prices go up. This is the fundamental concept that drives stock market investing. If there were no bulls or bears, asset prices would never change. This difference in perception drives action and makes it possible for speculative investors to profit.
If you’re ready to learn more about trading, you should sign up for Stock Dork Alerts. Our reports can teach you everything you need to know to start making money in stocks. Sign up today and get our 2020 Growth Stock Guide as our thanks for signing up. It’s totally free and there’s no obligation, so sign up and claim your free guide today
Making money in the stock market involves two critical actions; buying and selling. Timing those decisions is the key to successful trading, however, it’s one of the hardest skills to master. Mastering when to sell stocks can take years of practice, but there a few quick tips that can help you improve your timing.
Traders only make money when they sell a stock for a profit. If you’re holding stocks that are up, your gains are only potential profits until you sell. This brief guide will give you a better idea of when to sell and how to go about it.
Buying stocks is practically effortless, but it can be hard to let go. Traders can get attached to their positions for various reasons, including greed, excitement, and other emotions.
However, traders can’t stay in a position forever. They need to sell their stocks to make a profit. It sounds simple, but perfecting the timing is no easy task.
There are countless reasons why you might want to sell a stock. These are a few common reasons that might make you want to sell.
If business fundamentals start to go downhill, it might be time to start planning your exit. You can spot trouble by following earnings reports and company press releases. Any signs of stress on revenues, earnings, debt levels, or other key operational metrics could indicate that a company is headed for trouble. While fundamentals don’t always align with stock prices, they can be a valuable warning signal that company operations are taking a turn for the worse.
If you have a healthy profit on deck, consider making an early exit if you see signs that a company is facing fundamental business declines.
In order to stay disciplined and stick to your plan, you should set target prices for your exit and entrance points. Before you enter into a trade, identify your sell limits. If it falls below your minimum price, you can sell to avoid further losses. Conversely, you should also consider exiting once you hit your profit target. You don’t have to sell everything, but you should at least take a portion of your position off the table once you hit your predetermined price target. Adhering to this practice will help you be a more disciplined, less emotional trader.
When a company starts cutting its dividends, it’s time to consider selling your shares. A dividend cut could signal big financial problems. If a company can’t afford to make its dividend payments, it could be having cash flow problems or much worse. This is a big red flag and a clear sell signal.
If you’re lucky enough to hit a home run trade, you could find yourself on a very profitable ride. However, you should know when it’s time to take the money and run. Stocks can’t go up forever, so you need to realize that you’re going to have to get off the gravy train eventually. If you wait around too long, you could be stuck holding the bag when it comes back to Earth.
Don’t be greedy. If your position doubles in value over a short period of time, you should at least take half off the table. That covers your initial investment, and the rest is house money. Consider using a trailing stop-sell to exit your positions automatically if share prices start to pull back.
If you really like the stock, you can always buy it back on a dip. Be smart and sell if you’re rocket-ship trade looks like it’s running out of gas.
Sometimes, a company’s valuation gets significantly higher than its competitors. When a stock is on a rally, its P/E ratio can easily get out of line from its peers. It’s not uncommon for this to occur naturally because traders are willing to pay more for the best companies. As a result, it’s not a code-red sell signal. However, if a P/E ratio significantly exceeds its historical or industry averages, it could be a signal to sell.
As your positions gain in value, they can become disproportionate segments of your overall portfolio. You might have to sell and shift capital to other investments in order to maintain balanced allocations. This practice is called rebalancing your portfolio, and it helps reduce risk and maximize your chances at steady gains.
Timing is one of the most important aspects of investing. If you want to trade, you have to know when to sell stocks and when to buy them. It’s not an easy art to master, but practice makes perfect. However, it makes it a lot easier to spot the best time to sell if you research your trades and stick to your game plan. Sign up for Dork Alerts to get regular updates on market activity and trade tips that can help sharpen your skills. Click here to sign up now and get our 2020 Growth Stock Guide for free.
Virtually everyone knows what unemployment means or what it stands for. However, several different factors contribute to the overall unemployment rate. One reason for overall unemployment is regular fluctuations in economic activity that result in cyclical unemployment.
Cyclical unemployment is practically unavoidable due to its close correspondence with economic activity, but understanding how it works can give you an investing advantage.
Cyclical unemployment is a type of unemployment that occurs when the overall demand for products and services in an economy doesn’t support full employment. Cyclical unemployment usually occurs during periods of slow economic growth or during economic recessions.
Cyclical unemployment relates to growth and production cycles within an economy. These cycles regularly fluctuate back and forth. Expansions turn to recessions, recessions than recover into expansions, and so on.
According to economists, cyclical unemployment occurs because there is a lower demand for labor. During a downturn, employers often can’t afford to hire new people because their profits are being squeezed by the recession.
When the economy takes a downturn, there is less demand for products and services. As a result, the supply side reduces its production capacity. As production capacity is reduced, there is less need for labor. Surplus employees are usually laid off and subsequently join the ranks of the unemployed.
Unfortunately, this problem tends to compound itself. Rising unemployment rates tend to add to the economic despair of a recession. As more people lose their jobs, there is less money to buy goods and services, so it puts more stress on the demand side of the economy. In turn, falling demand adds more pressure to the supply side and so on. Eventually, it leads to further declines in economic activity.
A famous example of this type of unemployment is the housing bubble of 2008. Following the housing bubble and the Great Recession of 2008, more borrowers couldn’t pay up the debt obligations connected to their homes. As a result, new housing loans became harder to get and demand new construction dropped.
The drop in new construction further led to a decline in the number of workers. Due to the recession and borrowers unable to meet up with their obligations, around 2 million workers in the construction industry were out of jobs. This is a typical example of cyclical unemployment.
The economy began to recover over time, and more loans were made available to people. Thus, people began to build new homes, offices, remodeling, and more. The construction jobs returned to meet the increase in real estate demand. Thus, resulting in the decline of cyclical unemployment.
According to economists, there are several types of unemployment. A few examples include structural, frictional, and institutional unemployment.
Frictional unemployment is a short-term loss of a job as a result of transitioning between one job and another. Structural unemployment is a result of the fundamental shifts in the composition of an economy. Meanwhile, institutional unemployment comes from institutionalized obstacles to employment, such as unionization, minimum wages, discriminatory hiring process, and more.
All the different types of unemployment factor into the overall unemployment rate. They can all occur simultaneously, even during an economic expansion. Understanding the factors behind the unemployment rate can help you get a better take on which way the economy is heading. These insights are extremely valuable for investors, and having that kind of foresight can generate big returns.
Cyclical unemployment results from regular swings in the business cycle. However, it’s only one of the forces that factor into the overall unemployment rate. Modern economies are very multifaceted, so cyclical unemployment can occur during an expansion too. For example, one industry or sector can undergo a recession while the overall economy expands. It’s important to understand the factors that drive the employment rate if you want to be a prudent long-term investor.
To learn more about the economy and cyclical unemployment, sign up for free Dork Alerts. The Dork has all the latest stock market news, in-depth analysis, and much more. Our reports are fun, informative, and easy to read. Sign up today and get a jump on the New Year with our 2020 Growth Stock Guide, it’s yours free when you join. Click here to join and claim your free copy now.
Robinhood is one of the most popular stock trading apps on the market. However, many Robinhood users are new to trading. If you’re a beginner who’s getting more confident in their trading abilities, you may be interested in shorting stocks. The obvious question is, what is the deal with Robinhood shorting?
Here, we’ll explain how short selling works and show you exactly how you can use Robinhood to make money when stocks fall.
Robinhood is an innovative and disruptive platform in the online brokerage industry. The company, which was launched in 2014, has a mobile app that allows customers to buy and sell stocks, ETFs, cryptocurrencies, and other assets without paying a commission.
This app caters to new investors. Since it’s designed for beginners, Robinhood might not have the robust features that active traders need to support advanced trading strategies. However, if you’re not a professional day trader, it probably works well enough for most. It can handle basic day-to-day transactions, and the company is in the process of rolling out new features, like cash management and fractional share trading.
If you sign up for Robinhood now, you can get a free stock if you use this referral link.
Shorting or short-selling is a scenario when a trader or an investor borrows stocks and sells them right away with the hopes of buying them at a lower price in the future. When he/she buys them at a lower price in the future, the trader will return the shares to the borrower and pocket the difference.
Short-selling stocks is riskier than buying them. When you short, the potential for loss is limitless. If you’re holding a stock in a traditional sense, also known as a “long” position, the worst that can happen is share prices go to zero and you lose all of your principal investment. However, with shorting, you’re losing money if prices go up, and there’s no limit to how high a stock’s price can go. As a result, there is no
The simple answer is No. At the moment, there’s no Robinhood shorting. The free-trading app doesn’t support short-selling stocks on its platform. This could be because Robinhood supports passive short-term or long-term investors rather than active traders.
In addition to not supporting shorting, Robinhood lacks several features that active traders can use to trade stocks. Thus, the reason why Robinhood appeals more to beginners and not active day traders.
A few other free trading apps such as Webull support shorting stocks on their platforms. You can read more about the comparison between Webull and Robinhood here (link to Webull vs. Robinhood article).
While Robinhood doesn’t support short-selling, it allows buying put options. This is another more multi-dimensional way of shorting a stock. While some investors can use this method, it is not the same as shorting stocks. There are several factors that influence option prices outside of share prices, so predicting price movements can be complicated for the uninitiated. If you’re not comfortable trading options, this might not be the best course of action.
You can also use Robinhood to buy inverse ETFs. These funds are built on shorts, so they go up when the underlying index goes down. Since it’s an ETF, you can’t micromanage your holdings. However, it’s a viable alternative to selling short.
Robinhood is one of the leading zero-commission stock trading apps available to traders and investors. It doesn’t support shorting stocks at the moment, but there are some viable alternatives that allow traders to make bearish bets. Put options and inverse ETFs are available on Robinhood, and they allow users to capitalize on bearish price action.
To find out more about Robinhood and other zero-commission stock trading apps, sign up for Stock Dork Alerts. The Dork has all the latest stock market news, in-depth analysis, and much more. Our reports are fun, informative, and easy to read. Sign up today and get a jump on the New Year with our 2020 Growth Stock Guide, it’s yours free when you join. Click here to join and claim your free copy now.
The Finviz stock screener is currently regarded as the best by most traders. Despite its popularity, some traders still don’t know how to use Finviz stock screener to their advantage. The tool provides traders with a lot of information about stocks.
The usefulness of the tool makes it essential that you know more about it. Here, we will discuss how to use Finviz stock screener properly.
A stock screener is a tool that searches through a wide array of stock data and churns out a list of stocks that match the criteria inserted by the trader. Stock screeners allow to search for stocks according to category.
Finviz is an acronym for ‘Financial Visualization.’ The Finviz stock screener is one of the largest and most widely used in the world. Finviz allows people to search for specific stocks according to certain criteria. You can search for stocks based on their market caps, industry, exchanges they are listed on, country, P/E, and a wide range of other options.
You can search for stocks on Finviz based on the following;
Descriptive: the descriptive criteria on Finviz include options such as average data, IPO date, dividend yield, market cap, sector, and more.
Fundamental: the fundamental criteria covers areas such as P/E ratio, dividend payout ratio, PEG ratio, etc.
Technical information: the technical criteria churns out stocks based on information such as 200-day moving average, 52-week high/low, RSI, and other technical analysis terms.
Note that you’re getting quotes delayed 15 minutes for NASDAQ and 20 minutes for NYSE and AMEX.
Finviz.com is one of the easiest stock screeners you can use. They have a wide range of criteria available, which makes it easy to narrow down the stocks you are searching for. Although it may take a while for the first time user. Here is a guide on how to use Finviz to get the best results.
The first step to using Finviz is to visit their homepage and click on the ‘screener’ tab. You can find the ‘Screener’ tab at the top page of the website. On the lower section, you’ll find the latest insider trading.
After navigating to the screener section of their website, you will need to select the criteria for your stocks. You can choose descriptive, fundamental, or technical measures. Finviz also allows users to choose all three criteria which will display all the screening options available. With fundamental filters, you can choose stocks based on EPS growth grate and other financial ratios. Technical filters are based on price, recent performance, etc.
You can select the different criteria available. Some of the most popular standards include sector, exchange, market cap, dividend yield, P/E, Target Price, Country, Industry, IPO date, Relative Volume, and more.
The overview offered by Finviz gives you the overall details of a stock. However, you can choose to see particular information such as the valuation of the stock, ownership, financial, performance, technical data, charts, tickers, basic, TA, stats, and snapshot.
After selecting your criteria, Finviz will proceed to showcase a list of stocks that fit what you are searching for. Having a few stocks to analyze is better than the thousands available to look into.
The final step is to digest the results from the search. You can pick the stocks that fit what you are looking for and go from there. If you are looking to invest in a computer, we advise that you have some understanding of what they do, their business model, economic barriers, and other crucial information.
Making sense of the market is never easy. After all, there are tens of thousands of securities one could trade. Who has time to get intimate with all of them? In this finviz review, you are going to learn exactly how to use finviz to find the best stocks to trade!
Trading has become a game of speed, a competition on who can act on new information the fastest. Traders who make use of tools like stock screeners and alerts allow themselves to process information and organize thoughts quicker. There are plenty of stock screeners to chose from, but I prefer using finviz.com.
It’s a web-based platform, and free to use. Some of its most useful features include quotes, charts, screening, and top insider trading.
However, if you register for free you’ll unlock more features like customizing layouts, screener presets, and creating a portfolio. If you want to upgrade your Finviz experience, join thousands of traders in the paid version called FINVIZ*Elite. It features real-time quotes, advanced visualizations, backtesting, and much more. Also, it has fundamental charts, and the ability to set email alerts, as well as, all the features in the registered version. Premium features, real-time quotes, more insider info, and other advanced trading functions will allow a trader to get the best out of this screener.
Source: finviz
Now, a lot of useful information can be picked up just from the home page. For example, at the top, you’ll see how the major indices are doing. Below that, are the largest gainers and losers on the day. If you look to the right, you’ll see a heat map, the giant red in AMZN, AAPL, GOOGL, and FB tells me that the NASDAQ and tech are weak. Below the heat map is a list of stocks that have a change or something.
You can catch up to speed on insider trading and the market’s daily activity from the home page.
Day-traders need volatility more than anything if they want to obtain money in the stock market and in this finviz review I want to point out exactly how to use the stock screener to lock on to good trade ideas. The typical trading day starts hours before the market opens. Day-traders spend their pre-market time reading morning research reports. Of course, they are also looking at the pre-market movers. If a stock is moving in the pre-market, there is a good chance its because of news or a corporate event like an earnings release.
The Top Gainers & Top Losers signals on the home page are great for day-traders looking for trading fast-moving stocks.
You can get into greater detail by switching to the top gainers’ signal and viewing a snapshot.
Source: finviz
Here we can see a chart of Therapix Biosciences Ltd. (NASD: TPRX) along with key data about its fundamentals and how it trades. For example, we can see that the average trading volume is 288K shares, but on this day the stock traded more than 788K. The stock jumps to 52-week highs on above-average trading volume, a healthy sign for the bulls.
Source: finviz
Now if you look at the headlines, you’ll see that it is involved in medical cannabis, a fast-growing sector in the economy. Scroll further down, and you’ll see that the company signed an LOI to be acquired by FSD Pharma Inc. (OTC: FSDDF) on October 22.
What should the stock price of Therapix be right now according to the terms of the deal? Will investors approve the deal?
These are the types of questions an advanced trader might have. On the other hand, some may ignore the reports and primarily focus on the price action. They might be asking questions like– Is the stock overbought here or does it have more room to run?
Source: finviz
Day traders like to focus on stocks that are making significant moves on above-average trading volume, and this one fits the bill. You’ll be able to create a watchlist easily if you scroll through the top gainers and losers. For example, there is usually a second-day trade which can be made. Check out TPRX the following day.
For the most part, day traders focus on stocks that are in reports or are experiencing above-average volatility or change. Two of the most popular day trading strategies is trend trading and reversal trading. Trend traders go with the momentum, while reversal traders go against it.
For example, if a stock is gapping up higher, a momentum trader will buy the stock with the idea that it will continue to trend higher. On the other hand, the contrarian or reversal trader will short stocks that are trending higher and buy stocks that are selling off.
When a company issues a press release, it is presenting new information to the market. That said, traders are trying to decipher those reports in real-time and what its impact is on the stock price.
With finviz.com, you can do quick scans for stocks that could be poised for big moves so you can get earnings at an early time with your trading.
Jones Energy, Inc. (NYSE: JONE) announced after the close on Nov 6 that it appointed two new independent directors to the company. This was viewed as bullish because the company has been struggling and maybe some new blood can shake things up.
The following day, the stock spiked to the upside.
One of the worst-performing stocks on the year, the bounce in Jones Energy stock could imply that more positive catalysts are on the way.
Regardless, the company had a 21% short interest. In other words, 21% of the stock float has been loaned out and shorted. Generally, when a heavily shorted stock has a positive catalyst, it creates a “short squeeze.”
A short squeeze occurs when the shorts are forced to cover their position, adding further buying pressure to the stock at the current time.
The beauty of finviz.com is that it allows you to create watchlists. For example, here is one that highlights stocks that have high short interest:
You even have the option to sort out stocks that have had reports over the last 24 hours time.
Do this in the pre-market, and you’ll have a solid list of short-squeeze candidates for the day.
Finviz is a powerful and affordable tool that investors and traders can use to make more informed decisions. It has features that allow you to sort out stocks by its financials, technicals, valuation, and much more. You can also get insider info, idea generation, do backtesting, etc. Note that backtesting is an advanced option that’s available on the premium version features.
But whether you choose the free or premium version, Finviz.com is excellent for creating watchlists and getting caught up with the day’s action. Check it out for free and see for yourself.
The Finviz stock screener is one of the most widely used stock screeners by traders and investors due to the features it provides. If you’re ready to know more about stock screeners, you should sign up for Stock Dork Alerts. We offer a steady stream of stock market reports and analysis that will help keep you informed on everything happening in the world of Wall Street. Plus, our reports are written in plain English, so they’re easy to understand. After just a few weeks reading Dork Alerts, you’ll sound like the smartest guy at the water cooler. Sign up today and get a jump on the New Year with our 2020 Growth Stock Guide, it’s yours free when you join. Click here to join and claim your free copy now.
As an investor, knowing terms related to the investment world is essential as it helps you understand what companies are up to. One such word is the Retained Earning Formula. The term is used predominantly in the investment world and carries a lot of weight.
For those who don’t know the term, this post will discuss Retained Earning Formula and what you need to know about it.
Retained Earnings (RE) refers to the amount of net income remaining for a company after it has paid out dividends to its shareholders. In general, companies generate either positive or negative earnings.
When they generate positive earnings, they have the opportunity to utilize the surplus money. In most cases, companies share the funds to shareholders or use it for growth. The funds not paid to shareholders is usually regarded as retained earnings.
To calculate the Retained Earnings of a company, use this formula:
RE= BP+ Net Income (or Loss) −C−S
In this case;
BP stands for Beginning Period RE
C stands for Cash dividends
S stands for Stock dividends
In full, the formula goes like this:
Retained Earnings = Beginning Period RE + Net Income/Loss – Cash Dividends – Stock Dividends
The Retained Earnings Formula is a calculation that obtains the balance in the RE account as the end of a reporting period. The RE is usually converted to working capital, an asset for the company, or used to pay down outstanding liabilities by the company.
In a scenario, a company generates excess income, some long-term investors of the company could expect regular income in the form of dividends. This is their reward for investing in the company. For short-term traders, they might get dividends that will offer instant gains.
When companies share excess income, they usually do so with dividends. This is because dividends are tax-free income in most jurisdictions, while profits on stocks are subject to taxes. However, the company can decide that it has better use for the excess money.
Usually, in this case, the management reinvests the excess funds and pay higher dividends to shareholders in the future.
The surplus money from a company can be utilized in various ways.
Management decides what to do with retained earnings. They can choose to pay investors through a dividend, reinvest it into the company, or settle debts.
Executive leadership usually allocates these funds because they have a better knowledge of the market. However, sometimes shareholders have the opportunity to vote on the matter.
In most cases, the management of a company takes a balanced approach. They pay investors a certain amount as dividends while the remaining Retained Earnings are used to boost the growth of the company.
The Retained Earning Formula is a crucial term for investors to know as it allows them to keep track of company activities. If you’re ready to know more about Retained Earnings Formula and more, you should sign up for Stock Dork Alerts. We provide a steady stream of stock market news and analysis that will help keep you informed on everything happening in the world of Wall Street. Plus, our reports are written in plain English, so they’re easy to understand. After just a few weeks reading Dork Alerts, you’ll sound like the smartest guy at the water cooler. Sign up today and get a jump on the New Year with our 2020 Growth Stock Guide, it’s yours free when you join. Click here to join and claim your free copy now.
Over-the-counter stocks are don’t trade on major exchanges like the NYSE and NASDAQ, so accessing OTC stocks can be more difficult. However, once you find a broker who offers access to OTC stocks, the buying and selling process is pretty much the same.
In this short post, we’ll explain OTC stocks and show you how to trade them.
OTC stocks are stocks that don’t trade on regulated exchanges. Often times, OTC stocks are high-risk, high-reward investments. Traders can buy a huge quantity of shares with only a small investment. If the company becomes successful, investors make huge profits from a small stake in the company.
Most companies trading on OTC markets are known to have massive potential because of new technology, the product they roll out, or other activities they carry out. However, because these companies don’t divulge much information, investors don’t really know much about their activities.
You should know that OTC stocks are usually riskier compared to other stocks. Treat them as speculative investments and strategize appropriately. Don’t invest anything that you are not willing to lose.
The second step is to find an appropriate broker. Most major brokers offer OTC trading. However, smaller brokers like Robinhood and Webull don’t offer access to OTC stocks. Look for a broker that offers OTC stocks with no trading fees.
Once you’ve opened your brokerage account, it’s time to fund it. Deposit your investing funds and get ready to buy. Be aware that some brokers charge a deposit fee, but most reputable brokers do not. Use an ACH transfer from a US bank account to minimize fees. Funds should be available within a few business days.
Buying OTC stocks is pretty much the same as buying exchange-listed equities. Once you type in the ticker and find the stock you want, all you have to do is press buy and enter your order. The process is pretty much identical. Just enter the ticker symbol and go.
As long as your broker offers OTC stocks, this part should be easy. If you can’t find the stock you’re looking for, your broker might not offer OTC trading. You’ll have to double-check with customer service to make sure.
Most times, you can still use your broker’s full arsenal of trading options and tools. However, be aware that data can be limited for OTC stocks. You might not have access to all the analytics you’re used to using. Sometimes, the charts might seem choppy or there might not even be a chart available. You might have to do some digging to access the data you’re looking for. Remember, OTC stocks can vary depending on where you’re buying them, so it’s hard to find universal price data.
Pay attention to volume and liquidity. Look at the spread between the buy and ask prices on the order book. If there is a wide gap between them, you could run into problems when it comes time to exit your positions. Always be careful when purchasing low-volume, low-liquidity OTC stocks.
OTC stocks can be great speculative investments for traders with a decent appetite for risk. If you’re ready to take a deeper dive into OTC stocks, you should sign up for Stock Dork Alerts. We write Dork Alerts so they’re fun, informative, and easy to understand. Best of all, they can help you become a better trader. Sign up today and get a jump on the New Year with our 2020 Growth Stock Guide, it’s yours free when you join. Click here to join and claim your free copy now.
ETFs and stocks have very similar attributes. Unlike mutual funds or other financial instruments, ETFs and stocks can easily be liquidated and traded. However, there are a few key differences when it comes to ETFs and Stocks. Pay close attention, because we’re about to look at ETF vs. stock and explain all the key differences.
ETF stands for exchange-traded fund (ETF). Depending on the fund’s strategy, each holds a variety of underlying assets, such as stocks, bonds, options, or other investments. When you buy a share of an ETF, you’re essentially buying a small piece of each of the fund’s assets.
Although ETFs and mutual funds are both funds, there are a few key differences. Unlike ETFs, Mutual funds don’t trade freely during the day. Mutual fund trades are settled at the end of the session, so it’s a lot harder to capitalize on short-term price movements. Some mutual funds also require minimum investments and restrict sales, so they are much more cumbersome financial vehicles than ETFs.
Conversely, stocks and ETFs trade actively throughout the day. To offload ETF shares, traders simply put in a sell order while the market is open. Buying shares is a similar process. There are no minimum investments with ETFs either. If you have enough to buy a share, you can invest.
Ultimately, ETFs are much more flexible than mutual funds. In fact, most traders view mutual funds as antiquated financial tools. While they still serve some useful purposes, they have largely been overtaken in popularity by ETFs.
Stock is also called equity, and each stock is broken down into individual units called shares. Each share represents an ownership stake in the underlying company. Investors holding company stock effectively own a tiny portion of a company, and they’re afforded certain rights as shareholders. Some shareholders are entitled to dividend distributions, others have voting rights when it comes to major company decisions. It all depends on the company and the type of stock but, ultimately, each share of stock represents an ownership interest.
Like ETFs, stocks trade on various exchanges. NYSE and NASDAQ are the most reputable, but there are also smaller exchanges and over-the-counter markets.
Usually, companies issues stock to raise capital. Basically, the company sells pieces of itself in return for cash, which it can use to finance whatever operations it has in mind. This is called equity funding and, depending on the situation, it can be a preferable alternative to raising capital by borrowing. However, when equity funding is used in excess, it can dilute shareholder value and be negative for investors.
Here are the significant differences between ETFs and stocks
Although they are different asset classes, ETFs and stocks have some things in common.
For ETF vs. stock, here are the pros and cons of trading each of them.
There are a lot of differences between ETF vs. stock, but they’re currently the most popular investment options on the market. They offer excellent liquidity and low barrier to entry, so they’re ideal for beginning investors.
To learn more about investing, you should sign up for Stock Dork Alerts. We provide a steady stream of stock market news and analysis that will keep you informed on everything happening in the world of Wall Street. Our reports are written in plain English, so they’re easy to understand. Sign up today and get a jump on the New Year with our 2020 Growth Stock Guide, it’s yours free when you join. Click here to join and claim your free copy now.
It takes a lot of hard work to be a successful penny stock trader. If you’re new to trading, you probably don’t know how to invest in penny stocks. That’s okay, everybody starts somewhere. If you want to learn how to trade penny stocks, you’ll have to do some homework.
Penny stocks are intimidating, even for experienced traders. However, there are huge profits in store for traders that can find the winners before the market gets hip to them. If you’ve never traded stocks before, you should probably get some practice before you start risking your hard-earned cash.
If you’re ready to start trading penny stocks now, you’re in the wrong place. Check out our top penny stock picks for our newest trade ideas. Our top 5 penny stocks list is updated monthly: https://www.thestockdork.com/penny-stocks
Stocks that trade for less than $5 are commonly referred to as ‘penny stocks’
Investors make simulated trades based on actual market data so they can hone their skills without risking any capital. Almost every professional stock trader on Wall Street had to practice with paper trades at some point in their career.
It doesn’t matter how much research you’ve done. The market is always ready to throw you a curveball. Some things can only be learned through experience. Paper trading allows new traders to gain experience without risking their cash.
Paper trading helps traders gain valuable experience without risking capital.
These days, you need more than a pencil and a pad to make realistic paper trades. Most modern paper trading is done with full-feature stock market simulators. These advanced programs provide 100%-realistic trading experiences.
Many brokers have paper trading options built into their platforms. Usually, you start with a set amount of “cash” in your account. Trade with your account just like you would a cash account. It’s a great way to realistically gauge your ability. Once you can consistently make profitable trades on paper, you can start thinking about making cash trades.
If you’re looking for a paper trading app, check out WeBull. The mobile app has a built-in stock simulator. Once you’re ready to trade for real, you can deposit funds and trade on the same exact app.
You can trade penny stocks on any broker. You can trade NASDAQ and NYSE-listed stocks through practically every U.S. broker. Even discount brokers offer access to exchange-traded funds. These are the most popular brokers for new traders.
If you’ve got a bigger trading budget or you’re looking for more stable companies, be sure to check out The Dork’s ‘Best Stocks Under 10 Dollars’ monthly watchlist.
Younger traders embraced Robinhood’s simplified trading platform and zero-fee accounts. Now, it’s one of the most popular mobile brokers. Robinhood users can trade exchange-listed penny stocks and select cryptocurrencies. Users can’t trade OTC stocks, bonds, or international stocks. Learn more about Robinhood penny stocks here.
WeBull offers similar market access to Robinhood. Users can trade stocks listed on major exchanges, including penny stocks.
If you want to access to the complete penny stocks universe, you’ll need a broker that offers access to over-the-counter markets. OTC stocks are some of the riskiest investments around, but many traders are willing to use them for speculative trades.
Full-service brokers offer access to alternative assets too. If stocks feel to risk for your needs, consider alternatives like bonds, mutual funds, and gold.
Robinhood set the trend towards zero-commission trades, and now the big brokers are following suit. Even the powerhouse brokerage firms are throwing out their trading fees. The competition is crazy in this industry, and that’s great for traders! These firms offer a full range of investment vehicles, including mutual funds, options, and OTC stocks.
Schwab was the first major brokerage firm to trash trading commissions, setting off a chain reaction that carried across the industry. Schwab offers a full suite of investment tools and free research reports from Morningstar.
Another popular discount broker, E*Trade has powerful technical analysis tools built directly into its trading platform. The followed Schwab’s lead and went to a zero-commission cost structure in late 2019.
TD Ameritrade also cut broker fees after the other major brokers made their move. TD Ameritrade has tons of research and education tools, including SinkorSwim education and options paper trading.
Finding quality penny stocks is difficult, but there’s an easy way to come up with a shortlist of picks that fit your criteria. Stock screeners help traders find new companies and investment opportunities. Stock screeners vary in sophistication and ability, but they all pretty much do the same thing. Professional-grade screeners are fully customizable and offer a variety of options, while more basic programs might only screen for a few main areas.
Finviz offers a free stock screener that has a ton of features. It’s a great tool for new traders. Signup is free and includes access to a powerful screener that scans all stocks listed on major exchanges, including the NASDAQ, NYSE, and AMEX. Although Finviz does not scan OTC markets, there is a professional version available that offers more comprehensive features. Click here for our full Finviz review.
The free Finviz stock screener has tons of filters. The categories mentioned in this article are underlined for your convenience.
Setting too many screener filters can be counterproductive. You can end up missing out on great opportunities or, worse yet, picking total losers based on arbitrary statistics. Figuring out which screens work best for your trading strategy takes time. That being said, you may want to consider using some secondary filters to further shorten your list.
That’s how to trade penny stocks. If you’re still lost, be sure to check out our full selection of penny stock trading articles. They have everything you need to learn how to trade penny stocks.
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If you’re just getting into trading, you’ve probably heard a lot of talk about penny stocks. However, the name is a bit of a misnomer. Penny stocks don’t cost a penny – not all of them, at least – but they are very cheap compared to the rest of the market. So, what are penny stocks anyway?
If you’re looking for this month’s best penny stocks, you’re in the wrong place. You can find this month’s top penny stock picks here.
Penny Stocks are Stocks That Currently Trade for Less Than $5 Per Share
You might be asking, “what are penny stocks?”. The answer isn’t as complicated as you may think and it actually doesn’t have anything to do with pennies.
Penny Stocks (n): A stock or security that is currently trading for less than $5.
That’s it. If a stock costs less than 5 dollars to buy, it’s considered a penny stock. Some very cheap options actually cost a penny, or even less, but these tend to be very risky stocks from small companies.
If you have a bigger budget for buying stocks, check out the Dork’s best stocks under 10 dollars.
Penny stocks are high-risk, high-reward assets that can make or break your portfolio. Despite the risks, these types of investments are extremely popular because of the incredible potential profit they can offer the average, low-budget trader. Buying a round lot of penny stocks costs a lot less than buying a round lot of more expensive stocks, so just about anyone with a brokerage account can afford to make moves.
However, none of these traits are universal. The only truly common characteristic shared by all penny stocks is a cost of less than $5 per share, but even that can change. Stocks oftentimes go up in price, and when a stock’s share price goes above $5 it loses its penny-stock status.
Now that “what are penny stocks” has been answered, let’s talk about risks.
All stocks carry risk. Some of those risks are foreseeable, but many are not. Every company has its ups and downs, but smaller companies don’t have the firepower to cope with adversity like larger blue-chip firms. If a small company hits a few bad quarters in a row, they might go out of business. Conversely, big firms often have enough cash to stay afloat, even if there is a prolonged crisis.
While all penny stocks present significant risks, some are more stable than others. If you want to look for options with the least inherent risks, screen for penny stocks that are listed on major exchanges.
Companies that want to list on the Nasdaq and NYSE have to meet strict regulatory requirements before they can get there. Once they’re on the exchange, they still need to comply with the listing standards. The regulatory hurdles help to keep out the riff-raff and ensure that every exchange-listed company is at least somewhat reputable.
If you’re willing to take a little more risk for the chance at much higher rewards, you may want to expand your search to include the OTC markets. OTC stocks comprise the vast majority of the penny stock universe so you will have to consider them if you want to really get into the game. Out of all of the OTC market, OTCQX has the highest listing standards so it’s a good place to start for beginners. Its standards are lower than Nasdaq or NYSE, but its better than nothing.
You need to do your homework if you want to trade OTC stocks. The listing requirements are pretty low, so the market is a breeding ground for ‘pump and dump’ scams. Make sure the company you’re trading is a real company, with real earnings, before you buy. If you get caught on the wrong end of a pump-and-dump scam, you can easily lose your entire principal investment.
Trading Penny Stocks Can Be a Risky Endeavor. Be Sure to Do Your Due Diligence.
If talking about all of these risks are starting to make your stomach turn, stocks might not be your best option. If you’re looking for safer investments, check out our post on top gold stocks. Gold is considered to be a ‘safe harbor’ asset because it tends to perform well in times of economic uncertainty.
Buying penny stocks is as easy as buying any other stock. If you’re using a discount mobile broker, like Robinhood or WeBull, you’ll only be able to access exchange-listed stocks. Learn more about WeBull on our WeBull review page. As of now, neither of these brokers offer access to OTC markets. However, you can still access all of the major exchange-listed stocks, including those trading for less than five bucks. There’s nothing wrong with sticking to exchange-listed stocks, but you’ll have to find an OTC markets broker if you want access to the full market.
To trade OTC markets, shop larger brokers like TD-Ameritrade and Schwab. These full-service brokers provide traders with access to a diverse selection of investments, including OTC stocks. Best of all, many of the big-budget, old-school brokers are dropping their trading commissions to zero. That means you can trade OTC stocks – or any of your favorite stocks – for free. Best of all, most of these brokers provide free access to expert research and analysis tools. However, most analysts don’t bother to cover penny stocks so there’s no guarantee that you will be able to find professional research reports for the stocks you’re shopping.
That depends. Ask yourself what your tolerance for risk is before you make any decisions. Expert traders consider penny stocks to be speculative investments. That puts them in the same class with bitcoin, derivatives, and other whacky financial instruments. Don’t invest any money in these assets that you can’t afford to lose.
If you’re a long-term investor who buys stocks and holds them for years, you might want to look elsewhere for trades. Many smaller businesses to survive into maturity so a lot of the stocks trading today won’t exist 10 years from now. Cheap stocks are especially risky because their respective companies are less equipped to combat unpredictable events. If you’re shopping for your IRA or 401(k), penny stocks probably aren’t the best fit. Do you think you’ve got a real-deal, long-term winner on your hands? Then pull the trigger. Just be conservative and don’t invest any money that you aren’t willing to lose.
Day traders and swing traders like trading these types of stocks because they’re often very volatile assets. Short-term traders love volatility because it gives them plenty of opportunities to turn profits. If you’re more interested in stick-and-move trading, then penny stocks are definitely worth a look.
Should you start trading penny stocks? The answer is, maybe. It all depends on your financial situation and your trading styles. As always, be sure to do your own due diligence. You may even want to consult with a financial advisor before you get started. If you’re retired or getting close to the finish line, don’t take any chances. You don’t have as much time to make back your losses as younger investors.
It Will Cost You More Than This to Invest In Most Penny Stocks, but The Rewards Can Be Huge If You Can Pick Winners.
You asked ‘what are penny stocks,’ and now you have your answer. Now that you know what they are, what’s next? A good place to start is our best stocks under 5 dollar rankings. It has the latest top stocks and it’s updated monthly. Check out the rankings now.
Stay up on the hottest stocks by signing up for FREE Stock Dork Alerts, and don’t forget to follow us on Facebook, Twitter, and Google News for the latest stock market news.
Penny stocks are just like any other stocks, but they are different in a few key areas. Trading penny stocks successfully requires a completely different approach than other investments. However, at their core, penny stocks are regular securities that cost less than five dollars.
If you’ve decided to start investing, you’ll need to find a broker. Almost every broker allows users to trade some penny stocks, but you will need to find a broker that offers OTC stock trading if you really want to get in the game.
Looking for this month’s top penny stock picks? You can find them on this page.
Millions of retail traders use zero-commission brokers like Robinhood and WeBull, but many of these budget brokers don’t offer access to OTC stocks. Despite the limitation, investors can still trade lots of exchange-listed cheap stocks. However, if you really want to dive into the penny stock game, you’re going to need a broker that offers OTC trading.
Charles Schwab Now Offers Zero-Commission Trading
Luckily, most major brokers dropped their trading commissions in 2019. Now, you don’t have to pay $5 to trade with a big-name broker. Schwab, E*Trade, and TD-Ameritrade now offer zero-commission trades. Traders can access a vast array of investment options with any of these brokers, including OTC stocks.
If you’re interested in trading cheap stocks but want something a little more stable, be sure to check out the top stocks under 10 dollars. Find this month’s top picks here.
Over-the-counter (OTC) stocks aren’t listed on major exchanges. Instead, OTC stocks trade via a broker-dealer network. The dealers use the Pink Sheets listing and OTC Bulletin Board to make the market.
Pink OTC Markets Have Become More Popular Then OTCBB in Recent Years
The key thing to remember about OTC stocks is that trading is facilitated by dealers, not a public exchange. Dealers set the prices for these securities.
OTC Bulletin Board (OTCBB) is an electronic listing service. It’s operated by the Financial Industry Regulatory Authority, aka FINRA, and it’s free for subscribing members. OTCBB used to be a popular forum for trading OTC stocks, but these days it’s on the decline. Pink Sheets is taking the lead in OTC trading.
Pink Sheets operator OTC Market Group offers three listing classes: OTC Pink, OTCQB, and OTCQX. OTCQX is more tightly regulated than other types of listings and companies need to meet certain requirements to make the grade, so companies listed on the QX are higher quality investments than other OTC options. Outside of the OTCQX, the OTC market is pretty much a free-for-all. Practically any company can list its shares, as long as they have enough money to pay for it.
Companies choose OTC listings for a variety of reasons, but most of them are financial. NYSE and NASDAQ require companies to meet strict financial and governance standards before they can list shares. This can be a significant burden for smaller companies, companies with low levels of cash, and foreign firms. Instead, many choose to forego major exchanges to list OTC. However, successful companies don’t stay there for long. Most successful companies eventually transition to major exchanges.
When you access the OTC markets, you’re opening up a whole new universe. Traders can access thousands of stocks that aren’t available via traditional exchanges. Many of these companies are small and obscure, however, so most OTC penny stocks ARE NOT suitable investments for most traders. If you’re going to trade OTC stocks, make sure you do your due diligence and fully understand the risks.
Trading Penny Stocks Can Be Stressful. If You’re Investments Are Stressing You Out, You’re Risking Too Much. Always Err On the Side of Caution
In this case, higher risk translates to greater potential for reward. Picking winning penny stocks can net truly massive gains. Traders who buy successful companies early are in for a long, profitable ride to the top. Can you imagine buying Amazon (AMZN) in 1997 what it was trading for $1.31 per share? Penny stocks trading offers the potential for truly amazing rewards, but this is obviously an extreme example. Unfortunately, picking winners isn’t easy and many penny stocks eventually go to zero. If you’re a long-term investor, penny stocks aren’t usually the best option.
Conversely, volatility in penny stocks gives short-term traders plenty of opportunities to turn a profit. These stocks often trade erratically, and they’re so cheap that traders can leverager smaller moves into larger profits. That’s why day traders love penny stocks, they don’t care if the stocks they buy eventually go to zero because they don’t hold stocks overnight. If they catch a pop, they’ll be long gone before share prices come back down.
Conversely, there are a number of downsides associated with penny stocks. First and foremost, they’re risky. That’s a fact that can not be emphasized enough. You have to be very careful when trading stocks this cheap, especially if you’re considering the OTC market. Many of these companies won’t survive long enough to grow into maturity.
Be very careful when trading OTC stocks. OTC listings are lightly regulated so they attract scammers. Shady firms form shell companies with no value, list them OTC, pump up the price with misleading marketing or outright lies, and then cash out their shares. These types of scams, ‘Pump and Dumps’, occur regularly so traders really need to be cautious when considering OTC investments. Always, Always, ALL-WAYS; do your due diligence!
If you’re shopping for long-term investments, steer clear of penny stocks. Most of them aren’t suitable for the average investor. For every success story, like Amazon or Netflix (NFLX), there are thousands of losers that go to zero. Stocks go to zero every day. Failed companies outnumber successful ones by a large margin. These are not the kinds of stocks you buy for your 401(k) or IRA, penny stocks are best suited to short-term, stick-and-move trades.
If you’re searching for investments with fewer risks, you should check out our article on the best gold stocks.
People that are new to trading love penny stocks because they’re so cheap, but new traders should be careful. It’s a challenge predicting which way these stocks will go. Make sure you have a plan before entering a trade and stick to your strategy. Don’t let stop-loss orders give you a false sense of security, these stocks can make huge downward gaps.
It’s not all doom and gloom. There are plenty of opportunities for disciplined traders who are willing to do some research but, please, be careful.
Don’t forget to join Stock Dork Alerts for FREE hot stock alerts, and follow us on Google News, Twitter, and Facebook for the latest stock market news.
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is a measure of a company’s financial health and earnings potential from core business operations. Its purpose is to give investors a better idea of how much a business earned from its actual business operations. Since interest, taxes, depreciation, and amortization are mostly unique events that have little to do with the underlying business, its often more useful to look at EBITDA numbers than overall net earnings.
To calculate EBITDA, you need to know some basic information that you can find on just about any corporate income statement or balance sheet. This is the most simple way to calculate EBITDA:
Alternatively, you can also use this method. However, it requires more data inputs:
Whichever form you prefer, they both will take you to the same destination. Stripping out extraneous factors allows traders to see how the core business is operating. The downside is that is doesn’t speak for management. Core businesses can be performing well while companies decline due to poor management. Like any other data point, EBITDA is most effective when used in conjunction with other types of analysis.
Traders can use it to help identify whether or not a core business is performing well. This form of earnings strips extraordinary expenses and allows for better baseline comparison of the underlying business model. Comparing stocks using EBITDA numbers allows traders to look at the companies in a more objective way because it compares actual underlying business operations. Traders frequently used this figure to measure corporate profitability, and it’s also used to estimate incoming cash flow and a company’s ability to cover its long-term debts. Many traders prefer to use EBITDA when comparing different companies with sector benchmarks because they offer a more objective view of a company’s business.
EBIDTA on Financial Statements
Discovering the information you need to perform this calculation is easy. You can find the required data in a company’s income statement under selling, general, and administrative expenses (SG&A). This category includes depreciation and amortization expenses.
EBITDA helps interested parties evaluate similar companies in their respective business. Differences in companies’ accounting practices cause differences in net income earned. However, this is not to say that the company is a standout or a laggard. This information alone cannot tell investors how the company is doing relative to its peers.
This form of earnings measurement first gained notoriety amongst leveraged buyout investors in the 1980’s, and it’s been hanging around ever since. The metric became popular as a means for finding companies with good underlying businesses and bad balance sheets, two attributes of an excellent distressed debt trade. These days, EBITDA is as popular as ever. Traders still use it to evaluate distressed debt, make apples-to-apples comparisons of different businesses, and compare potential investments to sector bench
Generally accepted accounting principles (GAAP) do not cover EBITDA statements. As a result, the way companies calculate EBITDA varies from one company to the next. Many companies will emphasize the EBITDA ahead of their net earnings, but this could be a red flag. Sometimes, companies will emphasize the earnings before interest, taxes, depreciation, and amortization figures ahead of net income so they can disguise or distract from inherent problems with the business.
If a company starts to prominently report EBITDA after not regularly doing so in the past, it’s a potential omen of bad things to come. Companies that borrow heavily or have problems with rising capital costs, may begin to emphasize these types of unregulated earnings figures over the more strictly regulated net income numbers. If you see a company suddenly shift towards non-GAAP earnings figures on their quarterly earnings report, it’s very often a bad sign and – at the very least – it’s worth looking into.
In conclusion, knowing and understanding EBIDTA is essential in analyzing companies. Not knowing this measure makes comparing similar companies difficult. Estimating the fair value for stocks relies on this at its core.
Interest is largely a management choice- a financing decision. Financing decisions are not directly correlated with market demand for products. Also, market demand and growth ultimately decide the analyst’s predictions of stock prices. Any successful form of market analysis or company analysis includes an understanding of EBITDA.
Net income – also known as net earnings – tells investors how much income a company generated over a given period. In order to calculate net earnings, we need to first determine revenues. Then, deduct all expenses from revenues to determine net earnings. That’s it. Sounds more complicated than it is, right? The actual net income formula goes like this:
Net Income = Total Revenues – Total Expenses.
Furthermore, let’s take a look at expense items. The first expense is the cost of goods sold (COGS). Subtracting Revenues from COGS yields gross profit. This shows how much it costs a company to produce sales. Next comes operating expenses. These expenses do not directly relate to the production of goods. These include salaries, utilities, and depreciation.
Finally, deduct interest expenses and taxes. After deducting all the aforementioned expenses, a company finds its net income.
Net earnings is a key figure that is an integral component of several important analysis ratios. Without net earnings, traders can’t calculate many of the most important financial metrics. One of the most notable ratios that rely on net earnings figures is the profit-times-earnings (PE) ratio. PE is the cornerstone ratio for most forms of equity analysis. It’s the key metric for determining the fair value of a stock.
To go even further, PE is the foundation of several other formulas that measure more aspects of a business’s fundamental value. For example, PE growth, or PEG, is a key metric for growth investors. Net earnings is also a determining factor in the payout ratio and other key statistics. To truly understand business fundamentals and equity analysis, it’s important to understand net income and what it represents.
Businesses are built on earnings, so it’s important to understand earnings metrics if you want to be a successful investor. If you understand how these figures are calculated, it provides a deeper level of understanding and utility than simply looking them up online. Before you trade stocks, you should understand how businesses calculate these important ratios.
Earnings growth is calculated by comparing net income over time. By looking at net earnings on a quarter-by-quarter basis, you can determine the rate at which the company is growing its overall earnings on a short-term basis. You can look at things from a more long-term perspective by looking at annual growth, which gives you an idea of how much earnings are growing on a year over year basis.
Positive earnings growth is a key attribute for most successful companies. There is an old saying that goes, “if a company is not growing, it’s dying” and that axiom holds true for most investors. If a company’s earnings begin to contract, it could be a bad sign for things to come. However, like most rules in investing, this one also has some exceptions.
Investors expect different things from different companies, and some growth investor may be more concerned with revenue growth than negative earnings. Therefore, stocks may react differently to earnings releases. Share prices are largely driven by sentiment, so understanding the fundamentals is only half the battle. Make sure you understand the Street’s sentiment towards a stock so you know what to expect as events develop. If it’s a small startup that is growing rapidly, many growth investors could care less about earnings as far as revenues are growing at a high rate. Conversely, a well-established company could be in big trouble if they report a quarterly operating loss.
Make sure you understand what investors are looking for so you know how share prices will react to changes in net earnings.
Don’t sleep on the net income formula. It’s foundational knowledge for any trader. Use it to calculate a stock’s inherent value or project future growth. It’s useful in so many different capacities that it’s practically impossible to make informed investment decisions without. Don’t underestimate its importance to equity analysis.
To put it simply, net income measures how much money a company earned in profits over a given period. That’s pretty important, so every trader should know how to calculate net income.
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Stop-loss orders are an important tool in any trader’s toolbox. When used correctly, stop-losses can help you protect yourself from losses and limit downside risk. However, if you’re new to investing, there’s a good chance that you don’t know what the heck a stop-loss order does. Before you get started trading stocks, it’s important that you know how to use this powerful tool.
Stop-loss orders offer a way to conditionally buy or sell stocks or other securities when they reach a certain price. Investors commonly use stop-loss orders to protect themselves from further losses. When a stock reaches the specified price, the order converts into a market order and executes as the next available price.
The most commonly used stop-loss order. A stop sell tells your broker to execute a market sale when a security reaches a specific price. These work great for protecting your principle from further losses and serve as a predetermined worst-case exit point for a trade.
Stop buys tell your broker to buy a security if it reaches a certain price. You can use stop buys to enter into a trade when a stock hits a price that’s higher than its current position. This can be useful for covering short positions or initiating a trade automatically after a stock breaks above a key technical support level.
Stop-loss orders help traders automate their trading strategies and limit their downside risk. Placing a stop-loss can usually help cap losses. For example, if you want to invest in a $10 stock and limit your losses to 30%, you should enter a stop-loss order at $7 after you purchase the stock. That way, the stock will sell as soon as the price hits $7. If it goes any lower, you’re already out of your position so you protect yourself from further losses.
Stop-loss orders are great tools for technical traders. Setting up stops at key support points can help protect you from big dips. If share prices break below a key support level, they are likely to continue to fall further. Therefore, placing a stop right below key support enables you to exit your position before prices slide even further. However, they also allow you to stay in the trade for as long as possible without having to sell your shares prematurely.
If you bought the S&P 500 at around 2,970, it might be wise to look at the chart to identify key technical levels to help you place your stops. Placing stops below key technical support is a great way to help limit your downside risk. With some quick technical analysis, we can see that the S&P 500 has strong support at 2,750. This provides a great place to place stops. If prices reach these levels, it seems that they would be likely to continue towards greater losses.
Be mindful that stocks are volatile assets that often fluctuate significantly in price during times of heightened uncertainty. A stop-loss order will execute as soon as prices reach the set stop level, so you need to leave enough room for regular volatility to run its course. Make sure that your stop is far enough below key support levels that it won’t be executed because of normal fluctuations in prices. Otherwise, you could find yourself sitting on losses while share prices rebound and you’re sitting out.
Traders should exercise caution when they use stop-loss orders. These aren’t the one-size-fits-all solutions that some make them out to be. In fact, if you’re not careful, stops can actually puy you on the wrong side of a trade.
Stops offer traders a way to protect their downside in the event of unexpected downward moves, but they shouldn’t rely on them entirely. Stocks can make big jumps down in prices. Don’t let stop losses give you a false sense of security. Pay attention to your portfolio and only rely on stop orders to protect you in the event of an emergency.
Stops come in more than one variety. In addition to the types of orders discussed here, you can also enter stop-limit orders. Stop-limits are similar to traditional stop orders, but they are different in one key regard: they convert into limit orders, instead of market orders, when they reach the preset price. More on stop-limit orders here.
Day trading can be intimidating for many investors, but finding quality day trading stocks isn’t quite as stressful. If you know what to look for, you can find great day trading opportunities every day. Day traders only hold stocks for a few hours, so the attributes of quality day trading stocks vary significantly from those of traditional long-term investments.
Most notably, day traders don’t care which way a stock is headed in the long run. Many day traders exit their positions by 11:30 AM, and none of them hold stocks through the close. Day traders exposure to stocks is so brief that certain areas of equity analysis become largely irrelevant. For example, who cares how much debt a company has on their books if you’re only holding shares for 3 hours? If it won’t affect the stock in the day’s trading session than day traders don’t care. Resultantly, day traders rely less on fundamentals and more on momentum.
Day traders can find better trade opportunities in a newspaper than a balance sheet. News events fuel most daily movements in stocks, so following the news and predicting the market’s response is imperative to successful day trading.
It doesn’t matter what happened, predicting how the market will react is the objective. Stocks don’t always move along lines of reason. Stocks regularly go down after beating on quarterly earnings estimates or go up after missing. Why? Because prices are subjective interpretations by emotional humans. However, in the long run, free markets almost always balance themselves out over time.
Following the news is mandatory for any active investor. Advanced traders need to follow a business newswire site to stay informed. Stock Dork Alerts are totally free email updates that will help you track the market with regular alerts, and it’s totally free to join. Click here to sign up. Don’t worry, there are plenty of free sites available if you’d rather not do email. Check out these free newswires from MarketWatch and Yahoo! Finance
Day traders are the guerilla raiders of the investment world, they get in and then get out. In many cases, day-traders use leverage to get the most out of what may only be a small change in share prices. When you’re making high-volume leveraged trades, one or two pennies could cost you thousands of dollars. For that reason, day traders favor stocks with excellent liquidity.
Spread is the difference between the bid and ask prices in stocks. High spreads mean a greater risk of losing money due to low liquidity. To avoid high spreads, look for high-volume stocks with spreads of less than 1 cent to ensure that you can exit your position when you need to.
Abnormal trading activity in premarket hours indicates that a stock could be making a move. The resultant buzz creates a buying frenzy that runs up share prices. Many day traders screen for premarket volume above 50K when they’re looking for good day trading stocks. However, filtering to 100K returns even stronger day trading opportunities.
4. Pre-Market Day Trading: GapsDay traders use gaps to find good day trading stocks. If a stock opens at a different price than its previous close, it’s called a gap. Stocks can gap up or gap down, and either type provides information that day traders can exploit. In most instance, stocks gap because some kind of news even occurred while the market was closed. When stocks open a session on a gap, they tend to trade in the same direction of the gap. Day traders might buy a stock because it was gapping upward and, once they’re in, they ride the gap momentum to gains and then try to sell as close to the high as possible.
The same strategy also works with short stocks. A downward gap indicates that a stock is likely to go down further in the short-term, and short-sellers exploit this in the same manner as buyers.
Gap trading is not easy so don’t let this explanation fool you into a false sense of security. The open is the most volatile part of the day, so buying into a gap can sometimes go dramatically wrong. Like anything else, don’t go in without a complete strategy.
Most investors are familiar with the concept of supply and demand, but understanding how public float affects share prices eludes them. It may sound complicated but it’s actually quite simple. Float is the total number of investable shares available to the general public. Just like any other product, stocks are influenced by supply and demand. When public float, or the supply of the stock, is small it means that shares are in tight supply.
When supply goes down, prices generally go up. Stocks with lower public float are more likely to come into short supply and subsequently increase in price.
This figure measures the number of shares that are currently loaned out on short sells. A lot of shorts usually indicates that the market has poor outlook on a stock, but the market gets it wrong pretty frequently. When shorted stocks start gaining, short-sellers get nervous. The higher share prices go, the more they have to spend to buy back the shares they have to replace.
If high-short stocks make an abrupt upward move, it can create panic amongst short sellers to replace their shares. This increased buying actually can accelerate an upward move and create additional momentum towards higher prices. This scenario is called a ‘short squeeze’ and it usually pays off big for investors that are long in the stock. Open short interest ratios above 20% make a sweet setting for a possible short squeeze.
Day trading is one of the most difficult niches of the investment world. It’s a high-stakes way to trade so it’s not for the faint of heart. This guide introduced you to some basic day trading concepts but, remember, it’s still up to you to do your due diligence. With a lot of practice and a little luck, you could one day be an effective day trader.
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Millions of traders use the MACD indicator to time their entrance and exit points. It’s a favorite among swing traders because it signals when a stock like those is about to shift trends. MACD charts may look complicated, but it’s essentially two lines. When one line crosses over the other, it’s called a signal. Depending on which line crosses which, it’s either a ‘buy’ or a ‘sell’ signal.
MACD inputs vary depending on personal preference, but the fundamentals stay the same. A MACD chart includes three major pieces: Histogram, MACD Line, and Signal Line.
By default, most MACD diagrams are set to 12/26; meaning that they use the difference between the 12-day and 26-day exponential moving averages(EMA) as the MACD line. These inputs are a matter of preference so feel free to modify them to fit your needs. Personally, I like to use a 15/30 MACD because it smoothes out the chart and reduces false signals.
The 9-day EMA is usually used as the signal line, and the MACD histogram represents the difference between the two lines; in other words, the ‘convergence‘ or ‘divergence‘ of them.
That’s how we get the term Moving Average Convergence/Divergence. See? It’s less complicated than it sounds!
As share prices change, MACD fluctuates above and below the signal line. When the MACD crosses above the signal line, it’s considered a buy signal. When it goes below, its an indicator that prices could decline.
MACD can help you trade stocks more effectively because it can tell you when an uptrend is running out of steam. It can also be used to determine if a downward-trending stock has bottomed.
Always ensure the MACD line has truly crossed over before making a call. MACD commonly tricks traders by running along the signal line and pulling back at the last minute without a crossover. If you’re going to use MACD to trade, be patient and don’t jump the gun.
Traders also use MACD to measure momentum in stocks. When MACD makes a drastic upward or downward movement, it’s a signal that the stock could be overbought or oversold. This technique is especially powerful when used in conjunction with the Relative Strength Indicator (RSI).
You can also use the MACD histogram to analyze your trades. The histogram provides all the relevant information you need to strategize your trades. However, there are timing differences between the histogram and the MACD signals so it takes some experience. MACD crossovers, rapid rises & falls, and divergence can all be gauged by examining the histogram.
MACD isn’t a perfect indicator because, if it was, we’d all be rich. Since MACD is a ‘trailing indicator’ it lags behind the actual price trends. By the time MACD shows a sell or buy signal, there’s a strong possibility you may have already missed the boat. Plus, false signals and fakeouts are also common, so be patient and disciplined when you use this indicator.
I prefer using MACD in conjunction with other oscillators and signals. I like to look for three confirmation signals before jumping in a trade. For example, if MACD is showing a bullish signal, check out some other indicators, like RSI or OBV, to see if they’re also showing positive signals. By double-checking your analysis with multiple signals, you reduce the chances of falling victim to a fake-out.
MACD is one of the most commonly used indicators because it’s easy to read and understand, but it’s not an end-all solution. Indicators like MACD are not perfect, so don’t rely solely on MACD to make your trades or else your portfolio will suffer. MACD is best used as a confirmation indicator, so always second guess it with common sense and patience.
Test it out for yourself. Indicators are largely a matter of personal preference, so try it out and see if you like it. If you don’t, there are tons of other indicators that you can choose from.
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Source: ici.org
More than $49 trillion in assets are kept in global regulated open-end funds, according to data from the Investment Company Institute. That said, roughly $21.8 trillion of total net assets are held in ETFs and mutual funds.
A mutual fund is an open-ended investment company that offers its shares to the public. However, instead of trading on an exchange, investors purchase and redeem shares directly from the fund. That said, there are thousands of mutual funds to select from, as they’ve been around for nearly a century.
Now, with a mutual fund, money is pooled together and invested based on the fund’s goals. Some mutual funds specifically invest in stocks, while others might invest in bonds or money market funds.
However, what the fund invests in is not a mystery. They lay out their strategy, risk, track record, a background of the management and portfolio manager(s), and the fees the fund charges, all in what is called the prospectus.
Source: OakMark Funds
For example, the Oakmark Fund has an objective of long-term capital appreciation. It attempts to achieve this by investing in a diversified portfolio of large-cap stocks, using a value investment philosophy.
That said, when you invest in a mutual fund, you also invest in the fund’s manager ability to find winning stocks.
Some mutual funds invest in growth stocks, while others focus on value. A fund objective could be international, mid-cap, small-cap, sector-related, you name it, there are thousands of them.
There are even mutual funds that invest in other funds. Now, you might be asking what’s the point of that. It’s simple. Selecting the right fund can be just as profitable as picking the right stocks, and there mutual funds for that.
Now, here is a list of the type of fees that you might expect from a mutual fund: shareholder fees (fees paid directly from your investment) and annual fund operating expenses. Included in the fund’s operating expenses are the management fee, distribution fees, and other costs.
That said, other fees associated with the fund could be a sales charge, a fee your broker gets a commission on for introducing the fund to you. Also known as a “front-end load.”
Now, a “back-end load” is a fee that your broker gets when you sell your shares of the mutual fund. Not all mutual funds have front-end or even back-end loads; however, it’s something you should be aware of before deciding to invest in a fund.
That said, unlike a stock or ETF, an investor does not have to pay a commission after each transaction its mutual fund makes.
Mutual funds have taken a backseat to Exchange Traded Funds (ETF) over the last decade. The knock on mutual funds has been the average fund manager can’t beat the returns of the S&P 500. ETFs offer investors a chance to get into similar securities a lot easier and cheaper. Besides, ETFs disclose holdings a lot more frequently than mutual funds do.
Another issue mutual funds face is that they typically need to stay invested all year-round. Now, if you speak to any good trader, they’ll tell you that stock market isn’t always to read.
Sometimes the market trend is bullish, others its bearish or even sideways. During periods of uncertainty, it makes sense to reduce your exposure to stocks and get defensive. However, many mutual funds are long-only, and some are so big that it makes it difficult for them to stay nimble.
Mutual funds are not nearly as exciting as they were 15-20 years ago, but they still have a place in today’s financial market and most likely here to stay.
If you’re interested in receiving passive income from the stock market, then dividend stocks might be the right choice. To attract investors some companies will pay a cash dividend as a way for them to distribute profits to shareholders. The dividend yield is expressed in percentage terms and is calculated by dividing the dollar value of the dividend by the dollar value of the stock.
source: Yahoo
For example, International Business Machines Corporation (NYSE: IBM) pays its investors an annual dividend of $6.28 per share. The dividend is broken down into four payments and distributed quarterly.
If IBM’s stock price is $116.83 and it pays an annual dividend of $6.28, then its current dividend yield is around 5.37%.
source: Nasdaq
Here’s another example:
source: finviz.com
If General Electric Company (NYSE: GE) pays its investors an annual dividend of $0.48 per share and is trading at $9.58, then its dividend yield is 5.01%
source: finviz.com
Now, the dividend yield will change along with changes in the stock price. It is not a rate that is locked in nor is it a guarantee. For example, if a company is going through a difficult financial period, it may choose to cut or eliminate the dividend, as the case with General Electric.
source: CNN
There are several factors you should consider before investing in a stock. For example, if you invested in GE because of the dividend, then you would have lost money as its stock price was in free fall from late 2016 to 2018.
Some companies chose to re-invest profits into the business instead of distributing a dividend. For example, Amazon, Facebook, and Alphabet currently pay no dividends to investors.
Even the great Warren Buffett doesn’t like paying dividends. His company, Berkshire Hathaway, has historically not paid its investors an annual dividend. However, that doesn’t mean he doesn’t love receiving dividend payouts.
Source: CNBC
Companies like Microsoft, Apple, Wal Mart, Intel, and Disney are still growing. All five of them pay their investors a dividend. Ideally, you want to find the best of both worlds, a dividend paying stock that is still growing.
A high dividend yield could mean that the company’s stock has been performing poorly.
Now, if stock picking is something you struggle with but find high dividend yield stocks interesting then consider looking at dividend ETFs.
The SPDR S&P 500 Dividend ETF (NYSE: SDY) is an ETF that tracks an index that screens for companies that have consistently increased their dividend for at least 20 consecutive years, and weights the stocks by yield.
Some other ETFs in the category include iShares Select Dividend (NASD: DVY), and Vanguard High Dividend Yield ETF (NYSE: VYM).
A high dividend yield stock can be attractive only if its business is strong. Dividends have always been a way for companies to distribute profits. However, stock buybacks is another way to achieve similar results. Some companies prefer stock buybacks over dividends. While some like Apple engage in both activities, stock buybacks, and dividends.
If you speak to most investors, they’ll tell you that the fundamentals matter. The price of a stock can only tell you so much. Is the company growing its revenues? Is its EPS rising? How about its operating margin, is it consistently improving?
Analysts are paid big bucks to investigate these numbers and make future projections.
It measures how much profit a firm makes on a dollar of sales, after costs of goods sold and all operating expenses, not including interest or taxes. The operating margin is also called (EBIT) earnings before interest and taxes.
Operating Profit is the subtotal on the income statement, excluding non-operating income, taxes, and interest expenses. The operating expenses include selling, general, administrative, depreciation, amortization, and any other operating expenses.
Operating Profit = Gross Profit – Operating Expenses
The best way to calculate the operating profit margin is to use the income statement. It’s achieved by dividing the operating income by total revenue, then multiply by 100 to express it in percentage terms.
Operating Profit Margin = (Operating Profit ÷ Revenue) × 100
Revenue
– COGS
(Gross Profit / Revenue) x 100 = Gross Margin
-Selling, general, & admin. expenses
-Depreciation/amortization
-Other operating expenses
(Operating Profit / Revenue) x 100 = Operating Margin
Let’s look at an example of Exxon Mobil (NYSE: XOM):
source: nasdaq.com
For the year 2017, Exxon had total revenue of $237,162,000 and an operating income of $12,074,000. That said, its operating margin for the period was 5.09%
In the example, Exxon makes $0.059 before interest and taxes for every dollar of sales.
Is that good?
As with most numbers in finance, it’s all relative. That said, you’ll have to compare it to its industry peers.
A rookie mistake is comparing apples to oranges. As you can see below, some sectors are more profitable than others.
source: CSI Market
source: Bloomberg
Operating margin tells us how efficient a company is at its core business. Generally, the more profitable a company is, the better its stock price will perform.
Amazon.com is an exception to the rule.
source: macrotrends.net
Amazon.com, one of the best-performing stocks over the last decade, has struggled to increase its operating margin. On the other hand, having a high operating margin doesn’t always mean that the stock will be a top performer.
For example:
source: finviz.com
source: finviz.com
Operating margin is one way to measure a company’s profitability. The way it changes (in % terms) over time can give an accurate picture of how efficient a company is running different parts of its business.
That said, consider adding other fundamental indicators in your analysis, such as revenue growth, P/E ratio, net profit margin, and EPS to name a few.
Now, if you’re a day trader, you probably aren’t overly concerned on what a stock’s operating margin is. Instead, your focus is on price action or some news catalyst. But for a long-term investor, monitoring the EBIT.
Now, if you remove depreciation and amortization from the EBIT, it deletes all non-cash expenses from operating income. That said, analysts prefer earnings before interest, taxes, depreciation, and amortization (EBITDA) over EBIT because it gives a more accurate reading of operating profitability.
Analysts and investors can get a better grip on the financial health of a company by reading its quarterly and annual earnings statements. The profit margin (aka net income margin) is one of the most widely used financial profitability ratios. It tells us how much revenue, in percentage terms the company keeps in earnings.
The formula for calculating the net profit margin:
Net Profit Margin = (Net Profit ÷ Total Revenue) * 100
Gross profit margin and operating profit margin are two other primary profitability ratios. They’re easily calculated using the income statement subtotals and net profits.
Example:
Revenue $1,225
Gross Income 750 —-> Gross Profit Margin 750 ÷ 1,225 = 61.2%
Operating Income 456 – –> Operating Profit Margin 456 ÷ 1,225 = 37.2%
Net Income 305—— Net Profit Margin 305 ÷ 1,225 = 24.9%
source: jalopnik.com
source: Reuters
Basic fundamental analysis uses profit margins to compare a company to itself, competitors, and benchmark.
Here is how Apple (NASD: AAPL) compares to its industry and sector.
Profit margins can vary among sectors. Apple’s gross profit margin above shows 38.27%. That said, car maker BMW sees its profit margins in the low teens (2nd qtr 2018 was 11.4%). The average net profit margin for the S&P 500 stocks for Q1 2018 stood at 11.1%.
If you talk to an investor like Warren Buffett, he’ll tell you that he prefers to buy companies that have high net income margins. Financial analysts pull historical financial statements into financial models calculate margins, growth rates, and ratios. They do it because it helps them come up with forecasts and projections.
Sure, it’s important for long-term investors. After an earnings release or company update, traders are closely following what the company says about its net income margin. Now, if there are any surprises, you could see a whole lot of volatility in the stock.
source: Financial Times
When a company’s earnings change, the income statement will show where the changes occur.
For example, a big increase in the cost of goods sold will decrease gross profits and all other profits while a tax increase will only reduce net profits at the very bottom.
Think about it, if a company’s cost of goods sold and expenses are too high then it will struggle to turn a profit.
Net income margin is one of the most important financial ratios you’ll see on a financial statement. If you are an earnings trader, it is one you’ll want watch closely.
As with most financial numbers, they become useful when compared to something else. Think in relative terms.
Leverage is a necessary yet risky aspect of corporate structure. For this reason, analysts and investors pay close to attention to a company’s debt to equity ratio. This reveals capital structure of the company and tells if the company operates at optimal levels.
The Debt To Equity Ratio Shows How Much Debt Relative To Equity Is Used To Finance Assets
The debt to equity (D/E) ratio measures a company’s financial leverage. To calculate this ratio, one divides total liabilities (debt) by total stock holder’s equity.
D/E = total liabilities / stock holder’s equity
Additionally, the debt to equity ratio shows how much debt a company takes on relative to the value of its stock. Higher D/E ratios imply riskier financing tactics by the company. Also, higher levels of debt often lead to erratic earnings pattern given the interest expenses on the debt.
Some consider the use of leverage risky, which leaves some companies with only equity financing. However, using debt often creates shareholder value, which is management’s foremost goal. If the company generates more profit than it would have without the debt, and the earnings outweigh interest expenses, shareholders benefit. Conversely, too much debt or too high of interest payments destroys value and decreases company earnings.
Furthermore, if a debt-laden company files for bankruptcy, equity shareholders potentially receive nothing. In bankruptcy, owners of debt recoup losses first.
Also, the debt to equity ratio alone misguides analysts. Analysts must compare it against a benchmark, such as an industry average. This means that tech heavy companies have a much different D/E ratio than a utility company. Comparing them side by side does not make sense.
Finally, debt to equity ratios are integral in financial analysis. Companies without debt may be leaving potential earnings on the table, while overbearing debt cripples other companies and forces bankruptcy. Comparing D/E ratios within industry reveals valuable insights and shows investors if the company maximizes its earnings potential.
Management’s main job is to create value for shareholders. How do they know if a new project will create or destroy value for the firm? Net present value serves as a guide for these decisions.
Markets always discount future expectations to the current environment. This is seen through opportunity costs and expected cash flow. Net present value (NPV) compares the current cash outflow against the present value of expected future cash flow. Found below is the equation for net present value:
Net Present Value Calculation
where:
Ct = net cash flow during time t
Co = total cost of investment
r = discount rate
t = time periods
Additionally, management considers any positive expected NPV worth profitable. Conversely, a negative NPV results in a loss. The time value of money theory lies at the root of this equation. This assumes that a dollar made in the future is worth less than a dollar made today. Dollar made today immediately contribute to future growth.
Management uses this calculation in making purchases of financing decisions. Evaluating the discount rate is different in many cases. However, the same base premises remain. Companies compare estimated returns of projects with similar risk, or compare the discount rate to the current cost of borrowing money.
For example, companies that require heavy machinery face this dilemma frequently. If new equipment costs $200,000 up front, and management estimates the discounted future cash flow of the useful life of that equipment over $200,000, management considers this a positive NPV endeavor and pursues it.
One way management evaluates discount rates is the internal rate of return (IRR). IRR is the discount rate rate of an investment when the NPV is 0. This tells management the anticipated growth rate of an investment. This is one way management finds an accurate discount rate against which to evaluate the NPV of projects.
Net present value is invaluable to both management and shareholders. If shareholders believe management pursues negative NPV projects, they either voice their opinion, or sell shares of stock thinking the company will be less valuable. Management’s goal is to create value with positive NPV investments.
Analysts use different methods of evaluating company performance. Earnings before interest and taxes (EBIT) is an accounting measure that describes core profitability.
Earnings before interest and taxes measure core operating profitability
Earnings before interest and taxes is a profitability measure calculated as revenue minus expenses, before taxes and interest. These expenses include operating expenses, such as salary, utilities, and insurances. Thus: EBIT = Revenue – Operating Expenses. Furthermore, one sees that this measures a company’s efficiency of operation. These expenses are unavoidable. For example, net income measures the amount of revenue left after deducting all expenses. Theoretically, some of these expenses are one time, such as a large interest payment that will not recur in the future. EBIT, however, focuses only on core business operations and does not penalize one-off payments.
Also, earnings before interest and taxes ignores a company’s capital structure. This is significant because creative accounting or advantageous capital structure skews net income numbers.
Analysts and investors alike use relative valuation in making investments or recommendations. For example, companies in similar industries both report similar income numbers, but this does not tell the whole story. The companies most likely have different tax burdens or capital structure. Comparing their earnings side by side a fatal mistake.
However, using a measure such as EBIT removes the variability and ensures sound comparison. Additionally, an investor looking to purchase an entire company looks at earnings before interest and taxes rather than net income. This is because investors concern themselves with future earnings and not capital structure.
It is important to note that interest extended to customers as the result of a sale does not qualify for EBIT, and is left in the number. Interest from loans, such as bond payments qualifies.
Earnings before interest and taxes is yet another profitability measure which interested parties use to value companies. Different sectors weigh different measures more than others. EBIT is a sound method of evaluating companies in similar businesses of most tangible goods producing companies.
Companies today produce a tremendous amount of revenue, and consequently expenses. Profitability ratios express these numbers in a simple and easily comparable format.
Profitability Ratios Measure The Efficiency Of Like Companies
Profitability ratios measure a company’s ability to produce income relative to its expenses. Since each company has different market capitalization and capital structures, these ratios make it easy to compare companies side by side. These ratios are relevant over time periods, typically quarters or years.
Furthermore, these ratios show how well a company utilizes its assets to generate income and create shareholder value. Various types of profitability ratios exits, each measures efficiency in a different area. Some that focus on earnings are: operating margin and gross margin. Also, others that measure balance sheet performance are return on assets (ROA), return on equity (ROE) and return on capital (ROC).
As shown above, profitability ratios focus on margin and return. Gross margin shows the cost of goods sold (COGS) as a percentage of sales. This shows how much it costs a company to produce the goods it sells. Investors keep an extremely close eye on this measure as an upward trend shows investment opportunity to create even more value. Operating margin shows how efficiently a company conducts its core business relative to its sales. Core business operation expenses include necessary items such as wages, rent and insurance.
Additionally, return ratios such as ROE show how investors earn return on their investment. If a company increases its asset base without taking on large debt, shareholders experience higher returns. This is a classic example of organic growth. Also, ROA shows how efficiently a company’s asset base translates to sales. The theory holds that economies of scale generally lower production cost. Thus higher ROA shows the potential for future growth, which attracts investors.
Profitability ratios help investors and analysts compare companies within similar industries. Evaluating trends over time relative to stock prices reveal profitable investment opportunities, and raise red flags on lagging companies.
The cash conversion cycle estimates the time is takes for cash to flow through a company. Sales are the beating heart of any business, but the sales process is complex.
The Cash Conversion Cycle Measures The Efficiency Of Converting Materials Into Cash
The journey from raw material to cash on the income statement is long with many variables. The cash conversion cycle (CCC) measures the amount of time in days it takes for those input materials to turn into cash on hand. Also, it measures the overall health of a company in addition to its efficiency. Management uses this metric in evaluating its strengths and weaknesses in places like sales teams, or the supply chain.
Furthermore, the cash conversion cycle = DIO + DSO – DPO
DIO = days inventory outstanding
DSO = days sales outstanding
DPO = days payable outstanding
Intuitively, the CCC evaluates the time it takes to sell inventory, collect receivables, and pay its bills. DIO is the number of days it takes to sell an entire inventory. The lower the better in this regards. DSO calculates the number of days to collect on accounts receivable. DPO calculates the amount of time the company takes to pay its own bills. Conversely to the first two numbers, a longer DPO is preferred as it allows the company to hold onto cash longer.
Large scale business is not typically done on a cash basis. For example, a company buys inventory on credit, and sells on credit. This results in accounts payable and accounts receivable credits and debits, respectively. Additionally, this strategy focuses on the sale and worries about the actually payments later. This structure only works if both the parties have reputable credit history.
Lastly, the cash conversion cycle is an excellent indicator of management’s efficiency. Measures within industries, the CCC tells how cash strapped a company will be if they decide to invest heavily in the future for higher sales.
The cash conversion cycle is a transparent way to analyze companies operating efficiency. Companies that turn sales into cash sooner dominate the market and become market leaders. These leaders eventually either buy out or push weaker companies out of the space, increasing their own worth.
Before entering a business space, one measures risk and competition. An oligopoly offers tremendous upside potential with limited competition.
A Few Firms Dominate The Industry In An Oligopoly
Unlike a monopoly, an oligopoly has a few businesses in the industry. However, this does not imply perfect competition. In fact, only a few industries dominate in a an oligopoly. These firms cannot keep others from strongly influencing business practices of others. Also, no real upper limit exists to number of firms in an oligopoly.
For example, businesses with the largest market share tend to dictate industry trends. This makes oligopoly the most common market structure. The clearest example lies with auto manufacturers. This industry has significant startup costs and product differentiation. For these reasons, only a few firms dominate the industry, such as Ford, Honda, Toyota, etc.
How does this business structure succeed? First, we look at what defines an oligopoly. Characteristics include dependency on other firms, barriers to entry, and differentiated products. Companies affect other companies based on pricing and production numbers. Competitors often undercut one another with discounts or promotions. This causes a reaction by others in the space. Barriers to entry exist in this structure, meaning not just any old shop can open and immediately take market share. These businesses often have significant startup costs and brand loyalty. Lastly, companies compete on a non-price basis. This means that product quality and customer satisfaction keep consumers coming back, not necessarily bargains.
Furthermore, this structure gives these dominant firms different strategic options. Firms either concentrate on products, which leaves price out of the equation. Conversely, discount retailers often start price wars, looking for consumers who are price conscious. Businesses also collude, meaning they work together, often leading prices higher and giving consumers no choice but to pay up.
Finally, oligopolies are the most common market structure. Think of coffee shops, tech giants, or steel manufacturers. This market structure works in consumer driven markets, and competition keeps checks and balances in place unlike monopolies.
Like other financial leverage ratios, the equity multiplier measures asset financing practices. However, this measure offers insight into future earnings.
The Equity Multiplier Is A Leverage Ratio That Measures Financing Leverage
The equity multiplier measures the amount of asset financing attributed to equity. Equity Multiplier = Total Assets / Total Equity. A high equity multiplier infers high debt financing, meaning a relatively low portion of assets financed by equity.
Furthermore, investors use this metric in evaluating investments. Low equity multipliers typically indicate growing or new companies. Conversely, if a new company shows a high equity multiplier, this shows high levels of debt. Overbearing interest payments cause new companies to experience erratic earnings streams. This confuses investors and causes wild stock price moves. Additionally, investors do not understand what the company is worth, causing liquidity concerns.
This measure is an accounting ratio that measures risk to creditors. Creditors measure risk primarily by liquidity, or ability to repay the loan amount. Savvy investors pay attention to industry trends regarding this leverage ratio. Furthermore, an outlier causes concern to investors. However, this does not mean that the company is doomed. Perhaps they have a new business practice that will leave the competition in the dust.
Conversely, perhaps unusual equity multipliers show poor management decisions. Risky capital structure sometimes destroys shareholder value. For example, the equity multiplier is the cornerstone for Dupont Analysis. This analysis, first used by Dupont, suggests that higher equity multipliers yield a higher return on equity (ROE) ratios. Some investors use strategies that revolve entirely around this financial ratio, thus seeking companies that fit the mold.
Finally, the equity multiplier, like other leverage ratios, need to be compared across industries. It does not make sense to measure a telecom company against a internet security startup. Investors who use factor-based analysis, such as investing in companies with high ROE, find this ratio essential in-stock selection.
As a shareholder, ever wonder how much of the company’s income returns to you? The payout ratio shows precisely that. Investors use this measure when making investment decisions.
The payout ratio shows the percentage of a company’s earnings paid out as dividends.
The Payout Ratio Tells Investors What Percentage Of Income Is Paid As Dividends
Payout Ratio = (Dividends / Net Income) * 100
or
Payout Ratio = (Dividend per share / Earnings per share) * 100
Additionally, dividends are an integral part of corporate policy. After all, dividends are the only non-speculative way to earn return in the stock market. Surely, investors sell stock higher than they purchased for a profit, but this is capital appreciation, and much more unpredictable than dividends.
Why does this matter to investors? Dividends are not guaranteed by management. Once management declares a dividend, they usually uphold the policy as a sign of strength. However, in dire circumstances, companies either reduce the dividend or stop it altogether.
For this reason, investors use this measure for clarity. A low payout ratio indicates that companies keep more of their earnings in order to fuel growth. Conversely, companies with a higher ratio have no better use of their cash. Savvy investors have opinions on how much retained earnings the company needs going forward. For example, a growing company that burns cash quickly with a high payout ratio might not be sustainable. For this reason, investors forgo the investment, or even bet against the company.
Also, what ratio is best for companies? It is certainly a matter of investor preference. An investors who relies on dividends as income looks for a lower to medium ratio. This is because the company is likely to increase or maintain the current payout ratio. Conversely, older companies with higher payout ratios cut dividends if earnings decrease.
The payout ratio paints of a picture of how a company uses its net income. Also, payout ratio trends gauge the overall health of the company as a whole. This ratio is valued by speculative investors and long-term investors alike.
Analysts and investors measure companies in various ways, many relating to the amount of profit produced in a given time. Operating income measures the performance of the company’s core operations. This number gives some of the clearest forecasts for company performance.
Operating Income Measures How Efficiently A Company Runs Its Core Business
Operating income shows a company’s profit after deducting operating expenses. Various operating expenses include salaries and wages, depreciation, cost of goods sold (COGS), and items like utilities and office supplies. Also, this accounting measure includes selling, general, and administrative costs (SG&A), such as advertising.
Operating Income = Net Sales – COGS – Operating Expenses
Furthermore, operating income excludes actions such as investment in outside firms, or the sale of real estate (given the company is not in business to sell land). Expenses such as taxes and interest expenses do not qualify as operating income. The simplest explanation for operating income is if the cost supports the company’s core business practice. Additionally, one may wonder why financing charges such as interest are not included. Operating income judges a company’s efficiency from core operations and how they fare in the market. Interest is a necessary part of business and has no relation to market demand or operating efficiency.
This section of income goes one step beyond gross income. It gives a complete picture of how a company measures up to others in its space. Additionally, discrepancies between like companies allow investment opportunities. For example, a company with a greater operating income has more money to either return to shareholders, or pursue new projects.
Conversely, savvy investors notice that companies with high operating income, but low net income deduce that the future will be better- perhaps the company had a large lawsuit bill as a one time expense. If the company’s stock shows a negative reaction based on net income numbers, but operating numbers remain strong, investors buy weakness believing current prices trade at a discount.
Operating income is yet another accounting measure of a company’s performance. This measure is industry specific and typically is of no use across industries. Successful analysts focus on core operations in predicting future values of companies.
Order types are an edge that trades use in the market. A limit order guarantee trade execution at predetermined prices. This mitigates risk for sophisticated traders.
A Limit Order Only Executes If Price Reaches The Set Limit Price Of The Order
A limit order is an order set by investors. Execution only takes place if the price trades at or through the price set by the market participant. Also, fills rarely occur if price only trades at the limit price. Fills are only guaranteed if prices trades through the set limit.
Additionally, investors set time limits on these orders. Some limit orders terminate immediately unless filled- these are called “immediate or cancel” (IOC). Another name for this order type is “fill or kill” (FOK). Day traders or complex hedge funds use these orders. Other time limits are “good till cancelled” (GTC), meaning these limit orders exist as long as the investor does not cancel the order.
Limit orders are passive orders, meaning they sit idle until price reaches the limit. Conversely, market orders execute immediately at the best available price in the market. For example, an investor that is long a stock and looking to sell at a specific price that shows a profit, he places a limit order to sell his position at the desired price. This way he sells his stock without watching the market tick by tick.
Additionally, sophisticated investors use this order to enter the market at predetermined prices. If an investor believes that fair value for a stock is $20 and he is only willing to buy at that price, he enters a limit order for $20. The order activates when the stock trades for $20 or less, or until the investor cancels the order.
Finally, limit orders are a superb risk management tool. Investors control the price of their entries and exits. However, they risk executions, meaning they may miss an entry or exit depending on where the market trades.
Like banks, companies extend credit to consumers. This allows for the immediate purchase of goods with payment in the future. Accounts receivable turnover measures how effectively companies turn credit sales into cash.
Accounts Receivable Turnover Measures Efficiency Of Lending In Companies
Like many other measures in financial analysis, accounts receivable turnover has a ratio expression. This is a measure of how efficiently a firm uses its assets and financing structure.
Accounts Receivable Turnover = Net Credit Sales/Average Accounts Receivable
Furthermore, average accounts receivable is the value of accounts receivable at the beginning of the period plus the ending period accounts receivable divided by two. Evaluation typically takes place annually, although quarterly is also common.
Other than banks, companies who extend credit essentially lend money for free. For example, retailers typically do not charge interest on their inventory sales. Furthermore, retailers use this practice as it increases the inventory turnover. This is a profitable strategy if consumers pay in a reasonable time frame. Also, the time value of money implies that companies lose money on this deal. However, without extending credit, the sale may not exist.
For example, imagine a company had net credit sales during the year of $500,000. If beginning receivables equaled $25,000 and ending receivables equaled $30,000, then average accounts receivable = (25,000 + 30,000)/2 = 27,500. The accounts receivable turnover then = $500,000 / 27,500 = 18.2. This shows that the company collects accounts around 18 times per year. Additionally, dividing 365 days in a year into this number shows how long it took to collect during the year. Here, the average consumer took 365/18.2 = 20 days to pay.
Finally, accounts receivable turnover is industry specific. The number tells different stories about a company. It implies some companies operate more on cash, other times it shows that the company serves quality customers. Some believe that an overly pristine ratio shows conservative lending tactics by the company that, if more aggressive, would increase sales.
In conclusion, accounts receivable turnover measures the operating efficiency of companies. Extending credit is an effective means of moving inventory. Companies that manage this to perfection enjoy higher sales and consequently higher quarterly profits.
Business cycles are an unshakable part of world economies. Cyclical unemployment trends repeat over time and affect everyone in the workplace.
Cyclical Unemployment Occurs When Business Cycles Change
Economists classify causes of unemployment into buckets, making it easier to identify business cycles. Cyclical unemployment occurs when business cycles into recession, for example. The reason for unemployment in this classification is demand in the economy cannot meet the labor supply. Furthermore, think of the Great Depression when 1 out of every 4 individuals were willing and able to work but could not find employment. Here are some good current data.
Additionally, when businesses experience the boom phase of the cycle, unemployment is at its lowest. This is because economic output is maximized. Conversely, when economic activity wains, business cycles slow and cyclical unemployment rises. This differs than the other two classes of unemployment- structural and frictional.
Also, structural unemployment occurs when a mismatch exists between worker’s skill and employer need. Disruptive technology causes structural unemployment. For example, the structure of the economy changes. This is typically longer lasting unemployment, since a fundamental shift occurs.
Lastly, frictional unemployment occurs from naturally changing jobs throughout one’s life. Interviews and decisions take time, thus leaving some would-be workers temporarily out of work.
Cyclical unemployment is a repeating part of the business cycle. For example, when during the 2008 financial crisis, the housing market declined. This reached so far as to put many construction workers out of work.
However, seasonal unemployment is a shorter term, more predictable classification of cyclical unemployment. Furthermore, cyclical unemployment becomes structural unemployment if workers stay out of the workforce long enough to acquire new skills.
Cyclical unemployment is unavoidable, but can be managed. If one believes the economy is likely to turn down, he sharpens his skills or starts interviewing for new positions well in advance. Of course, this is only necessary if one’s career is business cycle sensitive.
Different order execution types exist in the market. This is to compensate for different trading styles. Often the cheapest is a market order.
Market Orders Show Immediate Execution At The Best Price In The Market
A market order tells a broker to execute an investment trade immediately at the best available current price in the market. Market orders have a high probability of being executed since they come with little restrictions. Conversely, limit orders only execute at predetermined prices. Market orders typically have low commissions due to the low amount of work done by the brokers to execute.
Furthermore, different orders have different advantages and disadvantages. For example, illiquid stocks usually have larger spreads. This means that the price between the best bid and best offer is wider and therefore more difficult to find a counterparty to trade with. If a trader sends a market sell order, he hits the bid price. Also, this means that the buyer of shares used a limit order. If the spread is $1, the seller potentially missed $1 of profit. Basically, market orders ensure a speedy exit from your position, but you risk losing out on the spread.
Additionally, slippage is a large risk to market orders. Slippage happens when insufficient volume exists at the current market to satisfy a market order. This scenario shows investors worse fill prices than expected. Slippage is common in thin stocks and costs investors significant money. For this reason, savvy investors study order types and decide which work best for their strategies.
For example, if a stock shows a bid/ask of $100/$102 with 100 shares bid and 100 shares offered, only 100 shares exist at that price, so a 200 share order fills half at the market and half at the next best price in the market.
Finally, market orders show immediate execution, which is efficient in liquid stocks. Typically, ample liquidity exists in the liquid stocks that market orders and limit orders show similar executions. However, thin market traders are aware of using market orders for execution, as it may cost a significant portion of the trade.
Simple interest exists in most short-term loans. such as a car loan. The payment calculation varies from a compound interest loan. Understanding the difference helps a borrower budget appropriately.
Simple Interest Helps Consumers Determine The Cost Of Borrowing On Their Loan
Simple interest is calculated by multiplying the daily interest rate by the principle times the number of days elapsed between payments. Each payment made during a period initially goes toward that month’s interest, and the remaining amount goes toward the principal. In this way, interest does not compound. Conversely, compounding interest sees interest accrue on top of interest.
Simple interest = P x I x N
Additionally, the timing of the payment matters. Those who make payments before the last day of the pay period enjoy fewer interest payments and more toward the principal amount. For example, if a due date for payment is July 1, those who pay on July 1 pay the maximum interest before deducting the principal. Those who pay before July 1 pay less interest, decrease the principal by a larger amount.
How is this relevant to consumers? First of all, this structure benefits those who pay their balance quickly. This supports the time value of money concept. Educated consumers are able to estimate the interest payments on loans before they decide to borrow. Also, using the simple interest formula, consumers estimate when they will make payments such that interest payments remain stable and tolerable to the borrower.
Additionally, without the simple interest calculation, consumers end up paying much more than anticipated on the loan. Late interest payments add up over time and present a situation where the consumer steps outside the anticipated budget of the loan.
Finally, before entering into a loan agreement, one needs to become familiar with the simple interest calculation. This holds true whether one is borrowing or lending. Interest is a part of our financial system, and those who understand its benefit, while those who do not end up losing money.
Management decides how to spend surplus income in a number of ways. Retained earnings shows investors how their profits drive future growth of the business. After all, as part owners of the corporation, shareholders want to see their put to good use.
Retained Earnings Shows Surplus Profit Not Paid As Dividends
Retained earnings is an accounting measure showing the amount of net earnings not paid as dividends. Management has various uses of this cash, such as reinvesting in the business through research and development (R&D), or buying new equipment. This number appears on the company balance sheet under shareholder’s equity.
Furthermore, retained earnings are reported each accounting period, and are added to the beginning retained earnings from the period, added to net income, less dividends. This equation shows Retained Earnings = Beginning Retained Earnings + Net Income – Dividends.
This number is another way of evaluating net income. From the formula, analysts see that net income affects the change in retained earnings. Though the change does not appear directly in financial statements, investors notice how this number changes each period. Also, they notice if the dividend grew, or if management spent capital on future growth.
Additionally, this measure does not infer excess cash earned, but rather labels how management used the net profit. Trends of dividend paying versus reinvestment differ across industry. Furthermore, they differ with maturity of companies. New companies need as much free cash as possible for expansion and liquidity, whereas an industry giant focuses on capital structure and returning money to shareholders.
Finally, it is important to remember that retained earnings is a measure of the company’s cumulative earnings since inception minus dividends. This is not to say it is a measure of the company’s value, but rather how the company uses its surplus profit over time. Savvy investors understand the best management techniques and invest in companies that use their profits to create the most value.
Conflict theory is an age old phenomenon that some believe still rules culture today. Regardless of opinion, how can one position themselves for success with or without conflict theory?
Conflict Theory Suggests That Individuals Constantly Compete For Scarce Resources
Karl Marx first introduced this theory about society. He suggests that society is in a constant state of competition. This is a byproduct of scarce resources, which the masses need or want. Furthermore, conflict theory suggests that the powerful, or wealthy, attempt to control these resources. This results in suppression of the of the poor or lower class.
This is a hard theory to prove or even gather hard evidence. In a capitalistic society, individuals respond to incentives, which creates innovation and growth. The classic debate over technology and incentives lies in the Malthusian Argument. He argued that human population grows at an exponential rate, while the food supply is arithmetic or linear. This is clearly unsustainable. However, the advent of technology allowed increased food production at a fixed or even lower cost. This begs the question, who reaps the rewards of inventing life sustaining technology?
Conflict theory suggests two primary classes, the wealthy and powerful, and the working class or poor. The minority, powerful class controls resources and exploits the poor. Marx suggested that the poor would revolt until conditions became acceptable, and the circle would repeat. An example of this occurs in landlord/tenant relationships, though this is typically a harmonious relationship as many housing options exist.
Furthermore, no real uprisings occurred recently in Western society, but the theory holds true. The advent of social media user generated content gives everyone a voice and better access to information. Now, if one cannot access the internet, this poses a problem. However, public libraries are the most accessible they have ever been.
Finally, capitalistic societies do experience conflict theory. However, the important point is social classes are not permanent. Many rags-to-riches individuals will testify that individuals respond to incentives and desires for a greater life.
Imagine if you earned the same salary today but lived in the time of your grandparents. There’s a good chance that you would be the wealthiest person in the neighborhood, but how can this be? Purchasing power explains the difference.
Purchasing Power Measures The Amount Of Goods Consumers Can Purchase With A Given Currency
Purchasing power expresses the amount of goods one is able to buy with a given amount of money, or currency. The value of currency fluctuates with interest rates, both long and short term. Inflation occurs when a currency’s purchasing power decreases. Additionally, the central banks of the world aim to keep inflation under control, or at healthy levels.
For example, rampant inflation causes businesses’s materials to increase, thus driving up the price. However, the consumer does not not typically experience a pay increase that matches uncontrollable inflation. This situation occurred in the past after wars and leaves countries and economies devastated.
How does one know when inflation increases or decreases? A government agency known as The U.S. Bureau of Labor Statistics (BLS) keeps a record known as the Consumer Price Index (CPI). This number records historical weighted average of prices of a basket of goods and services. Furthermore, this number serves as a benchmark in comparing inflation numbers over time. More CPI here.
Also, economic cycles impact purchasing power. For example, the world experienced a financial crisis starting in 2008. In order to ease consumer and investor fear and increase liquidity, central banks kept borrowing rates near 0. This theory assumes that the circulation of money will continue, as businesses continue to produce and consumers continue to spend. Additionally, if this scenario plays out on a global scale, all economies will control inflation, leaving no one in a a solvency crisis.
Purchasing power varies with different economic cycles. For example, housing prices were certainly cheaper a 30 years ago, but so were wages. As long as inflation remains stable, consumers’ purchasing power stays relatively constant.
A monopolistic market or monopoly market is significant for several reasons, one being it is so rare. In the past, companies experienced vast profits in such an environment. This all but ended with increased regulation and consumer activist groups.
Monopolistic Markets Lead To Inflated Profits
monopoly markets have one company that offers products or services to its customers (the public). In this way, the company sets whatever prices and production level it wishes. Most noteworthy, the company enjoys artificially high profits. However, in a competitive landscape, these profits are reduced.
Additionally, monopolistic markets are extremely rare in the economy today. They could, in theory, exist due to absolute control over a natural resource, or legislation banning raising barriers to entry in a market. Although unlikely, this arises when controlling powers such as governments believe the market cannot support a competitive sector.
Competitive economies are strong-history shows this is true. Innovation and competition causes growth. When a monopoly is present, it removes the incentive for innovation. The quality and usefulness of products generally stays the same. This hurts consumers and businesses alike.
Furthermore, the company in power exploits the consumers. Because no alternatives exists, consumers pay premiums for what is a less than perfect product. Also, monopolies restrict output. This is harmful to society in general, as it reduces income for workers.
Producers in a monopoly market have a demand problem. Marginal revenue is not constant. As output increases, the amount the monopoly gets for each unit decreases. However, this is only true if the company cannot price discriminate. This is true based on the law of the demand curve. Based on this law, monopolies are next to impossible in free markets.
Finally, history taught us valuable lessons about monopolistic markets, both legal and illegal. As the negative effects mentioned in the article became reality, governing bodies stepped in and created more competitive landscapes. The result is a highly productive and relatively safe consumer world in which we live today.
A leverage ratio is a simple measure of a company that tells a complex story. One cannot properly evaluate a firm without it.
A Leverage Ratio Measures A Firm’s Potential Risk
A leverage ratio is a expression of a firm’s capital structure. Furthermore, companies either use all debt financing, all equity financing, a mix of both. Choices of capital structure comes from management. For example, the best management use the capital structure that makes the firm most valuable.
Additionally, a number of these ratios exist. Listed in no order, some include: Debt:Asset, Debt/Equity, Debt/Capital (Debt/ (Debt + Equity), or Asset/Equity.
The most popular leverage ratios are Debt/Equity and Debt/Capital. Some consider a Debt/Equity ratios over 2 risky. However, leverage ratios fluctuate with industry.
Being debt-free is not always the best scenario for companies. If a company earns a return higher than their interest on the loan, the company grows profits. However, if leverage becomes excessive, the firm experiences bankruptcy risk. This happens when companies cannot pay back their loans.
Also, how does one know when a company is over leveraged? Leverage ratios vary across industries, but provide value when compared within industries. For example, utility companies typically use more debt than internet companies. Utility companies require large capital outlays for new plants and equipment, and see relatively more stable cash flow.
Standard debt/capital ratios stand at .05 or lower.
Why do these measures concern investors? During invariable economic downturns, cash strapped companies cannot pay interest expenses. This creates a panic situation, and share prices typically suffer, creating a perfect storm.
Unfortunately, this situation unfolded in 2008 in the American economy. Banks became over leveraged on certain insurance policies, which created a viscous circle of bad debts.
Finally, leverage ratios are critical in financial analysis. In fact, they should be viewed first when taking risk measures of a company. The greatest management vision cannot survive overbearing debt loads.
A company sells products to its costumers in hopes of turning a profit, this is business 101. However, what if the rate at which a company sells inventory gave analysts a better idea of future earnings? Inventory turnover is a good predictor a company’s success.
Inventory Turnover Measures Strength Of Sales
By definition, inventory turnover shows how many times a company sells inventory, then replaces it. Also, a few different ways of calculating this ratio exists. Some companies report inventory turnover in term of sales, while others use the cost of goods sold as their benchmark metric.
To determine average inventory, use this formula:
Average inventory = (beginning inventory + ending inventory) / 2
Furthermore, the aforementioned ratios are displayed below:
To determine inventory turnover in terms of net sales:
To determine inventory turnover in terms of cost of goods sold:
To determine how long it takes to ‘turnover’ (sell all of) inventory:
Companies never want excess inventory sitting on their shelves. This is potential profits that the company either reinvests or returns to shareholders. This measurement varies by industry, so you should always compare it to benchmark industry averages; not the overall market.
Analysts use inventory turnover to measure sales strength. Low inventory ratio leaves a company cash strapped and insolvent. Furthermore, this ratio relates to the company’s return on assets (ROA). Shareholders watch this ratio as it explains how efficiently a company utilizes its assets. Like other ratios, different industries scrutinize the measure with different importance. For example, a retail analyst shows great interest in the ratio, whereas a service company analyst values it less.
Finally, thanks to modern shipping practices, inventory turnover ratios are more important than ever. The rise of eCommerce created new challenges for retail businesses and place tremendous pressure on supply chains. Inventory management is becoming increasingly important in today’s fast-paced business landscape. Understanding supply-chain dynamics starts with learning how to utilize the inventory turnover ratio.
Like many other financial ratios, gross profit margin helps determine the underlying health of a company. However, this metric has immediate implications for the stock price.
Gross Profit Margin Is A Ratio That Measure Efficiency
Gross Profit analyzes how efficiently a company produces the goods or services it sells. Furthermore, gross profit margin converts this measure to a ratio. Analysts then use this ratio when evaluating a company over time, usually quarters or years. Also, the ratio is Gross Profit Margin = (Revenue – Cost of Goods Sold (COGS)/Revenue.
More simply, it is gross profit/ revenue. It reveals what portion of sales paid for the production costs. Analysts find these data in the income statement. Most noteworthy, the information is among the top line items.
Analysts keep such a close eye on this measure because without adequate margins, businesses cannot pay for operating expenses. Expenses such as salaries, rent, and insurance remain somewhat constant. Margins are ever-changing, based on the cost of production.
Also, if a company sees expanding margins, or starts operating more efficiently, stock prices appreciate on the basis of better future growth. Conversely, the opposite is true.
How does this measure change during a time period? Streamlining or automating supply chain functions are expensive at first, but ultimately lower future margins. This is a sustainable business practice that firms invested in recently. Conversely, new regulation or lower market prices lower gross margins and leave companies cash strapped.
Furthermore, this metric is not uniform across industries. This means that a retailer shows much different gross profit margins than a bank, but the theory remains the same.
Finally, gross profit margin provides value to a myriad of parties from investors to suppliers to producers. Any wrinkle in the number sends a shock to all valuation models, billing cycles, and investment schedules. It is the foremost efficiency indicator of a company.
New business ventures ultimately grow companies and provide shareholders a return on their investment. For this reason, financing decisions make or break a company’s future. This article discusses cost of capital and how the metric aids in the decision making process.
Investors Closely Examine A Company’s Cost Of Capital
Management makes financing decisions based on the growth opportunities. However, this seems a bit vague- what constitutes growth? The cost of capital is an economic term that defines the minimum expected return from investors for giving the company their capital. Also, consider this the benchmark for each new project.
Additionally, when management engages in projects that far exceed the cost of capital, value emerges for shareholders. This value sometimes comes in the way of stock price appreciation, or dividend growth. In either case, both investors and management are happy.
Given an array of projects, good management picks the highest expected return over the cost of capital. However, risk exists in every business venture. Thus, cost of capital decisions factor in risk when choosing.
Risk measurements are calculated similarly for equity financing and debt financing. Debt is a loan from outside lenders, which requires an interest payment. This interest rate factors in a default premium, which is some level above the risk-free bond rate. Furthermore, as the debt level increases, so does the default premium.
Conversely, equity financing is a bit more subjective. This component infers a cost of capital by comparing the investment to other comparable investments. Also, these investments both need similar risk profiles, as decided by management.
In conclusion, the cost of capital is paramount in management’s decision process. Furthermore, sophisticated investors use this in evaluating the effectiveness of their money. The cost of capital is the benchmark for management, investors, and lenders in agreeing on new projects and evaluating risk .
Many individuals start businesses, however, few achieve profitability. Many costs exists in starting and maintaining operations. The cost of goods sold (COGS) is among the most important measurement of successful businesses.
Cost Of Goods Sold Shows The Amount It Costs To Produce Goods
Cost of goods sold measures the costs associated with purchasing or manufacturing materials that a company uses for sales. Additionally, this is significant because it measures only those costs that directly impact production costs. Advertising or administrative expenses have no bearing on the production.
Furthermore, analysts find this measure imperative for a few reasons. We know that a company cannot make money without a sale. Sales – COGS = gross profit, and Sales / COGS = gross margin. These two calculations show how efficiently a company makes the products they sell. Therefore, if a company sees increasing gross margins, they are inherently more valuable.
Additionally, COGS is measured over a period of time, either quarterly or yearly. It requires inventory measurements, which reside in the income statement. The calculation is simply:
COGS = Beginning Inventory + Purchases in period – Ending Inventory.
These measures are self explanatory, except for beginning inventory. Beginning inventory shows inventory left over from the previous period, such as unsold items.
Furthermore, analysts, investors, and management keep a very close eye on this measure as the trend over time shows increasing or decreasing profitability. Since this is the first measure of the income statement, it impacts every line item below it.
Also, it inherently shows how well the company manages inventory. Inventory turnover is an important metric for companies as an other operating efficiency measure. The best recipe for success exists when companies have low cost of good sold and high inventory turnover.
In conclusion, cost of goods sold is the pulse of companies. It shows how profitable they are relatively, and shows how profitable they are able to be. When management mentions decreasing COGS, stock pricing typically react positively.
Gross Profit Shows How Efficiently A Company Produces Goods
Income statements show gross profits at the very top of the page. That’s why you often hear gross earnings referred to as “top-line earnings”. The figure shows how much a business earns after deducting production expenses. Use this equation to determine gross profits/earnings:
Gross Profit = Revenue – Cost of Goods Sold (COGS)
Additionally, analysts value this measure because other expenses typically stay stable over time. For example, a company takes large one-time loss or gains throughout time. They equal out and negate each other. However, if a company starts producing at a lower cost, they realize more profit. Conversely, if companies start producing at a higher cost, their future growth looks questionable.
Gross profit shows how efficiently a company operates. In fact, some prefer the ratio of Gross Profit/Sales, which is gross margin. Analysts compare gross margin over time, typically quarter-over-quarter (QOQ). Increasing gross margins indicate a company has brighter potential for future investment, which leads to growth. Stock prices typically appreciate on this news. However, the opposite is also true.
Additionally, consider that this measure does not include fixed costs such as rent or advertising. Theses are examples of controllable costs, and successful businesses keep these costs stable over time, making them predictable.
As with many other financial ratios, gross profit varies across industry. This simply means that one should not compare the measure of a food company against that of a hospital. Analysts become familiar with the industry standard and recognize when a business is leading or lagging the average.
In conclusion, remember that gross profit is a simple, yet powerful measure of a company’s efficiency. If a company suddenly produces at a lower cost than expected, future expectations for growth increase immediately, along with valuation of the company.
Receiving a paycheck is great, but how does one measure their salary income versus what they take home? Gross income measures the total amount of money earned over a given period.
Some refer to this measurement as gross pay or pre-tax earnings. This entire amount is not always subject to taxes, certain types of expenses can be deducted. In addition, the IRS offers credits and deductibles that can help reduce taxable income further.
Taxpayers use gross income as a starting point to calculate tax payments and refunds. Wages, tips, salary, and even dividends are examples of taxable income.
Determining gross earnings is simple. Use this formula:
Gross Income = Total Sales – Cost of Goods Sold (COGS)
This is obviously different from an individual’s point of view, however, the point remains that taxes are free from this number.
Certainly, this helps workers understand salary requirements. Also, this is especially true when choosing a job location. Tax burdens and cost of living differ with the region. For example, if location A has a high cost of living, a worker requires a higher annual salary, then location B with a lower cost of living. This is because salary does not take into account local and state taxes.
Furthermore, lenders use this measure as guidelines when making loans. This is significant when applying for a home loan, or other sizable life events that require loans.
For example, capital appreciation qualifies as taxable income, but other types of earnings are exempt.
Certain interest payments – such as distributions from municipal bonds – are not factored into gross income. Certain inheritances, life insurance payouts, tax-deductible donations, and IRA contributions also don’t count. This is significant as informed persons utilize these non-items in reducing their tax bill as much as possible.
The weighted average cost of capital (WACC) is an umbrella measure of risk, valuation, and expected return. Often misunderstood, this valuable metric provides tremendous insight into a company.
Investors consider WACC an opportunity cost of taking risk
Cost of capital is a metric by which investors measure the opportunity cost of their money. Management must provide shareholders a cost of capital above an equally risky investment. Furthermore, the WACC assigns proportionate weights to each category of capital.
Additionally, sources of capital include both common and preferred stock, and long-term debt, such as bonds. Firms used different capital structures depending on management decisions, or industry specifics. For example, come companies carry no debt, while other are extremely debt heavy.
WACC is the average cost of raising money for a firm. The equation for this calculation is:
WACC = (E/V) *Re + (D/V * Rd) * (1-T)
Where: E/V = % of equity financing , D/V = % of debt financing, Re = cost of equity, Rd = cost of debt, T = corporate tax rate
Also, E = market value of the company’s equity, D = market value of the company’s debt, and V = E + D.
Cost of equity is the return that the market demands for owning risky assets in a company. This measure comes with a bit of ambiguity compared to debt returns, which have set interest payments and values. The cost of equity is from the company point of view. If they fail shareholders and provide a lower rate of return, investors sell stock, hurting the company.
Cost of Debt is more simple. Interest paid on loans, minus the amount of taxes saved as a part of deductions, represents the cost of debt for a company.
Also, Management uses WACC, similar to cost of capital, in making decisions in order to maximize shareholder value.
Finally, the weighted average cost of capital represents an investor’s opportunity cost of taking risk. It is an ever-changing, somewhat subjective measure of judging risk and attracting the most capital available.
Individuals own stock for a variety of reasons, most notably to accumulate wealth. Owning stock gives investors partial ownership of a company, which comes with responsibility. One of these responsibilities is voting at shareholder meetings, however, many choose a proxy vote.
Proxy Votes Allow Shareholders Say In The Company
Companies hold annual shareholder meetings in order to give information on current business affairs, and vote on executive benefits. However, many cannot attend these meetings for a various number of reasons, and choose to vote by proxy, which is a ballot cast by one on behalf of another.
Additionally, shareholders designate someone that votes in line with shareholder interests, as indicated by the shareholder. This individual may be management, or even someone on the board of directors.
Based on corporate laws, certain issues require majority shareholder approval. Some of these events include election of directors, stock option plans, or mergers and acquisitions. These votes typically arrive at least one day before the shareholder meeting.
Different types of proxy votes include plurality vote and majority vote. Plurality vote only requires that one candidate receive more votes than a competitor. This makes it easier to win with less votes. A majority vote requires majority of shareholder approval. If an individual chooses to withhold a vote, or abstain, the information is disclosed in the proxy statement.
Furthermore, proxy voting gives shareholders tremendous power. A proxy fight takes place when a large shareholder or a group of shareholders convince others to surrender their voting power, such as in a proxy vote. This large block of voters exert greater influence than acting independently. This often helps achieve desired results that would not be possible without it.
Finally, a proxy vote is an efficient means of allowing shareholders a say in the company they own. It allows companies access to capital in a responsible way, while remaining accountable to the shareholders .
Investors and analysts use certain accounting measures in measuring the risk of companies. Financial statements are sometimes convoluted, or even too in depth for basic research. For this reason, certain measures, such as the current ratio exist.
The Current Ratio Evaluates A Company’s Liquidity
The current ratio is a measurement showing a company’s ability to meet its debts. The definition of the gauge is as follows.
Current Ratio = Current Assets / Current Liabilities
Additionally, current assets include both liquid and illiquid assets. it is essentially a measure of liquidity of a company. For example, if a company shows a current ratio of 2, this means they have 2 times the amount of current assets for each of its current liabilities. It is important to note that this includes all current assets and liabilities.
This ratio helps interested parties understand a company’s solvency position at any given time. Furthermore, some analysts consider companies with a current ratio less than 1 to pose liquidity concerns. Also, the current ratio gives insight into a company’s ability to turn product sales into usable cash. For example, if a company is not efficient at collecting on its accounts receivable, this may pose liquidity problems as it is not a sustainable position.
However, as with most financial measurements, interpretation of this measure is industry specific. Some industries require quick inventory turn over, which decreases the current ratio. This is not a sign of solvency concerns, rather a reality of operating in a space.
We mentioned that analysts and investors have interest in company solvency. Additionally, creditors or lenders become familiar with their borrowers liquidity. This ratio serves as a baseline for lending decisions, as it gives a high level view of a companies solvency.
The current ratio is a widely-accepted measure for analyzing alike companies and their financial position. Analysts use it to filter out weak companies, and lenders use it to weigh risks of loans. Becoming familiar with this metric will only boost one’s knowledge of fundamental company analysis.
Shareholder’s Equity (SE) is a financial metric used by analysts to determine the health of a company. Accountants estimate the value of the company if it liquidated and paid debts today using this measure. Also, let’s take a look at how investors and analysts use this metric.
Shareholder’s Equity Measures The Health Of A Company
What is the calculation for SE? Simply, it is SE = Total Assets – Total Liabilities. Furthermore,the definition is intuitive in the sense that it shows the amount shareholders expect in the event of a liquidation. Investors concern themselves with risk, and SE helps detail the worst case scenario.
Additionally, this metric measures bankruptcy risk. If a company has more liabilities than its current assets, solvency risks may arise in the near future. Negative Shareholder’s Equity companies pose greater bankruptcy risk than those with positive.
Also, let’s take a simple example explaining this measure. Suppose you invest $10,000 in a business, and borrow another $10,000. You now have $20,000 in assets. However, you owe $10,000, which is a liability. Therefore, you own $10,000, which is shareholder’s equity.
Additionally, in what ways does SE grow? If a business makes a profitable sale, assets grow. If management retains that profit in the business, it adds to SE. Conversely, if management takes that profit out, SE stays the same. Retaining profits is the fastest way management grows shareholder’s equity.
Analysts refer to SE as the “book value” of the firm. For some businesses understanding the book value is paramount before making investment decisions. For others, it is basically meaningless. The determination has everything to do with sector and business models. Becoming familiar with industry practices of the interested company is necessary when analyzing any company. The balance sheet reveals much important information regarding SE.
Shareholder’s Equity is an important accounting measure to understand. Investors need it when understanding the solvency of company, and if their investment is warranted. Understanding which industries rely on this metric and which do not gives investors and analysts an advantage when analyzing companies.
Sophisticated investors know their way around the 10-K report. It is a document released annually by companies to shareholders. Furthermore, the format is typically uniform, as it is a required submission. Next, we discuss the highlights and how to navigate such a large and comprehensive report.
The 10-K is an important report for shareholders
The deadline for submission of this report is 60 days after the end of the fiscal year. Additionally, companies with $10 million in assets and over 2000 owners in a class of equity securities meet the requirements to file such a report. Furthermore, every annual report contains 4 parts and 15 schedules.
Next, Part 1 details business activities , specifically what the company does and who it owns. This part contains issues relating to competition, regulations and labor issues. Furthermore, this section describes risks to the business and any outstanding legal proceedings.
Part 2 further details the current business environment. This section measures stock performance over the given time period. Additionally, it gives details related to stockholder issues such as purchase of securities. Also, investors find consolidated financial statements in this section.
Part 3 talks about the C-level management. This includes the directors, officers, and corporate governance. Additionally, this section is home to executive compensation plans.
Lastly, Part 4 contains exhibits and financial statements. This is a wrap up and explanation for the rest of the document.
This document is a tell-all for the business environment in which the company operates. Though these reports are often dry, the information is sound. This annual report details exactly in what space the company operates, and what risks it anticipates moving forward. This is especially important because things may look calm on the surface, but a big lawsuit could spell trouble in the future for any business.
Finally, despite being a required document, the 10-K is also extremely helpful in making investment decisions. Investors find relevant information regarding risks and general health of the business environment here. Next steps for investors include listening to conference calls or investor meetings. This ensures that investors understand what they read in the 10-K.
Pattern Day Trader is a FINRA designation for participants in the stock market. The regulatory body differentiates frequent trading activities by professionals apart from those whom participate as a hobby. This designation protects unsophisticated investors from themselves. Furthermore, it ensures the integrity of trading, separating it from gambling.
Pattern Day Trading is an SEC designation
This rule applies to any trader who buys and sells a security in the same trading day, and does this four or more times in any five consecutive business day period. Furthermore, this rule applies to margin, not cash accounts. This rule is both long and confusing, so let’s break it down.
This rule applies to those who execute four or more round-trip day trades within any five consecutive business days. A round trip is opening and closing a position within the same day.
Next, what happens if one exceeds their trading limit? First, the violating party will only be allowed to close positions or purchase with available cash for the next 90 days. Also, he can deposit $25,000 into the account. Whichever happens first relieves the account of the restriction.
Thresholds exist to ensure that traders are sophisticated and have a large enough grubstake to remain solvent. The Securities and Exchange Commission (SEC) believes day trading is inherently more risky than long term investors. A pattern day trader’s account must remain above $25,000 each day. Furthermore, these traders must deposit funds within 5 days in order to meet a margin call.
Additionally, having the pattern day trading designation allows traders to use margin, which is the ability to establish positions larger than the trader’s account. Usually margin gets as high as 4:1. If a trader has $30,000 account, he can trade as if it were a $120,000 account.
Finally, the pattern day trader designation allows professionals to operate their business efficiently, and ensures novices have risk controls. Additionally, different brokers typically give different margin, depending if positions are flat overnight or not. Make sure to find the right broker that fits a specific trading style.
Financial instruments have personalities. Not in the sense that they are humble or funny, but rather the way they move. ATR or average true range tells traders what to expect when trading these instruments. Consider it a rap sheet for the instruments recent behavior.
Average True Range defines behavior and participation in a stock
ATR stands for Average True Range, or Average Trading Range. Traders consider this a volatility measure. A volatile stock or commodity has a high ATR, a less volatile name has lower ATR. Additionally, this measure helps traders define risk and future expectations about the stock or commodity. The calculation is simply the absolute value of the current high minus the current low. Also, it is a moving average of values, normally kept during a 14 day period.
By definition, lower priced names have lower ATRs, and visa versa. This is why technical traders frequently plot the study under price charts. Furthermore, this study helps traders identify when stocks are most volatile relative to their past. It does not matter that a $4 stock has an ATR of .20. It matters only that the ATR a week ago was .10, for example. Traders use this information in combination with price when making trade decisions.
Additionally, stocks or commodities typically put in the largest ranges at the end of a move. Taking a long example, this makes sense because the action consists of the last buyers rushing to enter and the last shorts panicking to cover. In this way, the measure tells traders when to exit a winning position, or at least hesitate to initiate new positions.
Most noteworthy, ATR does not measure direction like other momentum indicators. Rather, it measure the level of participation of other players. This is paramount for traders because risk management is a best practice. A trader who does not understand ATR and how it affects their positions may end up risking more than originally anticipated. Over time, this mistake causes traders a massive reduction in capital, thus forcing them out of the business.
IRA stands for Individual Retirement Account and is a way for investors to save for retirement in a tax-efficient way. Many different tools for retirement saving exist. It is paramount that investors choose the right one for them personally.
Different Types Of IRAs
For example, two popular types of IRAs include Traditional IRAs and Roth IRAs. They serve similar purposes, however, have a different means of achieving that purpose.
Additionally, money contributed to a Traditional IRA is tax deductible. For example, if an investor contributes $2,000 to his IRA, the IRS does not apply income tax to those earnings. Capital gains in the account are tax free as well. This is helpful in several ways. First, it lowers the tax burden on the individual, essentially putting more money in his pocket. Second, it incentivizes people to save for retirement, which is always a good thing. However, these contributions are taxed as income upon withdrawal.
Conversely, Roth IRA contributions are not tax-deductible. Meaning one pays taxes on the earnings, then places them in the Roth account. However, as the account appreciates, the earnings are not taxed as capital gains. Additionally, the funds are not taxed upon withdrawal.
Unfortunately, governing bodies limit the annual allowed amount in these accounts. The cap on these IRAs is $5,500 or $6,500 if over 50 years of age. This ensures the system maintains integrity. Savvy investors may trade frequently in these accounts in order to get the tax benefit. These rules keep the playing field level.
Furthermore, choosing the right type of account saves money in the long term. How is this possible? Traditional IRAs make sense if you believe your current tax rate is higher than the tax rate you’ll face in retirement. Essentially, you get a tax break when your burden is highest.
Conversely, Roth IRAs make sense if you are in a lower tax bracket now than in the future. Keep in mind contributions here come from after tax dollars. For this reason, withdrawals are tax-free, leading to greater benefit in the future.
Free Cash Flow or FCF is another measure of a company’s financial performance. Operating cash flow minus capital expenditures results in FCF. More specifically, it is EBITDA – change in net working capital – capital expenditures. Cash flow is paramount for any company, regardless of their growth trajectory. However, for growing companies or startups, it is the lifeblood that keeps the company alive.
Furthermore, FCF allows companies to pursue new projects that increase shareholder value. A growing company with large FCF focuses on expanding production of popular products, developing new products, or acquisitions. These investments grow companies over time and yield larger returns.
Free Cash Flow Defined
Equity analysts focus on earnings and revenues in evaluating companies each quarter. However, earnings are easily changed or adjusted due to accounting practices. Conversely, cash amounts cannot be argued or manipulated.
Additionally, why does this matter? Some believe FCF is the best indicator of future company performance. This is not to say that companies with negative FCF are poor. Companies that invest heavily in new projects are often strapped for cash. However if these projects lead to long term value, the company becomes bigger and more profitable. For this reason, some investors only look to FCF before making decisions.
Simply enough, a statement called the “cash flow statement” lists precisely where the cash moves. This statement compliments the income statement and the balance sheet. Consider is more of a legend in decoding the aforementioned statements. This is where investors go if they want to dig deeper into a specific item of the income statement or balance sheet.
In conclusion, free cash flow is integral to all companies, but differs in analysis. Variable cash flow are common in oil and gas companies who make huge investments every few years. Start up companies may have little to negative FCF, while capital light companies FCF usually matches their income. Rather than make blanket statements, FCF tells different stories with each company.
Without audited financial statements, how can investors know the health of their investment? The income statement is an integral document detailing how a company earned its income. Furthermore, it reveals strengths and weaknesses of each company.
The income statement is the lifeblood of the financial statements
The income statement details a company’s financial performance over a given period. This is an accounting practice required by all public companies. Additionally, a uniform method of completion makes it easier for investors to analyze the document.
Furthermore, the income statement gives insight into how a company earns money through operating and non-operating activities. Analysts and accounts value these statement because it is the only one that reveals sales figures. Without sales, a company can’t survive for long.
Additionally, this document shows how sales produce income. It is broken down into two parts- operating and non-operating activities. Consider operating activities as core business practice by the business, such as the cost of goods sold. In fact, subtracting revenue from the cost of goods sold yield gross profit, and dividing these two yields gross margin. This information alone gives investors valuable data. It reveals how efficiently the company produces goods.
Conversely, the non-operating portion details expenses tied to non-core business activities. These include administrative expenses that every business incurs, or if the company sells real estate in a deal (assuming the company is not in the business of selling real estate).
This statement is the starting point for a myriad of metrics that analysts and investors alike use to value companies. Metrics such as return-on-equity (ROE) and return-on-assets (ROA) are not possible without numbers from the income statement. EBITDA is extremely important to investors, as it is a quick way to judge the company’s income removing noncash expenses. Additionally, many statements show several quarters or years of performance for ease of comparison.
The income statement reveals sales figures, which tells the true story of a business’ success. It is the root of many other metrics and valued by investors and analysts all over the world.
APR stands for Annual Percentage Rate and is the amount the borrower is charged yearly over the term of the loan. Its most common use is found in credit card charges. However, this term also applies to annual rates earned through investment. Intuitively, APR = U.S. prime rate + margin rate established by the lending institution.
APR does not take into account compound interest. Borrowers use annual percentage yield (APY) in analyzing compounded rates.
APR is the amount paid annually on a loan
Truly, interest rates and APR’s are very similar. However, they vary in ways that sometimes confuse borrowers. For example, interest rates are strictly the interest charged on the amount borrowed. This excludes other costs such as fees associated with receiving the loan.
Consequently, APR is typically higher than a loan’s nominal interest rate. Consider closing costs of a buying a house, or even mortgage insurance. Adding these cost to the original loan yields a new loan amount. A borrower now pays annual interest on the principle plus the additional fees. This new annual payment divided by the original loan amount tells borrowers their APR.
Lenders typically do not change this rate within the first 12 months of the loan. It is important to note preset times that the lenders change financing terms. Furthermore, companies usually offer a grace period for payment. If a borrower pays the balance of the loan each month, he does not pay interest.
Additionally, the interest charges increase inherently as the amount owed increases. For this reason, it is important to pay as much of the loan each month as possible. The loan charges will increase exponentially, causing the borrower to pay unnecessary charges.
In conclusion, APR tells borrowers the rate at which lenders charge for the loan. It gives a better understanding of the cost of the loan. This measure gives a ballpark starting point, telling borrowers the most basic terms of the loan.
Management’s main goal is creating shareholder value. Achieving this requires capital budgeting decisions that give positive expected returns, also known as the Internal Rate Of Return (IRR).
Interestingly enough, calculation of an internal rate of return first requires the formula for Net Present Value (NPV) of a project. When we refer to “project” we assume it means any capital budgeting decision management faces.
NPV is used in finding IRR
Here:
Ct = net cash flow during period t
C0 = total investment costs
r = discount rate
t = number of periods
We solve for r, which is the discount rate. Additionally, we do this buy setting NPV = 0. This cannot be done analytically, so we use software, or trial and error methods.
IRR is an important metric for management
Furthermore, internal rate of returns are paramount in management’s course for their respective business. Management looks for projects with the highest IRR because it is the most efficient use of their capital.
Additionally, returns that surpass US T-Bills and stock buybacks create value for shareholders. The actual rate of return often differs from that of the calculated IRR. However, this metric gives management an idea of which avenue to explore.
Any rate of return over the company’s cost of capital theoretically warrants the pursuit of the project. However, companies often set a required rate of return in order for management to move forward. This is the minimal accepted rate of return for a project.
For example, imagine a farming company that requires capital-heavy equipment. This equipment needs maintenance which is not free. The choice arises, to fix old equipment or buy new equipment? This is precisely where IRR helps management make the right decisions. Each choice is expressed numerically through IRR, making the decision clearer.
IRR is a powerful metric which companies use to grow their profitability and market share. Investors or analysts should keep close tabs on management’s decisions and if they are using their capital efficiently.
Gross margin is a financial measurement that reveals how much it costs for companies to manufacture the goods it sells. It is the most bare-bones measurement of a companies performance. However, it is perhaps the most important profitability measure for investors.
Gross margin is a closely watched measure of profitability
Gross margin (GM) equals a company’s sales revenue minus the cost of goods sold (COGS), then divided by the total sales revenue. This gives investors a universal percentage measure- easily comparably across companies and also over time.
Additionally, the measurement tells analysts the amount of each dollar a company retains after creating the product. Increasing GM comes in two ways. First, reducing COGS through buying supplies cheaper or automating processes. Second, companies increase price or create new demand for new products.
Furthermore, this metric is of extreme interest to investors and analysts. For example, companies who improve gross margins are suddenly more profitable and more attractive. Conversely, falling margins signal sloppy cost management or lack of demand. Slipping margins sometimes causes companies’ stock price to plummet, sometimes for entire quarters.
Also, gross margin is important because it tells interested parties how companies are performing in relation to their core activities. This metric leaves out expenses such as administrative expenses, and focuses on direct materials related to the products. Administrative expenses are more easily controlled than integral costs such as direct materials, thus emphasizing the important of gross margin.
Also, inventory turnover is a noteworthy consideration. For example, high inventory turnover accompanied with low gross margins is similar to low inventory turnover with high gross margin in a numbers sense. However, it signals differences in business practices that professionals are cognizant of.
Gross margin trends are imperative when analyzing a company’s financial health. Often times, they signal changes in future prices of the company’s stock. This is why gross margin draws the attention of traders, analysts, and investors, among others.
TTM stands for trailing twelve months. It’s used to represent the performance of company. That said, TTM is calculated manually by adding the last four quarterly values. You can use TTM for metrics like: revenue; operating income; operating margin; net income; diluted earnings per share; operating cash flow; capital spending; free cash flow and anything else you’ll see on an income statement.
The reason TTM is used is because some company’s fiscal year don’t coincide with the calendar year.
For example, look at Alibaba Group Holding (NYSE: BABA):
Source: Alibaba
As you can see, Alibaba reports its December 2017 quarterly results during the third quarter of 2018. Using TTM can be helpful for companies that report in this fashion.
Source: Morningstar
According to the SEC, firms must file their quarterly earnings for each of the first three fiscal quarters of the company’s fiscal year.
Here are the rules:
Source: SEC
You can calculate the trailing twelve month numbers by using income statements from a company’s quarterly reports. Since the data doesn’t represent a calendar year, it can show fluctuations due to seasonality.
Trailing twelve month numbers are drawn using the last interim or quarterly report that company’s issue.
Most Recent Quarter(s) + Most Recent Year – The Corresponding Quarter(s) 12 Months Before the Most Recent Quarter(s)
The trailing twelve month calculation is helpful for analysts covering a security. You see, some company’s will issue preliminary earnings reports. Analysts can use this info when its time to make a recommendation on a stock.
In addition, long-term investors can find the TTM calculation useful when they’re analyzing the fundamentals of a stock. However, if you’re primarily a day trader then the calculation will not be as actionable.
Publicly traded company’s must file quarterly results to stay compliant with the SEC. However, not every company has the same fiscal year. That said, the trailing twelve month figure can be a helpful tool for analysts and long-term investors.
RSI stands for relative strength index, it’s a technical analysis indicator that traders use to gauge momentum and if a stock is either overbought or oversold. The indicator was created by Welles Wilder and introduced to the public in the late 1970s.
You can calculate RSI using this formula: RSI=100 {100/(1 + (Average of Upward Price Change/Average of Downward Price Change)}
The indicator measures the speed and change of price movements. That said, it oscillates between 0 and 100.
Now, you don’t necessarily need to know how to calculate RSI yourself, it can be found on most charting packages. That said, it’s more important to understand how to read RSI.
Traditionally, the relative strength index uses a 14 look-back period.
The relative strength index is considered overbought when it’s above 70 and oversold when it is 30 or below.
Examples:
Source: TradingView
The chart looks at the SPDR S&P 500 ETF (NYSE: SPY), notice that it peaks as it reaches an RSI above 80, indicating an overbought condition. On the other hand, there were two occasions where the relative strength index hit 30, indicating that the ETF was oversold.
The overbought condition eventually leads to a sell-off. After the oversold reading, the ETF did bounce back. That said, taking a long based on oversold reading would be considered a contrarian strategy since you’re going against the trend.
Source: TradingView
The highlighted areas are oversold and overbought relative strength index readings. Notice how the United States Oil Fund (NYSE: USO) tends to see its price reverse after these conditions are met.
Sometimes a stock or ETF will make higher highs but RSI may not follow suit or even decline. According to Wilder, he defines that as bearish divergence. A potential spot where the stock price might reverse its direction.
Source: TradingView
In this chart, shares of Tesla make new highs but fail to make a higher relative strength index. Shares of the stock dropped shortly afterward.
Relative strength index is a popular technical analysis indicator used to measure speed and change of price movements. Traders use it to spot if a stock is either overbought or oversold. That said, no technical analysis indicator is foolproof. Test it out for yourself and see its of any use to your trading.
Yield is the returned income on an investment. This typically refers to income generated from interest or dividends. For the most part, yields are expressed in annualized terms. The two most common types of yields investors are familiar with are: bond yields and equity cash dividend yields.
Source: Bloomberg
Investors receive interest payments on their investment, known as a coupon. Coupon rates are fixed, based on the time of issuance and are paid on a specific schedule. Zero-coupon bonds do not pay a coupon; however, they sell at a discount to their value. Bond prices move inversely to yields.
Whenever you invest in a debt instrument like a bond, you also want to keep a close eye on inflation. The higher inflation gets, the higher yields go, and therefore, lowering your principal value of your bond investment.
One method corporations use to make their company more attractive to investors is offering a cash dividend. This is cash paid out by the firm to its stockholders. It’s also another way for a company to to return capital to its shareholders.
Source: Yahoo Finance
AT&T (NYSE: T) offers its investors an annual dividend of $2 per share. Now, if you take that number and divide it by the current stock price, you’ll get the annual dividend yield, which is 5.44% based on the chart above.
Source: Yahoo Finance
Exxon Mobil Corporation (XOM) pays investors an annual dividend of $3.08 per share owned. Based on the closing price of the chart above, the annual dividend yields 3.97%
Let’s say bought 100 shares of a fictional company called Evil Corp. Evil corp pays investors an annual dividend of $5 per share. With the stock trading at $100 that equates to annual dividend yield of 5%.
Let’s say the firms fundamentals worsen throughout the year, and its stock price plummets 40%. It’s true, a 5% annual yield is attractive to most investors. However, that did not come without risk. And with the stock trading at $60, the annual dividend yield is even higher, at 8.3% but anyone that invested at $100 would be down a significant amount on their position.
A high dividend yield is attractive but that doesn’t mean there isn’t risk. That said, it should never be a primary factor for selecting a stock. After all, the company can always change the dividend policy, cut it, or even suspend it.
The return on investment (ROI) is a ratio that measures the income earned on the invested capital. Return on investment is often used to evaluate performance.
source: finviz
The return on investment measures the earnings on investment and indicates how well the firm manages its assets. The above images shows the ROI for the largest publicly traded companies in the U.S. stock market.
Return on investment is useful for businesses as an evaluation tool. For example, an investment that is profitable and has a strong margin could be a focus on a firm. On the other hand, investments that have performed poorly might be dismissed in the future.
Source: finviz
The images shows some of the poorest ROI’s in the stock market. If you look at the performance of many these stocks they are among the worst in the market.
A poor ROI could mean that management is not as efficient as it should be. In addition, it’s important for a company to keep its debt under control. Borrowing funds can help a business grow, but if those funds are used irresponsibly it could cause the firm further financial damage.
Imagine you and a friend buy shares of GNC Holdings (NYSE: GNC).
You buy 100 shares for $4 and sell for a profit at $5. The total gain on the transaction was $100, with an ROI of 25%
On the other hand, your friend bought 200 shares at $4.5 and sold for a profit at $5. Their total profit on the trade was $100. However, their ROI was 11.1%
By using a ratio like return on investment you’re able to compare two businesses in the same sector, despite them having different market caps.
Return on investment is a financial ratio that analysts and investors use to help determine how efficient an operation is with its investments. Some of the top performing stocks in the market have positive ROI’s, while some of the poorest performers have negative returns on investment. While conducting your fundamental analysis, make sure to take a look at the firm’s ROI.
Return on equity (ROE) is one factor used to determine’s a firm’s growth rate. It’s the amount of net profits divided by equity. Equity is defined as the total assets minus the total liabilities.
Return on equity is expressed in percentage terms.
Some firms that boast a relatively high ROE are: Apple, Verizon, Visa, and Facebook.
Source: Yahoo
Apple generated $0.37 of profit for every $1 of shareholders equity, giving the stock a return on equity of 37%
Source: Yahoo
Amazon generated $0.129 of profit for every $1 of shareholders equity, giving the stock a return on equity of 12.9%.
Source: finviz
A high return on equity does not imply that it will stay at that level in the future. In addition, a decline in ROE could imply that the firm’s management is less effective. A rise in the return on equity implies that the firm is doing a better job of generating a profit without having to add additional capital.
In other words, past performance is not indicative of future results.
If the value of the shareholders equity declines, ROE goes down. Increased debt will make a positive contribution to a firm’s ROE only if the return on assets exceeds the interest rate on the debt.
ROE is used to compare companies in the same industry.
Some analysts will use ROE as a measure of management’s ability to generate profits from equity available to it.
Overall, ROE is used by analysts and investors how well a company uses investments to generate earnings growth.
If you’re a day trader or someone who takes short term positions, ROE is not something you need to concern yourself with. However, if you’re analyzing stocks in the same sector then it might make sense to look at ROE for long term investments.
However, also pay attention to how debt and share buybacks play an influence on ROE. It’s best to combine this metric with other valuation metrics when analyzing a stock. For longer term investors, ROE is an essential metric used to analyze the fundamentals of a company.
A moving average is primarily used as an indicator to gauge the momentum and trend for a stock, bond, commodity, or currency.
A moving average is based on the average price of the security over a given time frame.
The simple moving average or SMA is calculated by adding the closing price of the security for a specified time period and then dividing it by that number of periods.
Example:
Source: Yahoo
The closing prices of Tesla over the last five trading days has been:
315.23, 310.42, 315.73, 323.66, 322.31.
The sum of the stock prices over those five trading days is: 1,587.35
Take that sum and divide it by the number of trading days, in this case five.
1587.35/5 = 317.47
The average price of Tesla over the last five trading days has been 317.47.
The problem with using such a small sample size is that an outlier can easily influence the average. For example, Bill Gates is reportedly worth more than $88B, imagine if he was grouped with four individuals whose net worth was zero. The average income of those five individuals would be $17.6B.
That said, popular moving averages traders follow are the 20, 50, 100, and 200-day time periods.
A moving averages is a lagging indicators. One attempt to reduce that lag is by applying a higher weight on the most recent prices. This type of moving average is known as the exponential moving average (EMA).
Here is the formula over a ten-day period.
Initial simple moving average: 10-day sum/10
Multiplier: (2/(10 + 1) = 0.1818
EMA: (Close – EMA(previous day)) x multiplier + EMA (previous day)).
Now, the above chart is of the SPDR S&P 500 ETF (NYSE: SPY), notice that the trend has been up until recently. The lines on the chart are the 20, 50, 100, and 200-day moving averages.
Traders use moving averages to try to identify the current trend, as well as possible levels of support and resistance. In addition, they’ll use them to identify if the momentum is bullish or bearish.
Moving averages are used by many traders and even some investors. Even if you don’t believe in technical analysis they are worth watching. For example, if you have an idea of what levels traders might dump a stock or start supporting it that might help in your decision making process.
A bear market is a financial term used to express when the price of a group of stocks, bonds, currencies, or commodities are steadily declining or expected to.
The above chart is of crude oil, from 1997 when it went from $25 a barrel down to as low $11 in 1998. On June 17, 2014, crude oil futures were trading over $105 per barrel. However, fears of oversupply and lack of demand pushed crude prices lower, and have yet to fully recover, having some analysts believing that the bear market in crude oil is not over.
According to First Trust Adivsors L.P., the average bear market period in the stock market lasted 1.4 years with an average cumulative loss of -41%
One of the most violent bear markets occurred during the financial crises. From October 9, 2007 to March 9, 2009, the stock market declined by 56.8%
A bear market could arise from panic selling, fear, and overall negative sentiment on the market. Investors believe that the market will continue to decline which adds to the selling pressure.
For example, the financial crisis was largely due to the housing bubble collapsing. The economy weakened, debt escalated, businesses downsized, people lost jobs, and overall sentiment became very negative.
However, the economy began to stabilize and the bear market was short lived.
Despite bear markets being shorter than bull markets. The damage done in a bear market is violent. There is an old expression on Wall Street that says the stock market takes the steps up and the elevator down.
A bear market is caused by investors acting fearful. However, in the case of the stock market, bear markets have proven to be buying opportunities. It’s true that no investor can pick tops or bottoms. But a bet against the stock market is a bet against America. So far, America has always bounced back.
A bull market is a financial term to used to express when the price of a group of stocks, bonds, currencies or commodities are steadily rising or expected to.
The above chart is of the SPDR S&P 500 ETF (NYSE: SPY), notice from 2009 to the present the ETF has been rising steadily. It went from 70 to nearly 300 in less than decade.
According to data gathered by First Trust Advisors L.P, the average bull market period in the stock market has lasted 9 years. With an average cumulative total return of 480%
The longest bull market to date occurred between December of 1987 to March of 2000, ending with what is now known as the “dot com” bubble.
Bull markets are not just seen in the stock market, but also in commodities. The above chart is of crude oil futures, notice in 1998, crude futures were trading around $11 at one point. However, by the summer of 2008, it was trading near $150 per barrel.
A bull market can also occur in certain sectors of the market. For example, people’s demand for technology has caused semiconducter stocks to rise. Automated driving, smart home technology, virtual and augmented reality are all areas that need fast processing and computing power.
One company that’s taken advantage of the bull market in semi’s has been NVIDIA Corporation (NASD: NVDA).
The visual computing company has seen its stock rise from nearly $20 in the summer of 2015, to nearly as high as $250 in January of 2018.
When stocks are rising sentiment starts get more optimistic. Eventually that optimism turns into euphoria and investors get greedy while ignoring the risks.
We’ve recently seen this in the cryptocurrency market. In July of 2017, bitcoin was trading under $2000. By December of 2017, it was nearly $20,000. And by February of 2018, it was trading as low as $6,000.
All bull markets end because optimism and greed levels get too high. Eventually stocks get too expensive, the buyers disappear, and panic selling occurs.
It’s important to study bull markets because history has a tendency to repeat itself in the financial markets.
Volume is the number of shares traded in a stock or ETF during a given period of time.
Examples of Volume:
Source: Yahoo
On the above date, Apple (NASD: AAPL) traded more than 60M shares. For a transaction to occur a buyer and seller must agree on the price. In this case, over 60M shares of Apple were exchanged during the course of the day.
If you’re an active trader you’ll want to trade stocks that have a fairly decent amount of volume. The more heavily traded a stock or ETF is, the better the liquidity and spreads.
For example, check out the chart below:
Grupo Aeroportuario del Sureste, S. A. B. de C. V. (NYSE: ASR) is a thinly traded stock. On the above date it traded about 91K shares of total volume. That said, if you look at the bid/ask spread, you’ll see that it was 164.40 by 185.38. A spread that wide makes it unattractive to traders. Imagine being long the stock and a negative headline on it hits, you’ll get crushed in slippage.
Another reason why thinly traded stocks are unattractive for traders is that its hard for them to size up on them. If a stock or ETF does over 20M in total volume, a trader can put on positions exceeding 50K shares without worrying about slippage.
For the most part, stocks will trade more shares if there is a catalyst. A catalyst could be an earnings release, an analyst recommendation, a research note, press release, or anything else that is new information about the stock.
One way traders compare if a stock is active or not is by comparing it to an average.
For example:
On the above date, the SPDR S&P 500 ETF (NYSE: SPY) traded over 143M compared to 101M (30-day average).
Day traders will incorporate volume analysis to see if a stock is breaking down or about to head higher. A lot of strategies are based around following price action and volume.
The ability to analyze volume is extremely important to traders. Investors also need to be aware about it as well. They don’t want to be tied up in an illiquid product if they need to free up funds.
Most brokerage trading platforms have volume analysis on its charts and indicators. These are worth exploring as you continue your education on the subject.
The P/E ratio is the ratio of the current stock price to last year’s earnings. It is also known as the price-to-earnings ratio. The figure can be drawn from the firm’s financial statements, typically, the most recent past accounting earnings.
Examples of P/E Ratio:
Based on the closing price 2/9/18
Apple Inc (NASD: AAPL)- 16.09
You pay $16.09 per share per $1 of current earnings.
Amazon.com (NASD: AMZN)
Source Nasdaq
You’re paying $296.81 per share per $1 of current earnings.
Amazon has historically had a high P/E ratio and been among one of the top performing Nasdaq stocks in the market.
Some analysts will tell you that investing in stocks with a low P/E ratio is a better bargain than ones with a higher one. However, if you listened to that line of thinking you would have missed of some of the biggest stock gainers over the last few years.
Bank stocks typically have low P/E ratios. For example, Bank of America (NYSE: BAC), JP Morgan (NYSE: JPM), Wells Fargo (NYSE: WFC), and Citigroup (NYSE: C) all have P/E ratios below 20.
However, there can be large disparities even among sectors. For example, Netflix (NASD: NFLX) has a P/E ratio of nearly 200. While, other companies in the space like: Dish Network (NASD: DISH), CBS Corporation (NYSE: CBS), and Charter Communications (NASD: CHTR) have P/E ratios nearly ten times as small.
Using the P/E ratio alone to make an investment decision doesn’t make a whole lot of sense. As we’ve seen, some of the best stocks to own over the last decade, Netflix and Amazon, have boasted some of the highest ones.
Investors could use it to compare companies in the same sector. But take it with a grain of salt. Depending on what stage a company is in, whether its trying to expand and grow. If the number is high, investors have expectations that growth will be greater in the future. In addition, companies that are posting losses do not have a P/E ratio.
Overall, its good to know but if you are a trader that number will not help you. An investor may or may not find value in using the price-earnings ratio.
Actual volatility is the measure of the amount of randomness in an underlying asset at any point in time. Actual volatility is instantaneous and can not be measured. That said, volatility is usually measured along a specified period. This is often referred to as historical or statistical volatility. When it comes to volatility in the stock market that is a little easier to quantify. Read on to learn more.
A lognormal distribution is used to model the distribution of security prices. The reason for that is that stocks cannot have negative prices. The normal distribution is used to model returns since it is possible to lose money from investing.
Standard deviation is the statistic used to measure the amount of variability (randomness) around the mean. Standard deviation is commonly used to measure volatility.
Volatility is expressed in annual terms. For example, let’s say Netflix shares are trading at historical volatility of 54% over the last twenty trading days, what does that really mean?
Generally, there are 252 trading days in a year. To express that in a way that traders would understand, we would take the historical volatility and divide it by the square root of the number of trading days.
(.54/15.87)= 0.034
Now, let’s say that Netflix is trading is trading at $250 per share. Take the stock price and multiply it by .034, which results to 8.50.
In other words, the standard deviation says the stock will trade within a (+/-) $8.50 range. A two standard deviation move would by (+/-) 17.
Theory states that prices should stay within a two standard deviation about 95% of the time. Of course, stocks are notorious for having extreme price moves, as witnessed by black swan events like the 1987 Crash and 2008 Financial Crisis.
Knowing what the volatility in a stock is, can be very helpful in terms of your trade preparation. For example, if a stock on average has traded in a $15 range over the last twenty trading days, setting a $0.50 or $1.00 stop on a trade might be a poor idea. You see, that type of move is so small relative to how the stock trades that your chances of getting stopped out are likely high.
Some traders use volatility for mean-reversion strategies. For example, lets say that a two-standard deviation move in a stock is (+/-) $6 and the stock is trading $9 lower, some traders might buy the stock thinking it will bounce.
That said, volatility is mean-reverting. Periods of high volatility are followed by periods of lower volatility.
Source: Yahoo Finance
The chart above is that of the VIX, the volatility index, and what many market pundits call the fear barometer. When the VIX is high, above 25, the market is fearful and the sentiment is bearish. When VIX is low, 20 and below, sentiment is bullish and the appetite for risk is high.
At the end of the day, you’ll want to know how much a stock will move in order to set profit and loss targets, as well as, position size your trade. That said, standard deviation has its flaws. However, if you know these flaws you’ll be able to work around them.
The term averaging down in stock trading is the act of buying more shares to improve your price. Lets say you bought 100 shares of Apple at $100 per share. The stock drops to $95, and you still believe it’s a buying opportunity so you average down (buy more). By adding an additional 100 shares, your average price per share improves from $100 to $97.50.
Averaging down improves your pricing but it also increases your risk or exposure to the stock.
If you are averaging down, you are adding to a losing position. That said, averaging down is a strategy that Pros use effectively but one that amateurs implement poorly.
Let’s say a trader is long 1,000 shares of XYZ stock at $5 per share. The trader has a stop loss at $4.50 and a profit target at $6.5o. When the stock drops to $4.60 they buy 1,000 more shares and average down. Their price improves to $4.80, which means instead of the stock rising 40 cents to get to break-even, it just needs to rise 20 cents from $4.60.
Why might this make sense?
Because the trader is doubling their position size and they are only adding about $100 more risk to the trade. Averaging down makes sense when you are at a point where the reward outweighs the risk.
On the other hand, a new trader might average down on a bad idea or trade that has no real edge. They might not have a concrete trading plan and just adding to a loser.
When you average down on a trade you’re adding more risk on. If you don’t have a solid trading plan, one that includes a profit target and a stop loss, than averaging can be a potentially dangerous strategy.
Have a trading plan, if you can add to a stock position without increasing your risk by too much but improve your price than consider doing it. Adding to a loser simply to improve your price is a recipe for disaster.
