Archive for the ‘Stock Basics’ Category
How do you tackle a large problem in your daily life or manage a project at work? If you’re like me, you look at the big picture and define what you need to accomplish, understand what variables exist and how they affect your progress, and create a strategy for execution. That is, you work your way from the top down to the details. This is also the essential idea behind “top-down” investing.
Top-Down Investing in a Nutshell
Top-down investors strive to understand how supply and demand is changing at a macroeconomic level and identify what sectors, industries, or geographic areas will benefit from these trends. From there, they look at what specific stocks have a competitive advantage and stand to realize the greatest gains as a result of these shifts.
The US Housing Market - A Brief Example
It’s no secret that the US housing market is (at the time of this article) severely depressed. However, while housing is in trouble today, a top-down investor will be focused on finding good companies in the industry that will benefit when the market for homes rebounds in the future. That is, he uses the overall economic trend as a guide for “where to look”, and then makes some basic assumptions about the industry moving forward. In this case, he assumes that the market for housing related goods and services (builders, etc.) will eventually improve in the long term.
In doing so, he is also acting as a “contrarian” investor. That is, he is investing against overall market trends in hopes of purchasing shares today at discounted prices (in order to profit in the future).
Tags: investing strategy, stock strategy, top down investing
One of my goals is to ensure that investors are able to learn the basics of finance and investing without having to wade through all of the “fluff” contained in many books. That is, I want to focus on just the “need to know” so you learn only the most important information when it comes to investing. So, let’s get started with one of the most important concepts in finance: the time value of money.
If you’ve ever watched CNBC or read the Wall Street Journal, you’ve probably heard the term “value investing” thrown around quite a bit. And, like me, you probably assumed that it involves something along the lines of finding good stocks at cheap prices. Well, you’re right, but I think it’s important to lay it out a bit more formally. In a nutshell:
- Stocks prices are affected by many variables which cause them to fluctuate
- Human psychology (i.e., irrational behavior) is a huge driver of these fluctuations
- However, despite this, these stocks do have real underlying values
- Value investing entails buying only those stocks trading significantly below those real values
An Easy to Understand Example
For example, take the current housing situation. If you were to ask the average investor which housing stocks he would buy today, they would probably laugh and respond “I would stay away from anything having to do with housing right now”.
For the most part, they are right. But, what if you found a homebuilding stock that had a strong balance sheet, no debt, and had positioned itself to minimize risk exposure to falling property values? Further, what if that company was trading at a price per share that was lower than the per share value of its assets (if they were to be liquidated)?
A true value investor (i.e., Warren Buffett) would take a conservative approach and wait until the stock traded at a price at least 20% below what he / she thought it was worth before buying it. By doing so, they are taking advantage of irrational investor behavior, as well as the institutional “bias” toward stocks considered en vogue. In addition, they are giving themselves what Benjamin Graham dubbed a “margin of safety” which ensures solid returns.
Cash is, quite simply, king when it comes to stocks. While the income statement captures the earnings of a company for a given period, some of those earnings haven’t been realized yet. That is, the company may have sold 100 mainframes in the first quarter of the year, which will show up as revenue booked on the income statement. However, if the company which purchased those items doesn’t pay for them until the end of the year, that money won’t be reflected as “cash flow” until Q4. Thus, net income is more representative of transactions, while cash flow reflects when money actually changes hands. As you would expect, investors prefer cash since it is “money in hand” vs. an IOU.
There are typically 3 main components of the cash flow statement. In general, these are comprised of a number of detailed line items. We’ll cover the high level concepts below.
The income statement is one of the most important financial statements produced by a company. In a nutshell, the income statement is a summary of operations for a given period (year or quarter) which outlines revenue, cost, and profit produced by the firm. When a company “announces earnings” this is invariably the document which is being referenced. It is also where the Net Income and Earnings Per Share (EPS) metrics are found.
However, keep in mind that earnings numbers can be manipulated using fancy or “creative” accounting techniques which can hide unfavorable performance. Therefore, it is always important to maintain a critical eye when reviewing this document - and to cross reference the Statement of Cash Flows as well. The major components of the Income Statement are outlined below.
Categories
- Economic Indicators (14)
- Investing (40)
- Large Cap Stocks (25)
- Mid Cap Stocks (2)
- Small Cap Stocks (4)
- Stock Basics (8)
- Stock Market News (40)
- Stock Metrics (3)
- Stock Picks (1)
- The Stock Market (11)