Difference Between Cash Flow and Net Income

Different types of Stock

Blue Chips (also called Stalwarts)

These are stocks of high quality,financially strong companies which are usually the leaders in their industry.They are stable and matured companies. They pay good dividends regularly and

the market price of the shares does not fluctuate widely. Examples are stocks of Colgate,

Pond’s Hindustan Lever, TELCO, Mafatlal Industries etc.

Growth Stocks

 Growth stocks are companies whose earnings per share is grows faster than the economy

 and at a rate higher than that of an average firm in the same industry. Often, the earnings are ploughed

back with a view to use them for financing growth. They invest in research and

development and diversify with an aggressive marketing policy.

They are evidenced by high and

strong EPS. Examples are ITC, Dr. Reddy’s Bajaj Auto, Sathyam Computers

and Infosys Technologies ect.. The high growth stocks are often called

GLAMOUR STOCK’ or HIGH FLYERS’.

Income Stocks:

A company that pays a large dividend relative to the market

price is called an income stock. They are also called defensive stocks. Drug,

food and public utility industry shares are regarded as income stocks. Prices of

income stocks are not as volatile as growth stocks.

Cyclical Stocks:

Cyclical stocks are companies whose earnings fluctuate with

the business cycle. Cyclical stocks generally belong to infrastructure or capital

goods industries such as general engineering, auto, cement, paper, construction

etc. Their share prices also rise and fall in tandem with the trade cycles.

Discount Stocks:

Discount stocks are those that are quoted or valued below

their face values. These are the shares of sick units.

Under Valued Stock:

Under valued shares are those, which have all the

potential to become growth stocks, have very good fundamentals and good

future, but somehow the market is yet to price the shares correctly.

Turn Around Stocks:

Turn around stocks are those that are not really doing

well in the sense that the market price is well below the intrinsic value mainly

because the company is going through a bad patch but is on the way to recovery

with signs of turning around the corner in the neat future. Examples- EID –

Parry in 80’s, Tata Tea (Tata Finlay), SPIC, Mukand Iron and steel etc.

Open Market Purchase Operations

An open market purchase raises the monetary base= B,because the monetary base is the sum of currency in circulation= C and bank reserves = R

This can be expressed as B = C + R

when bank reserves R increase, the monetary base B increases.

World Rice Exporter Countries 2010

What is Banker’s Acceptance ?

Banker’s Acceptance Definition

Here’s how it works: A customer of the bank will ask the bank to make a payment in the near future, usually in about six months. When the bank agrees to this order, it is now liable for that payment. Once the bank has signed off on the order, it can then be traded in the world financial markets, hence the name, a “banker’s acceptance”. People in the financial industry like bankers’ acceptances because they are considered very safe assets. This is also why they’re so popular in terms of international trade and finance, because it’s not easy to verify the solvency and standing of the corporate or financial entity you’re dealing with. After all, there’s only so much information a trader in Los Angeles can glean about a trader in Pakistan or Austria.

Example of a Banker’s Acceptance

Let’s say, for example, you own a furniture company in Miami. You want to buy five very expensive sofas from a furniture manufacturer in Sweden. However, you don’t have the cash to buy the sofas and since you’ve never worked with the manufacturer before you haven’t established any credit with them. You do, however, have a great credit record with your bank. So, you go to your bank and ask them to front you the cash for the sofas. The minute the bank accepts your request, it is now liable to pay for the sofas, which makes the manufacturer in Sweden happy because they now know that the bank will pay for the sofas. So off they go to your showroom to be sold by you. As with all money market instruments and other questions concerning how, when, and where to invest your money, be sure to sit down with a qualified financial services expert and ask him or her all the questions you have on your mind before committing to an investment.

What is securitization ?

A securitization is a financial transaction in which assets are pooled and securities representing interests in the pool are issued. An example would be a financing company that has issued a large number of auto loans and wants to raise cash so it can issue more loans. One solution would be to sell off its existing loans, but there isn't a liquid secondary market for individual auto loans. Instead, the firm pools a large number of its loans and sells interests in the pool to investors. For the financing company, this raises capital and gets the loans off its balance sheet, so it can issue new loans. For investors, it creates a liquid investment in a diversified pool of auto loans, which may be an attractive alternative to a corporate bond or other fixed income investment. The ultimate debtors—the car owners—need not be aware of the transaction. They continue making payments on their loans, but now those payments flow to the new investors as opposed to the financing company.

All sorts of assets are securitized:

auto loans

student loans

mortgages

credit card receivables

lease payments

accounts receivable

corporate or sovereign debt, etc

Assets are often called collateral,Collateral will typically pose credit risk. For example, people may fail to make their credit card payments, so credit card receivables entail credit risk. This can be addressed with some sort of credit enhancement such as over-collateralization or a third party guarantee. Tranching is also widely used to allocate credit risk among investors.

Credit ratings are often obtained for  securitizations that entail credit risk, and most ratings are investment grade. If a securitization has different tranches, each may receive a different credit rating.

.

With a securitization, the party underwriting credit risks is not the party taking that credit risk. This opens the door to various abuses. Such abuses, especially with regard to securitizations of subprime residential mortgages, were a primary cause of the 2008 financial crisis.

Standard categories of securitizations are

mortgage-backed securities (MBS), which are backed by mortgages;

asset-backed securities (ABS), which are mostly backed by consumer debt;

collateralized debt obligations (CDO), which are mostly backed by corporate bonds or other corporate debt. 

Let's see the Video below about  securitization.

What is 200 Day Moving Average ?

The 200 Day Moving Average is a long term moving average that helps determine overall health of a stock. The percentage of stocks above their 200 Day Moving Average helps determine overall health of the market. When this number gets below 20%, many traders look for a sharp reversal in the market that can quickly bring the number up to 40%. When this number gets above 85% or 90%, many traders look for a reversal in the market.

A stock that is trading below its 200 Day Moving Average is in a long term downtrend. The stock is generally considered as unhealthy, until it breaks out above its 200 Day Moving Average. Some traders like to buy when its 50 day moving average crosses above its 200 Day Moving Average.

A stock that is trading above its 200 Day Moving Average is in a long term uptrend. This is considered to be a healthy indication. A healthy stock will generally have a rising 200 Day Moving Average. When its 50 day moving average crosses below its 200 Day Moving Average, it is called a Death Cross.

The 200 Day Moving Average often works as a major support level in a bull market. This can present a low-risk opportunity to buy a stock, however a break below it can lead to a large gap downward. In a bear market, the 200 Day Moving Average often works as a major resistance level, however a break above it can lead to a sharp rise.

In a bull market, a buying signal may be generated as the stock dips close to the 200 Day Moving Average and a sell signal may be generated when it goes far above its 200 day Moving Average. In a bear market, a buying signal may be generated when it dips far below its 200 Day Moving Average, and a sell signal may be generated when it rises close to its 200 Day Moving Average. However the opposite signals may be generated on strong breakthroughs of the 200 Day Moving Average.

Competitive Analysis of Stocks

Competitive Stock Analysis. By far the most important way to value any company is to compare it to others. By using competitive analysis, you can put to use all of the ratios above and compare them to one another so that you can get a much more complete picture of the stock valuation of the company you are researching. To start a competitive analysis, follow these steps:

1 - Find a list of comparable companies.

A comparable company is any company that is similar to the company you are valuing. For example, if you are valuing Wal-Mart, you'll also want to look at other public companies like Target, Kohl's, Kmart, Sears, Shopko, JC Penney, Federated Dept Stores, and Saks. To find a quick list of comparable companies you can search most financial sites by industry and get a list of all stocks that are included in that industry. I usually use Yahoo Finance. This is the easiest way to find comparable companies, however it is not a very comprehensive list and many companies are so unique that they do not have identical competitors. If this is the case, you need to use your imagination. Find companies that provide similar goods or services, or that have similar business models. Even if the companies don't do the same thing, if there growth and outlook is similar, the stocks will often be valued similar, and you can therefore compare them to each other. Once you've compiled as comprehensive list of companies as possible, it's time to create your spreadsheet table for analysis.

2 - Create a spreadsheet.

Create a spreadsheet to organize your competitive stock analysis. List the comparable companies down the left side of the spreadsheet and the ratios and values you are computing along the top / columns. Suggested columns include Company Name, Ticker, Price, Fully Diluted Shares, Market Cap, Total Debt, Enterprise Value, LTM Sales, LTM EBITDA, LTM Net Income, LTM EPS, This Year Calendar EPS (estimated), Next Year Calendar EPS (estimated), 3 - 5 Yr Growth Rate (estimated), LTM P/E, This Year P/E, Next Year P/E, PEG Ratio, Price / Sales, EV / Sales, EV / EBITDA ratio and anything else you see fit to add. For examples of how each value is included, refer to the stock valuation section. If you'd like to use our Excel spreadsheet template, please click here to download.

3 - Gather the data.

Now it's time to fill the spreadsheet in by gathering all of the financial data for each of the comparable companies. You can find the information from several sources, but if you want to do the most accurate job, then you should look for numbers directly from the companies and then adjust them yourself if necessary. At first it will seem a little confusing, but once you've looked at a few dozen companies you'll begin to understand more and more about what their numbers and ratios mean. To start, go to each company's website and look for their investor section. They usually have quarterly and annual financial statements, as well as press releases, recorded conference calls and webcasts, and sometimes they'll even have product updates and more. Read as much information as you can. If you can't find much historical information on the company's website, visit any finance site for more info (I like Yahoo Finance for information and BigCharts.com for charting). Begin filling in the columns of your spreadsheet with the information you are gathering. To get the estimated fields (like future EPS and EPS growth) you'll have to create estimates by doing your own stock research. When you've finished doing that, you'll be ready to compute the ratios.

4 - Compute the ratios.

Computing the stock valuation ratios can be tricky, so make sure that you double check each figure to see that it makes sense. The example comparable stock analysis spreadsheet we've compiled has many of the ratios computed for you.

5 - Look for Outliers and Adjust the Ratios.

Now look closely at all of the stock valuation ratios you've computed. Do any of them stand out? You should look for any outliers and then try to adjust them so that they are comparable to the other companies. When you find a number that doesn't make sense or seems too high or low there is always a reason behind it. It could be that earnings are negative, that the company's asset structure is different, or that the figures you're using to compute it are wrong. Even if you can't adjust or correct the valuation ratios it is just as important to understand why they are different. Now that your spreadsheet is complete, it's time to compare the companies' stock valuations.

Stock Valuation Methods

Stocks have two types of valuations. One is a value created using some type of cash flow, sales or fundamental earnings analysis. The other value is dictated by how much an investor is willing to pay for a particular share of stock and by how much other investors are willing to sell a stock for (in other words, by supply and demand). Both of these values change over time as investors change the way they analyze stocks and as they become more or less confident in the future of stocks. Let me discuss both types of valuations.

First, the fundamental valuation. This is the valuation that people use to justify stock prices. The most common example of this type of valuation methodology is P/E ratio, which stands for Price to Earnings Ratio. This form of valuation is based on historic ratios and statistics and aims to assign value to a stock based on measurable attributes. This form of valuation is typically what drives long-term stock prices.

The other way stocks are valued is based on supply and demand. The more people that want to buy the stock, the higher its price will be. And conversely, the more people that want to sell the stock, the lower the price will be. This form of valuation is very hard to understand or predict, and is often drives the short-term stock market trends.

In short, there are many different ways to value stocks.  I will list several of them here.  The key is to take each approach into account while formulating an overall opinion of the stock.  Look at each valuation technique and ask yourself why the stock is valued this way.  If it is lower or higher than other similar stocks, then try to determine why.  And remember, a great company is not always a great investment.  Here are the basic valuation techniques:

 

Earnings Per Share (EPS).  You've heard the term many times, but do you really know what it means. EPS is the total net income of the company divided by the number of shares outstanding.  It sounds simple but unfortunately it gets quite a bit more complicated.  Companies usually report many EPS numbers.  They usually have a GAAP EPS number (which means that it is computed using all of mutually agreed upon accounting rules) and a Pro Forma EPS figure (which means that they have adjusted the income to exclude any one time items as well as some non-cash items like amortization of goodwill or stock option expenses). 

 

The most important thing to look for in the EPS figure is the overall quality of earnings. Make sure the company is not trying to manipulate their EPS numbers to make it look like they are more profitable.  Also, look at the growth in EPS over the past several quarters / years to understand how volatile their EPS is, and to see if they are an underachiever or an overachiever.  In other words, have they consistently beaten expectations or are they constantly restating and lowering their forecasts?

 

The EPS number that most analysts use is the pro forma EPS.  To compute this number, use the net income that excludes any one-time gains or losses and excludes any non-cash expenses like stock options or amortization of goodwill.  Then divide this number by the number of fully diluted shares outstanding.  You can easily find historical EPS figures and to see forecasts for the next 1-2 years by visiting free financial sites such as Yahoo Finance (enter the ticker and then click on "estimates").

 

By doing your fundamental investment research you'll be able to arrive at your own EPS forecasts, which you can then apply to the other valuation techniques below.

 

Price to Earnings (P/E).  Now that you have several EPS figures (historical and forecasts), you'll be able to look at the most common valuation technique used by analysts, the price to earnings ratio, or P/E.  To compute this figure, take the stock price and divide it by the annual EPS figure.  For example, if the stock is trading at $10 and the EPS is $0.50, the P/E is 20 times.  To get a good feeling of what P/E multiple a stock trades at, be sure to look at the historical and forward ratios.

 

Historical P/Es are computed by taking the current price divided by the sum of the EPS for the last four quarters, or for the previous year.  You should also look at the historical trends of the P/E by viewing a chart of its historical P/E over the last several years (you can find on most finance sites like Yahoo Finance).  Specifically you want to find out what range the P/E has traded in so that you can determine if the current P/E is high or low versus its historical average.

 

Forward P/Es are probably the single most important valuation method because they reflect the future growth of the company into the figure.  And remember, all stocks are priced based on their future earnings, not on their past earnings.  However, past earnings are sometimes a good indicator for future earnings. Forward

P/Es are computed by taking the current stock price divided by the sum of the EPS estimates for the next four quarters, or for the EPS estimate for next calendar of fiscal year or two. 

 

I always use the Forward P/E for the next two calendar years to compute my forward P/Es.  That way I can easily compare the P/E of one company to that of it's competitors and to that of the market.  For example, Cisco's fiscal year ends in July, so to compute the P/E for that calendar year, I would add together the quarterly EPS estimates (or actuals in some cases) for its quarters ended April, July, October and the next January.  Use the current price divided by this number to arrive at the P/E.

 

Also, it is important to remember that P/Es change constantly.  If there is a large price change in a stock you are watching, or if the earnings (EPS) estimates change, be sure to recompute the ratio.

 

Growth Rate. Valuations rely very heavily on the expected growth rate of a company.  For starters, you can look at the historical growth rate of both sales and income to get a feeling for what type of future growth that you can expect.  However, companies are constantly changing, as well as the economy, so don't rely on historical growth rates to predict the future, but instead use them as a guideline for what future growth could look like if similar circumstances are encountered by the company. 

 

To calculate your future growth rate, you'll need to do your own investment research.  The easiest way to arrive at this forecast is to listen to the company's quarterly conference call, or if it has already happened, then read a press release or other company article that discusses the company's growth guidance.  However, remember that although company's are in the best position to forecast their own growth, they are not very accurate, and things change rapidly in the economy and in their industry.  So before you forecast a growth rate, try to take all of these factors into account.

 

And for any valuation technique, you really want to look at a range of forecast values.  For example, if the company you are valuing has been growing earnings between 5 and 10% each year for the last 5 years but suddenly thinks it will grow 15 - 20% this year, you may want to be a little more conservative than the company and use a growth rate of 10 - 15%.  Another example would be for a company that has been going through restructuring. 

 

They may have been growing earnings at 10 - 15% over the past several quarters / years because of cost cutting, but their sales growth could be only 0 - 5%.  This would signal that their earnings growth will probably slow when the cost cutting has fully taken effect.  Therefore you would want to forecast earnings growth closer to the 0 - 5% rate than the 15 - 20%.  The point I'm trying to make is that you really need to use a lot of gut feel to make a forecast.  That is why the analysts are often inaccurate and that is why you should get as familiar with the company as you can before making these forecasts.

 

PEG Ratio.  This valuation technique has really become popular over the past decade or so.  It is better than just looking at a P/E because it takes three factors into account; the price, earnings, and earnings growth rates.  To compute the PEG ratio (a.k.a. Price Earnings to Growth ratio) divide the Forward P/E by the expected earnings growth rate (you can also use historical P/E and historical growth rate to see where it's traded in the past). 

 

This will yield a ratio that is usually expressed as a percentage.  The theory goes that as the percentage rises over 100% the stock becomes more and more overvalued, and as the PEG ratio falls below 100% the stock becomes more and more undervalued.  The theory is based on a belief that P/E ratios should approximate the long-term growth rate of a company's earnings.  Whether or not this is true will never be proven and the theory is therefore just a rule of thumb to use in the overall valuation process.

 

Here's an example of how to use the PEG ratio.  Say you are comparing two stocks that you are thinking about buying. Stock A is trading at a forward P/E of 15 and expected to grow at 20%.  Stock B is trading at a forward P/E of 30 and expected to grow at 25%.  The PEG ratio for Stock A is 75% (15/20) and for Stock B is 120% (30/25).  According to the PEG ratio, Stock A is a better purchase because it has a lower PEG ratio, or in other words, you can purchase it's future earnings growth for a lower relative price than that of Stock B.

 

Return on Invested Capital (ROIC). This valuation technique measures how much money the company makes each year per dollar of invested capital.  Invested Capital is the amount of money invested in the company by both stockholders and debtors.  The ratio is expressed as a percent and you should look for a percent that approximates the level of growth that you expect.  In it's simplest definition, this ratio measures the investment return that management is able to get for its capital. The higher the number, the better the return.

 

To compute the ratio, take the pro forma net income (same one used in the EPS figure mentioned above) and divide it by the invested capital.  Invested capital can be estimated by adding together the stockholders equity, the total long and short term debt and accounts payable, and then subtracting accounts receivable and cash (all of these numbers can be found on the company's latest quarterly balance sheet).  This ratio is much more useful when you compare it to other companies that you are valuing.

 

Return on Assets (ROA).  Similar to ROIC, ROA, expressed as a percent, measures the company's ability to make money from its assets.  To measure the ROA, take the pro forma net income divided by the total assets.  However, because of very common irregularities in balance sheets (due to things like Goodwill, write-offs, discontinuations, etc.) this ratio is not always a good indicator of the company's potential.  If the ratio is higher or lower than you expected, be sure to look closely at the assets to see what could be over or understating the figure.

 

Price to Sales (P/S).  This figure is useful because it compares the current stock price to the annual sales.  In other words, it tells you how much the stock costs per dollar of sales earned.  To compute it, take the current stock price divided by the annual sales per share.  The annual sales per share should be calculated by taking the net sales for the last four quarters divided by the fully diluted shares outstanding (both of these figures can be found by looking at the press releases or quarterly reports). 

 

The price to sales ratio is useful, but it does not take into account any debt the company has.  For example, if a company is heavily financed by debt instead of equity, then the sales per share will seem high (the P/S will be lower).  All things equal, a lower P/S ratio is better. However, this ratio is best looked at when comparing more than one company.

 

Market Cap. Market Cap, which is short for Market Capitalization, is the value of all of the company's stock.  To measure it, multiply the current stock price by the fully diluted shares outstanding.  Remember, the market cap is only the value of the stock.  To get a more complete picture, you'll want to look at the Enterprise Value.

 

Enterprise Value (EV).  Enterprise Value is equal to the total value of the company, as it is trading for on the stock market.  To compute it, add the market cap (see above) and the total net debt of the company.  The total net debt is equal to total long and short term debt plus accounts payable, minus accounts receivable, minus cash.  The Enterprise Value is the best approximation of what a company is worth at any point in time because it takes into account the actual stock price instead of balance sheet prices.  When analysts say that a company is a "billion dollar" company, they are often referring to it's total enterprise value.  Enterprise Value fluctuates rapidly based on stock price changes.

 

EV to Sales. This ratio measures the total company value as compared to its annual sales.  A high ratio means that the company's value is much more than its sales.  To compute it, divide the EV by the net sales for the last four quarters.  This ratio is especially useful when valuing companies that do not have earnings, or that are going through unusually rough times.  For example, if a company is facing restructuring and it is currently losing money, then the P/E ratio would be irrelevant.  However, by applying a EV to Sales ratio, you could compute what that company could trade for when it's restructuring is over and its earnings are back to normal.

 

EBITDA. EBITDA stands for earnings before interest, taxes, depreciation and amortization. It is one of the best measures of a company's cash flow and is used for valuing both public and private companies.  To compute EBITDA, use a companies income statement, take the net income and then add back interest, taxes, depreciation, amortization and any other non-cash or one-time charges.  This leaves you with a number that approximates how much cash the company is producing.  EBITDA is a very popular figure because it can easily be compared across companies, even if all of the companies are not profitable.

 

EV to EBITDA. This is perhaps one of the best measurements of whether or not a company is cheap or expensive.  To compute, divide the EV by EBITDA (see above for calculations).  The higher the number, the more expensive the company is.  However, remember that more expensive companies are often valued higher because they are growing faster or because they are a higher quality company.  With that said, the best way to use EV/EBITDA is to compare it to that of other similar companies.

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