July 27, 2009

Price v/s Value -

The other day i was talking to one of my friends about stock market investing. He seemed to be pretty excited about lessons he learnt in his Finance 101 class about cash flows, dividend growth, etc. ..He said i am going to invest in this company X. Its a market leader in its field, has a strong brand recognition, its earnings are forecasted to grow N times and therefore its stock is worth investing in. You might say well my friend is making a correct decision with his investment.

Well, he might or might not be correct. I said to myself, He might make a VERY BIG Mistake. Why? Simply because of the fact that the stock of a good company need not always be a good investment. You may ask why? Whats wrong with investing in such a company. Because the stock might be over-valued in the market !

The biggest mistake that investors make is failing to differentiate between good companies and good stocks. Take the example of GE or e-bay. It is a good company but has been always over-valued. Its earnings have grown by leaps and bounds since the 90s but its stock price has roughly remained the same since then ! It would be so much frustrating to see no growth in your investment all these years. Or consider Microsoft and Google. Everybody knows these are excellent companies. But are their stocks worth investing in?They may or may not be. If you think their stocks are great investments at any price, you might be in trouble.

Here comes the emotional aspect of investing. Investors tend to overestimate the performance of good companies thereby driving-up their price to ridiculous levels.
They fail to realize that good investment is a product of fundamentals (cash flows, earnings growth, etc) and valuation (P/E, P/CF ratios, etc) . If you invest considering only one factor, you are at the risk of a loss.

Benjamin Graham had once said "Price is what you pay. Value is what you get".

July 19, 2009

Dividend Confusion

Every now and then i read news about dividend declaration by Mutual Funds and every time i read such news, i am sure a lot of investors especially new to the world of investing in mutual funds are mis-guided. Basically, a mutual fund offers three schemes to choose from : growth, dividend re-investment, and dividend pay-out. These have been in the market for quite some years now but many investors still dont completely understand the last one (dividend payout).

Simply speaking, a dividend payout scheme returns back a portion of an investors own money. Full Stop ! When and How much is upto the descrition of the company (thats why it cannot be a guranteed source of income as otherwise thought and promoted by many). Why does an MF declare a dividend? One reason might be there is no asset worth investing in the market at the moment. e.g. when markets are over-heated. Other reason might also be to attract new investors to the fund luring them to grab this "income".

For e.g. if you have invested $100 in a scheme which declares a 2 $ dividend, then your investment in the scheme now becomes 98$ if you had opted for a dividend pay-out scheme with the 2$ returned to you. Its as simple as that. Its upto you to decide what to do with that 2$. There are also some tax implications with dividends but i will leave them out from this discussion. The point is the term "dividend" seems so attractive that mis-informed investors easily fall prey to all the positive marketing about such schemes. They also plan their investment (in some cases even encouraged by the investment advisors!) close to the schemes dividend declaration date to capture that "dividend" because there is a gap between when the company declares a dividend and the time the money reaches the bank account.

My personal recommendation would be to invest in an MF (scheme suited to your equity-debt exposure) with a good track-record atleast for the past 5 years rather than falling prey to this very "attractive" dividend proposition. Finally, how much net return you make in the long-term is what really matters with or without dividends.

July 08, 2009

System Security at Banks

Recently an IT executive at a top US bank was arrested for stealing the companys proprietary trading software before moving to another employer. Apparently, there is a possibility of the entire trading platform to be stolen and if actually used by rival firms would result in losses of millions of dollars for the bank. The high-speed trading system used for taking equity and commodity markets positions is an asset to the bank as it assists in making trades ahead of the competition and thereby benefit from it. But if the system falls in the hands of rival firms, the banks competitive edge is eroded. Not only this, but if the system falls in the wrong hands for e.g. terrorists then the entire US financial system might be in danger !

The suspect quit the bank to move to a start-up company offering 3 times his existing salary. It is very likely then that he would have used the stolen trading application to benefit his new employer. Upon discovery of the theft, the new employer suspended the suspect. This event should be an eye-opener to banks and financial institutions to beef-up their IT security and take stringent measures to protect their data and systems agaisnt theft or mis-use and guard the interest of all the stake-holders in the financial markets.