Two of The World’s Greatest Investor

Warren Buffett, the "Oracle of Omaha," is considered by many to be the greatest investor ever. He is also known for giving much of his $40 billion fortune to the Bill & Melinda Gates Foundation, which is dedicated to bringing innovations in health and learning. Buffett is primarily a value investor that closely follows Benjamin Graham's investing philosophy after having worked at Graham's firm, Graham-Newman.

Buffett has several excellent investing rules. You can read about many of them in his company's (Berkshire Hathaway) annual reports, which are an excellent source of investing knowledge.

Here are three of Buffett's rules:

Rule No.1: Never lose money.

Rule No.2: Never forget rule No.1.

If you lose money on an investment, it will take a much greater return to just break even, let alone make additional money. Minimize your losses by finding quality companies that are temporarily selling at discounted prices. Then follow good capital management principles and maintain your trailing stops. Also, sitting on a losing trade uses up time, money and mental capital. If you find yourself in this situation, it is time to move on.

The stock market is designed to transfer money from the active to the patient.

The best returns come from those who wait for the best opportunity to show itself before making a commitment. Those who chase the current hot stock usually end up losing more than they gain. Remain active in your analysis, look for quality companies at discounted prices and be patient waiting for them to reach their discounted price before buying.

The most important quality for an investor is temperament, not intellect.

You need a temperament that neither derives great pleasure from being with the crowd or against it. Independent thinking and having confidence in what you believe is much more important than being the smartest person in the market. Most of the time, the best opportunities are found when everyone else has given up on the stock market. Over-confidence and emotion are the enemies of a high quality portfolio.

The Great Trader Gartman

In the October 1989 issue of Futures magazine, Dennis Gartman published 15 simple rules for trading. He is a successful trader who has experienced the gamut of trading from winning big to almost losing everything. Currently, he publishes The Gartman Letter, a daily publication for experienced investors and institutions.

Here are three of Gartman's best rules:

There is never one cockroach.

When you encounter a problem due to management malfeasance, expect many more to follow. Bad news often begets bad news. Should you encounter any hint of this kind of problem, avoid the stock and sell any shares you currently own.

In a bull market only be long. In a bear market only be short.

Approximately 60% of a stock's move is based on the overall move of the market, so go with the trend when investing or trading. As the saying goes, "The trend is your friend."

Don't make a trade until the fundamentals and technicals agree.

Fundamentals help to find quality companies that are selling at discounted prices. Technical analysis helps to determine when to buy, the exit target and where to set the trailing stop. A variation of this is to think like a fundamentalist and trade like a technician. When you understand the fundamental reasons that are driving the stock and the technicals confirm the fundamentals, then you can make the trade.

Patience Is A Trader's Virtue

Although the best investors and traders understand the importance of patience, it is one of the most difficult skills to learn as an investor and trader.

Dennis Gartman, a successful trader and publisher of The Gartman Letter has this to say about the value of patience: "Proper patience is needed throughout the lifecycle of the trade, at entry, while holding and exit."

Waiting for Your Entry Point

You have done your homework and have identified the entry point for a promising stock. Now you are waiting in anticipation for the price to reach your entry point. Instead of pulling back, the price lunges upward. You panic, entering an order above your planned entry point in a rush to make sure you don't miss the trade. By doing this, you give up some of your potential profit, but, more importantly, you actually violate the rules that caused you to enter the trade in the first place.

If you've ever let your emotions rule the day, you know that it can often lead to disappointing returns. In fact, impatient investors who violate their discipline may be headed down the path to ruin. Following a predetermined set of rules keeps the emotional side of trading and investing at bay.

Fishing for a Winner

Patient investing is similar to fishing. There are many fish in the lake and it isn't necessary to catch every fish that swims by in order to be successful. In fact, it's only necessary to catch those few that bite and fill up your net (or that meet your trading criteria).

It is important to remember that there are always many trading opportunities in the market, even in a tough stock market, so the difficulty is not so much in finding trading opportunities, but making sure the opportunities fit your trading rules. It is vital that you concern yourself with getting good entry points and making sure you have defined exit points along with stop losses without having to get in on every trade. If the stock doesn't want to bite, or it fails meet your criteria, then don't worry about it. Be patient. There will likely be another fish, or opportunity, right around the corner.

If you find that you have lost control and entered a stock before its time, it is usually best to exit the trade and wait for it to develop based on your predefined rules and not on your emotions. Take the costs associated with the trade as a lesson, learn from it and move on.

Waiting for the right entry point is an essential characteristic of every successful trader. If you find yourself tempted to enter an order before its time, step away and go over the reasons you selected the entry point once more. Then remind yourself that following your discipline will contribute to your success.

Give the Position Time to Develop

One of the stocks you have been following hits your entry point and you pull the trigger. After entering the trade, you enter a good-till-canceled bracketed order with your target and trailing stop, which define where you will take profit and where you will take a loss. Now you wait for the expected move to happen. As you watch the trade develop, it starts to move into a profitable position.

According to the original plan, this stock still has more room to run until it hits your defined target. But before you take the quick gain, the trade retreats and falls below your original entry point, but fails to hit your trailing stop. You panic and sell, generating a small loss. Just after you exit the trade, the price moves up again and reaches your target, only now you are out of the trade. Sound familiar? It turns out that in some cases, your well-thought-out plan will be right, and you'll let a fear of a loss get in the way of the trade proceeding as expected.

Rest assured, this is a common trait among many traders. Exhibiting patience with a good trade setup is a difficult task. It requires confidence in your research and in your system. While no one is infallible, the best traders trust their discipline to make them successful. They do not waver from their trailing stop methodology by letting the trade play out. If it incurs a loss, they capture all the relevant information to assess what went right and what went wrong. If their discipline needs to change, then so be it. But whatever you do, do not let your emotion take control - it will inevitably leads to losses.

That said, keep in mind that losses are part of trading. It is your discipline along with good entry points, trailing stops and exit targets that lead to consistent profits and keep you from incurring unwarranted losses. Stay patient and let your process go to work. If you are tempted to exit a trade prematurely, step away and go over the reasons why you originally set your stops and targets. Then remind yourself that it is discipline that makes a great trader.

Knowing When to Sell a Position

There are times when you follow your discipline faithfully, but despite your patience, the price of your stock barely moves. You have been patient and followed the rules - now what do you do?

In most cases, it is best to go back and re-examine your analysis of the trade. Take a fresh look and try to find what has changed. If something is different, does your new analysis change the original reason for entering the trade? If the rationale for the trade has changed, does your analysis call for you to avoid the stock at this price? If you should not be in the stock, then sell it immediately. On the other hand, if your analysis indicates that this stock meets all of your criteria to own and the entry point is very close then it makes sense to continue to hold your position.

In many cases, the price of your stock will approach your target, and being patient will work out well for you. Now comes the time when you need to close out your position. You can continue to be patient, waiting until the price hits your target or your trailing stop,or you can tighten up your stop to ensure that you capture a profit on the trade. In either case, it is time to reward your patience with a profitable trade.

While there is a little more discretion provided to selling, make sure that you make changes to targets and stops based on some pre-determined criteria. For example, you may decide that when a trade gets half-way between the entry and the target, you'll adjust the stop to the entry price.

Summary

In summary, so much of trading is psychological, making patience a great virtue for investors. Exhibiting patience when entering a trade and having patience while a trade develops are integral parts to successful trading and investing. However, allowing patience to turn into stubbornness is something you must always guard against; consistently exiting a trade according to predefined criteria is one of the best methods of improving your success as a trader. .

5 Investors Who Move The Market

There are people in every industry that have so much of an effect on it, it seems unfair. Golf has Tiger Woods, politics have the President of the United States, and the investing world has these players.

1. Warren Buffett

Warren Buffett has the distinction of the having celebrity status both in and out of the investing world. Of all of the leading voices in the market, Buffett is the largest, although his voice is rarely heard. Buffett is the CEO of Berkshire Hathaway, a $184 billion company that owns controlling interests in companies like Geico, Netjets and many others. He is the third wealthiest person in the world and has made his empire as possibly the most successful value investor as well as a proponent of the buy and hold investing model.

During the peak of the Great Recession of 2009, Buffet wrote an op ed piece in the New York Times. It was hailed as a vote of confidence in an economy that was faltering. When Buffett speaks, the market listens, and it is easy to see simply by watching Wall Street's as well as the news media's reaction to all of his words.

2. Carl Icahn

Corporate raiders find companies that they perceived to be undervalued and purchase a controlling interest in the company, often allowing them to gain control of a certain number of board seats. With those board seats the corporate raider is able to make changes to the company which increases their value.

Carl Icahn may be one of the best known modern day corporate raiders. Some of his most famous attempts at taking control of companies include his battles with Trans World Airlines, Yahoo! and Time Warner. Recently, Haines Celestial Group, maker of organic foods and one of Mr. Icahn's holdings, announced a better-than-expected quarter, allowing Icahn to profit $124 million - a 100% gain in just one year.

3. Bill Gross

Known as the bond king, Bill Gross is the founder and chief investing officer of PIMCO, a global investing firm focused primarily on bond investing. He manages the $235 billion PIMCO Total Return Fund, a fund mostly invested in bonds. He was referred to by the New York Times as the nation's most prominent bond investor.

Mr. Gross is vocal about his views of world monetary policy and the investing community listens. Over the years he has made some legendary calls including a recent 2011 warning to investors to steer clear of treasuries because of their negative return when accounting for inflation. If history is a guide, even the largest institutional investors will listen very closely to this warning.

4. Dennis Gartman

Dennis Gartman is best known for his daily newsletter, The Gartman Letter. Each day at 2:30AM he wakes up to write his four page publication for delivery to all subscribers no later than 6:00AM. This newsletter is read by institutional investors all over the world because it contains commentary on the world markets. Of particular interest is his commentary on currency and commodities trading. If you're looking for one of the best informed predictions on the gold market, Dennis Gartman may be your trader of choice.

Not only is he a commentator, he is also a trader himself. His 22 rules of trading are a must-read for all traders. One of his rules is to understand mass psychology more than economics because markets are more based on human emotion more than economic factors.

5. The Computer

It may seem odd that the computer is a market mover but the effect of the computer on the modern day trading market is staggering. Computers now account for more than 70% of all daily trading volume. To put that in to perspective, for every three trades made by a human, seven trades are done by computer - and those seven trades could have taken place in under one second.

Because of this, a new question must be asked by the modern trader: What would the computer do? Many argue that looking at the characteristics of a company are no longer as important as studying the company's chart. Understanding moving averages and support levels may now be more important than knowing what a company does and what new products are in the pipeline.

One thing is certain: The computer is now just as - if not more - important than the large volume hedge fund and mutual fund traders.

The Bottom Line

Whether the market is rigged or not will remain a question asked by traders for many more generations but it is certain that these influential traders have a profound effect on movement of the global markets. You may be wise to keep an eye on their movements and market predictions.

Market Strength

Market Strength

Table of Contents

1) Market Strength: Introduction

2) Market Strength: S&P 500 Futures

3) Market Strength: Advancers To Decliners

4) Market Strength: Relative Strength Index and Arms

5) Market Strength: Oil and Bonds

6) Market Strength: Conclusion

Introduction

There is an old saying that seems to always apply to the investment world: "hindsight is 20/20". When looking one, three or six months into the past, we can easily tell what the market did and why it happened. But if you are looking to discover the trends of the market today, where do you look?

In this tutorial we will go over various indicators used by traders and brokers to find out where the markets will open and how they will trade throughout the day. This tutorial will include an explanation of S&P 500 futures, the advance/decline line, the Relative Strength Index, the Arms Index, the price of oil and bonds and the ability of these indicators to detect market strength. Long-term investors should be warned, however. Over the long term, these day-to-day fluctuations in the markets are nothing to worry about, and for them, the long-term upward drift is much more important.

S&P 500 Futures

If you've ever watched financial television before or after the markets open you will probably notice that they often quote the latest index futures price on the "bug" in the bottom corner. The futures market is an important concept and can be used to gauge the trend of the market.

Futures There are two types of futures contracts, financial and commodities. No matter which type of contract you buy the basic premise is the same. The buyer of the contract agrees to deliver the product (or cash for financial futures) at the contract price on the expiry date. A contract can be on anything from corn, wheat, oil or, in our case, a stock index. It should be noted that a majority of futures contracts get "closed out" before the delivery date and so no physical delivery actually takes place. The Standard and Poor's 500 index (S&P 500) contains many of the largest companies in the world, so it only makes sense that movement in the direction of the S&P futures is one of the best indicators of overall short-term market direction (Note: The Nasdaq futures are considered a good indicator of technology stocks). The word futures might make this indicator sound confusing but it really isn't. If S&P futures are up, it's an indication that there is upward pressure on the market and the stock market will tend to rise. On the other hand, if S&P futures are down, it's a sign that there is downward pressure on the market and it will likely trend lower. This rise or decline in the futures contract is usually calculated as a change from fair value. Fair value is the equilibrium price for a futures contract. This is equal to the spot price after taking into account compounded interest and dividends lost because the investor owns the futures contract rather than the physical stocks. This price is determined over the period of the futures contract. Arbitrageurs Part of the reason that the markets follow the trend of futures contracts is because of arbitrageurs. An arbitrageur is someone who simultaneously purchases and sells a security (or index) in order to profit from a differential in the price, usually on different exchanges or marketplaces. For S&P futures contracts here is what happens: Suppose the futures contract is trading above fair value (higher), before the market is about to open. An arbitrageur will sell (short) the S&P futures contract and go long (buy) on the underlying stocks within the S&P 500 index. Therefore, the stock prices will increase until the S&P 500 index reaches fair value with S&P futures contract. This sounds like a lot of work but really isn't because of program trading. Using software that monitors both a stock index and futures contracts on the index, traders can be notified when there is a larger than normal gap. This strategy is commonly referred to as index arbitrage. Popularity The main reason that S&P futures are so popular for detecting strength is because this contract trades 24 hours a day on financial exchanges around the world. It allows traders and brokers to gauge the futures level before the actual stock markets open for trading which gives a sense of where the market is likely trend at the start of trading.

Advancers to Decliners

The advance/decline line (A/D) is a technical analysis tool and is considered the best indicator of market movement as a whole. Stock indexes such as the Dow Jones Industrial Average (DJIA) only tell us the strength of 30 stocks, whereas the A/D line provides much more insight. The formula is quite simple: it is the ratio between advancing stocks and declining ones. If the markets are up but there are more declining stocks than advancing ones it's usually a sign that the markets are losing their breadth or momentum. If the number of advancing issues is dominating the declining issues, the market is said to be healthy.

Unlike the S&P futures contract, this indicator is not necessarily short term. Looking at the A/D line (not just the advance decline ratio) shows us the cumulative trend of advancers to decliners over a particular period of time. Most of the time, the stock market does not turn around in an instant. Instead, the markets shift slowly, just as economic, business and market cycles would. This is why the general overall trend of the A/D line is important when determining the strength of the market. Even so, the advancers to decliners is a tool and not a crystal ball. Sudden market shocks that result from interest rate movements, war, or other drastic events can't be detected by the A/D.

Relative Strength Index and Arms

Relative Strength When talking about the strength of a stock or overall market, one great tool is the relative strength index (RSI) which is a comparison between the days a stock finishes up against the days it finishes down. It is a big tool in momentum trading. Depending on the type of investor, the RSI can be used to detect strength over a couple hours or over several months. Obviously, the longer trends are more valuable to long-term investors, whereas short-term trends in the RSI are popular with traders.

RSI = 100 - [100/(1 + RS)] where: RS = (Avg. of n-day up closes)/(Avg. of n-day down closes)

n= days (most analysts use 9 - 15 day RSI)

The RSI ranges from 0 to 100. A stock is considered overbought around the 70 level - a reason to consider selling. This number is not written in stone, in a bull market 80 is a better level because stocks often trade at higher valuations. Likewise, if the RSI approaches 30, a stock is considered oversold - a cause consider buying it. Again, make the adjustment to 20 in a bear market. A long-term RSI is more rolling and it fluctuates a lot less. Different sectors and industries have varying threshold levels when it comes to the RSI. Stocks of some industries will go as high as 75-80 before dropping back and others have a tough time breaking past 70. A good rule is to watch the RSI over the long term (one year or more) to determine at what level the RSI has traded in the past.

This chart was supplied by Barchart.com

Here we have an RSI chart for AT&T (T). The RSI is the green line and its scale is the numbers that go from 0 to 100. Notice that the RSI was approaching the 60-70 level and then the stock (blue line) sold off, both in December and January. Also notice around October when the RSI dropped to 25 the stock climbed up nearly 30% in just a couple of weeks. Arms Index (TRIN) The Arms Index is commonly referred to on financial television and short-term trading websites. Arms is a market performance indicator that varies from the A/D and RSI because instead of simply looking at the number of up and down ticks (or stocks) the Arms Index weighs each stock by the volume traded for each issue. A ratio of one means that the market is in balance. A ratio above one indicates that more volume is moving into declining stocks. A ratio below one indicates that more volume is moving into advancing stocks. Both the RSI and Arms are great little indicators that can help you detect the overall strength of the market. Most investors agree that the RSI and Arms is most effective in "backing up" or increasing confidence before making an investment decision.

Oil and Bonds

The price of oil and bonds as they relate to market strength is a wide topic, but these are two areas tend to have a large influence over the markets. In this section, we will address the basics of using the prices of these commodities to determine market strength.

Oil Energy is one commodity that affects every company in one way or another. For example, the price of wheat makes a greater impact on agriculture stocks, but oil influences everything from the cost of electricity and heating, to the cost of production and transportation. When the price of commodities, and particularly oil, is on the rise it signals that inflation is starting to become apparent. The day-to-day price fluctuations won't cause inflation fears, but the long-term trend will. If the price of oil has been steadily increasing, it could cause investors to be fearful that inflating energy prices will slow company profits. The price of oil has an opposite effect on those stocks directly influenced by the price of oil. Drilling, pipeline and retail distribution of energy stocks tend to have an extremely high correlation to the price of oil. Bond Prices Ten and 30 year bonds, along with interest rate futures are another indicator used by many investors to gauge the strength of the stock market. As you may already know, if bond prices are going up, then yields are decreasing. This decrease in yields causes investors to search for other areas in which to invest their money at a higher return - this usually means the stock market. On the other end of the equation, lower bond yields means that interest rates are low and companies will find it much cheaper to borrow money and finance expansion or growth. While bond and oil prices might not be as accurate and current as the S&P 500 futures, they are the useful when looking at the overall condition of the economy and, more importantly, at the trend of the stock market.

Conclusion

The usefulness of these indicators depends on what type of investor you are. Long-term investors shouldn't care too much if the S&P futures are up or down before the markets open, whereas traders and short-term investors find this type of information key. Regardless of what type of investor you are, knowing the overall trend of the market over several months is beneficial. It doesn't mean you should trade on the basis of this trend, but if you are informed you may be able to protect your assets. Here's a quick recap of what we've learned:

 The S&P 500 index contains many of the largest companies in the world, making it a good indicator of overall, short-term market direction

 If S&P futures are up, this indicates an upward trend in the stock market. If S&P futures are down, it's a sign that the market will trend lower.

 This rise or decline in a futures contract is usually calculated as a change from fair value, or the equilibrium price for a futures contract.

 An arbitrageur is someone who simultaneously purchases and sells a security (or index) in order to profit from a differential in the price - they are part of the reason that the market follows the trend in futures contracts.

 Index arbitrage is an investment strategy that attempts to profit from the differences between actual and theoretical futures prices of the same stock index. This is done by simultaneously buying (or selling) a stock index future while selling (or buying) the stocks in that index.

 The A/D line is a technical analysis tool. It is the ratio between advancing stocks and declining ones.

 The A/D line is not a short-term indicator; it shows us the cumulative trend of advancers to decliners over a particular period of time.

 Relative Strength Index (RSI) is a technical analysis indicator that compares the days that a stock finishes up against when it finishes lower.

 The RSI ranges from 0 to 100, but a stock is considered overbought if it reaches the 70 level, meaning that you should consider selling. When it is a true bull market, an RSI of 80 might be a better level since stocks often trade at higher valuations. Likewise, if the RSI approaches 30, it is a strong buying indicator (20 in a strong bear market).

 The Arms Index is a market performance indicator that weighs each stock by the volume traded for each issue. A ratio of one means the market is in balance. A ratio above one indicates that more volume is moving into declining stocks. A ratio below one indicates that more volume is moving into advancing stocks.

 Oil is an energy commodity; its price can affect many companies.

 The day to day price fluctuations in oil won't cause inflation fears, but if its price increases steadily it could cause investors to be fearful that inflating energy prices will slow company profits.

 The price of oil has an opposite effect on those stocks directly influenced by the price of oil such as drilling, pipeline and retail distribution of energy stocks.

 Bond prices can also be used to gauge the strength of the stock market.

 An increase in bond prices means a decrease in yields, which may cause more investors to move their money to the stock market for higher returns.

 Lower bond yields also tend to lead to lower interest rates, making it cheaper for companies to borrow money to finance growth.

Lifetime Payout Annuity

What Does Lifetime Payout Annuity Mean?

A type of insurance product that pays out a portion of the underlying portfolio of assets over the life of the investor. A lifetime payout annuity can provide fixed or variable payments. In a fixed payout scheme, the investor receives a fixed dollar amount for each payment, potentially with cost of living adjustments (COLA). Payouts under a variable payout scheme will fluctuate because payments are based on the value of the investments held in the annuity's portfolio.

Investors may choose a lifetime payout annuity to head off the risk of outliving the amount of money set aside for retirement. Basically, the guaranteed payments for life reduce a person's longevity risk. However, this payout scheme can cause problems for those wanting to leave estates to heirs. Payouts from a lifetime payout annuity typically end with the death of the policyholder. The policyholder can purchase adjustments which allow payments to continue to an estate or which allow for a guaranteed number of payments, but these can result in a different payout.

Earnings Manangement

Before diving into what earnings management is, it is important to have a solid understanding of what we mean when we refer to earnings. Earnings are the profits of a company. Investors and analysts look to earnings to determine the attractiveness of a particular stock. Companies with poor earnings prospects will typically have lower share prices than those with good prospects. Remember that a company's ability to generate profit in the future plays a very important role in determining a stock's price.

That said, earnings management is a strategy used by the management of a company to deliberately manipulate the company's earnings so that the figures match a pre-determined target. This practice is carried out for the purpose of income smoothing. Thus, rather than having years of exceptionally good or bad earnings, companies will try to keep the figures relatively stable by adding and removing cash from reserve accounts (known colloquially as "cookie jar" accounts).

Abusive earnings management is deemed by the Securities & Exchange Commission to be "a material and intentional misrepresentation of results". When income smoothing becomes excessive, the SEC may issue fines. Unfortunately, there's not much individual investors can do. Accounting laws for large corporations are extremely complex, which makes it very difficult for regular investors to pick up on accounting scandals before they happen.

Although the different methods used by managers to smooth earnings can be very complex and confusing, the important thing to remember is that the driving force behind managing earnings is to meet a pre-specified target (often an analyst's consensus on earnings). As the great investor Warren Buffett once said, "Managers that always promise to "make the numbers" will at some point be tempted to make up the numbers".

The Oracle of Omaha

What Does Oracle Of Omaha Mean?

A nickname for Warren Buffett, who is arguably one of the greatest investors of all time. He is called the "Oracle of Omaha" because his investment picks and comments on the market are very closely followed by the investment community, and he lives and works in Omaha, Nebraska.

Warren Buffett is one of the richest men in the world. He built his fortune using a simple yet powerful investment strategy. His investments are long-term positions, accomplished by the purchase of strong companies that are trading well below their intrinsic value. Some of his most well-known investments include Coca-Cola and Gillette.

What Does Berkshire Hathaway Mean?

A holding company for a multitude of businesses run by Chairman and CEO Warren Buffett. Berkshire Hathaway is headquartered in Omaha, Nebraska and began as just a group of textile milling plants, but when Buffett became the controlling shareholder in the mid 1960s he began a progressive strategy of diverting cash flows from the core business into other investments.

Insurance subsidiaries tend to represent the largest pieces of Berkshire Hathaway, but the company manages hundreds of diverse businesses all over the world.

Because of Berkshire Hathaway's long history of operating success and keen stock market investments, the company has grown to be one of the largest in the world in terms of market capitalization. Berkshire stock trades on the New York Stock Exchange in two classes, A shares and B shares. The A shares are noted for their very high prices - in excess of $100,000 per share in 2007.

Early in his career Buffett came across the novel idea to use the "float" from his insurance subsidiaries to invest elsewhere, mainly into focused stock picks that would be held for the long term. Buffett has long eschewed a diversified stock portfolio in favor of a handful of trusted investments that would be overweighted in order to leverage the anticipated return. Over time, his investing prowess became so noted that Berkshire's annual shareholder meetings became a mecca for value investing proponents and the focus of intense media scrutiny.

Warren Buffett is widely considered to be one of the greatest investors of all time, but if you were to ask him who he thinks is the greatest investor he would probably mention one man: his teacher, Benjamin Graham. Graham was an investor and investing mentor who is generally considered to be the father of security analysis and value investing.

His ideas and methods on investing are well documented in his books, "Security Analysis" (1934), and "The Intelligent Investor" (1949), which are two of the most famous investing texts. These texts are often considered to be requisite reading material for any investor, but they aren't easy reads. Here, we'll condense Graham's main investing principles and give you a head start on understanding his winning philosophy.

Principle No.1: Always Invest with a Margin of Safety

Margin of safety is the principle of buying a security at a significant discount to its intrinsic value, which is thought to not only provide high-return opportunities, but also to minimize the downside risk of an investment. In simple terms, Graham's goal was to buy assets worth $1 for $0.50. He did this very, very well.

To Graham, these business assets may have been valuable because of their stable earning power or simply because of their liquid cash value. It wasn't uncommon, for example, for Graham to invest in stocks where the liquid assets on the balance sheet (net of all debt) were worth more than the total market cap of the company (also known as "net nets" to Graham followers). This means that Graham was effectively buying businesses for nothing. While he had a number of other strategies, this was the typical investment strategy for Graham.

This concept is very important for investors to note, as value investing can provide substantial profits once the market inevitably re-evaluates the stock and ups its price to fair value. It also provides protection on the downside if things don't work out as planned and the business falters. The safety net of buying an underlying business for much less than it is worth was the central theme of Graham's success. When chosen carefully, Graham found that a further decline in these undervalued stocks occurred infrequently.

While many of Graham's students succeeded using their own strategies, they all shared the main idea of the "margin of safety".

Principle No.2: Expect Volatility and Profit from It

Investing in stocks means dealing with volatility. Instead of running for the exits during times of market stress, the smart investor greets downturns as chances to find great investments. Graham illustrated this with the analogy of "Mr. Market", the imaginary business partner of each and every investor. Mr. Market offers investors a daily price quote at which he would either buy an investor out or sell his share of the business. Sometimes, he will be excited about the prospects for the business and quote a high price. At other times, he is depressed about the business's prospects and will quote a low price.

Because the stock market has these same emotions, the lesson here is that you shouldn't let Mr. Market's views dictate your own emotions, or worse, lead you in your investment decisions. Instead, you should form your own estimates of the business's value based on a sound and rational examination of the facts. Furthermore, you should only buy when the price offered makes sense and sell when the price becomes too high. Put another way, the market will fluctuate - sometimes wildly - but rather than fearing volatility, use it to your advantage to get bargains in the market or to sell out when your holdings become way overvalued.

Here are two strategies that Graham suggested to help mitigate the negative effects of market volatility:

Dollar-Cost Averaging

Dollar-cost averaging is achieved by buying equal dollar amounts of investments at regular intervals. It takes advantage of dips in the price and means that an investor doesn't have to be concerned about buying his or her entire position at the top of the market. Dollar-cost averaging is ideal for passive investors and alleviates them of the responsibility of choosing when and at what price to buy their positions.

Investing in Stocks and Bonds

Graham recommended distributing one's portfolio evenly between stocks and bonds as a way to preserve capital in market downturns while still achieving growth of capital through bond income. Remember, Graham's philosophy was, first and foremost, to preserve capital, and then to try to make it grow. He suggested having 25-75% of your investments in bonds, and varying this based on market conditions. This strategy had the added advantage of keeping investors from boredom, which leads to the temptation to participate in unprofitable trading (i.e. speculating).

Principle No.3: Know What Kind of Investor You Are

Graham advised that investors know their investment selves. To illustrate this, he made clear distinctions among various groups operating in the stock market.

Active Vs. Passive

Graham referred to active and passive investors as "enterprising investors" and "defensive investors".

You only have two real choices: The first is to make a serious commitment in time and energy to become a good investor who equates the quality and amount of hands-on research with the expected return. If this isn't your cup of tea, then be content to get a passive, and possibly lower, return but with much less time and work. Graham turned the academic notion of "risk = return" on its head. For him, "Work = Return". The more work you put into your investments, the higher your return should be.

If you have neither the time nor the inclination to do quality research on your investments, then investing in an index is a good alternative. Graham said that the defensive investor could get an average return by simply buying the 30 stocks of the Dow Jones Industrial Average in equal amounts. Both Graham and Buffett said that getting even an average return - for example, equaling the return of the S&P 500 - is more of an accomplishment than it might seem. The fallacy that many people buy into, according to Graham, is that if it's so easy to get an average return with little or no work (through indexing), then just a little more work should yield a slightly higher return. The reality is that most people who try this end up doing much worse than average.

In modern terms, the defensive investor would be an investor in index funds of both stocks and bonds. In essence, they own the entire market, benefiting from the areas that perform the best without trying to predict those areas ahead of time. In doing so, an investor is virtually guaranteed the market's return and avoids doing worse than average by just letting the stock market's overall results dictate long-term returns. According to Graham, beating the market is much easier said than done, and many investors still find they don't beat the market.

Speculator Vs. Investor

Not all people in the stock market are investors. Graham believed that it was critical for people to determine whether they were investors or speculators. The difference is simple: an investor looks at a stock as part of a business and the stockholder as the owner of the business, while the speculator views himself as playing with expensive pieces of paper, with no intrinsic value. For the speculator, value is only determined by what someone will pay for the asset. To paraphrase Graham, there is intelligent speculating as well as intelligent investing - just be sure you understand which you are good at.

Commentary

Graham's basic ideas are timeless and essential for long-term success. He bought into the notion of buying stocks based on the underlying value of a business and turned it into a science at a time when almost all investors viewed stocks as speculative. Graham served as the first great teacher of the investment discipline, as evidenced by those in his intellectual bloodline who developed their own. If you want to improve your investing skills, it doesn't hurt to learn from the best; Graham continues to prove his worth in his disciples, such as Warren Buffett, who have made a habit of beating the market.

Think Like Warren Buffett

Back in 1999, Robert G. Hagstrom wrote a book about the legendary investor Warren Buffett, entitled "The Warren Buffett Portfolio". What's so great about the book, and what makes it different from the countless other books and articles written about the "Oracle of Omaha" is that it offers the reader valuable insight into how Buffett actually thinks about investments. In other words, the book delves into the psychological mindset that has made Buffett so fabulously wealthy.

Although investors could benefit from reading the entire book, we've selected a bite-sized sampling of the tips and suggestions regarding the investor mindset and ways that an investor can improve their stock selection that will help you get inside Buffett's head.

1. Think of Stocks as a Business

Many investors think of stocks and the stock market in general as nothing more than little pieces of paper being traded back and forth among investors, which might help prevent investors from becoming too emotional over a given position but it doesn't necessarily allow them to make the best possible investment decisions.

That's why Buffett has stated he believes stockholders should think of themselves as "part owners" of the business in which they are investing. By thinking that way, both Hagstrom and Buffett argue that investors will tend to avoid making off-the-cuff investment decisions, and become more focused on the longer term. Furthermore, longer-term "owners" also tend to analyze situations in greater detail and then put a great eal of thought into buy and sell decisions. Hagstrom says this increased thought and analysis tends to lead to improved investment returns.

2. Increase the Size of Your Investment

While it rarely - if ever - makes sense for investors to "put all of their eggs in one basket," putting all your eggs in too many baskets may not be a good thing either. Buffett contends that over-diversification can hamper returns as much as a lack of diversification. That's why he doesn't invest in mutual funds. It's also why he prefers to make significant investments in just a handful of companies.

Buffett is a firm believer that an investor must first do his or her homework before investing in any security. But after that due diligence process is completed, an investor should feel comfortable enough to dedicate a sizable portion of assets to that stock. They should also feel comfortable in winnowing down their overall investment portfolio to a handful of good companies with excellent growth prospects.

Buffett's stance on taking time to properly allocate your funds is furthered with his comment that it's not just about the best company, but how you feel about the company. If the best business you own presents the least financial risk and has the most favorable long-term prospects, why would you put money into your 20th favorite business rather than add money to the top choices?

3. Reduce Portfolio Turnover

Rapidly trading in and out of stocks can potentially make an individual a lot of money, but according to Buffett this trader is actually hampering his or her investment returns. That's because portfolio turnover increases the amount of taxes that must be paid on capital gains and boosts the total amount of commission dollars that must be paid in a given year.

The "Oracle" contends that what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.

Investors must think long term. By having that mindset, they can avoid paying huge commission fees and lofty short-term capital gains taxes. They'll also be more apt to ride out any short-term fluctuations in the business, and to ultimately reap the rewards of increased earnings and/or dividends over time.

4. Develop Alternative Benchmarks

While stock prices may be the ultimate barometer of the success or failure of a given investment choice, Buffett does not focus on this metric. Instead, he analyzes and pores over the underlying economics of a given business or group of businesses. If a company is doing what it takes to grow itself on a profitable basis, then the share price will ultimately take care of itself.

Successful investors must look at the companies they own and study their true earnings potential. If the fundamentals are solid and the company is enhancing shareholder value by generating consistent bottom-line growth, the share price, in the long term, should reflect that.

5. Learn to Think in Probabilities

Bridge is a card game in which the most successful players are able to judge mathematical probabilities to beat their opponents. Perhaps not surprisingly, Buffett loves and actively plays the game, and he takes the strategies beyond the game into the investing world.

Buffett suggests that investors focus on the economics of the companies they own (in other words the underlying businesses), and then try to weigh the probability that certain events will or will not transpire, much like a Bridge player checking the probabilities of his opponents' hands. He adds that by focusing on the economic aspect of the equation and not the stock price, an investor will be more accurate in his or her ability to judge probability.

Thinking in probabilities has its advantages. For example, an investor that ponders the probability that a company will report a certain rate of earnings growth over a period of five or 10 years is much more apt to ride out short-term fluctuations in the share price. By extension, this means that his investment returns are likely to be superior and that he will also realize fewer transaction and/or capital gains costs.

6. Recognize the Psychological Aspects of Investing

Very simply, this means that individuals must understand that there is a psychological mindset that the successful investor tends to have. More specifically, the successful investor will focus on probabilities and economic issues and let decisions be ruled by rational, as opposed to emotional, thinking.

More than anything, investors' own emotions can be their worst enemy. Buffett contends that the key to overcoming emotions is being able to "retain your belief in the real fundamentals of the business and to not get too concerned about the stock market."

Investors should realize that there is a certain psychological mindset that they should have if they want to be successful and try to implement that mindset.

7. Ignore Market Forecasts

There is an old saying that the Dow "climbs a wall of worry". In other words, in spite of the negativity in the marketplace, and those who perpetually contend that a recession is "just around the corner", the markets have fared quite well over time. Therefore, doomsayers should be ignored.

On the other side of the coin, there are just as many eternal optimists who argue that the stock market is headed perpetually higher. These should be ignored as well.

In all this confusion, Buffett suggests that investors should focus their efforts of isolating and investing in shares that are not currently being accurately valued by the market. The logic here is that as the stock market begins to realize the company's intrinsic value (through higher prices and greater demand), the investor will stand to make a lot of money.

8. Wait for the Fat Pitch

Hagstrom's book uses the model of legendary baseball player Ted Williams as an example of a wise investor. Williams would wait for a specific pitch (in an area of the plate where he knew he had a high probability of making contact with the ball) before swinging. It is said that this discipline enabled Williams to have a higher lifetime batting average than the average player.

Buffett, in the same way, suggests that all investors act as if they owned a lifetime decision card with only 20 investment choice punches in it. The logic is that this should prevent them from making mediocre investment choices and hopefully, by extension, enhance the overall returns of their respective portfolios.

Bottom Line

"The Warren Buffett Portfolio" is a timeless book that offers valuable insight into the psychological mindset of the legendary investor Warren Buffett. Of course, if learning how to invest like Warren Buffett were as easy as reading a book, everyone would be rich! But if you take that time and effort to implement some of Buffett's proven strategies, you could be on your way to better stock selection and greater returns.

Bonus Issue

Bonus Issue

What Does Bonus Issue Mean?

An offer of free additional shares to existing shareholders. A company may decide to distribute further shares as an alternative to increasing the dividend payout.

Also known as a "scrip issue" or "capitalization issue".

New shares are issued to shareholders in proportion to their holdings. For example, the company may give one bonus share for every five shares held.

What is a Book closure/Record date?

The registered shareholders of the company are entitled to corporate benefits such as dividend, bonus, rights etc. announced by the company from time to time. Since, the ownership of shares of companies traded on the stock exchange is freely transferable and to enable the company to know the persons entitled to the benefits, all transfers of securities have to be registered with the company (this is required in case of transfer of shares in physical form). Since transfer of securities is a continuous process open any time, the company announces cut off dates from time to time and members on the register of shareholders as of these cut off dates are entitled to the benefits. Such cut-off dates are record dates. Alternatively, the company might choose the close the register of shareholders for registration of transfer during a specified period. All transfer requests received before the commencement of the book closure or on or before the record date are considered for the purpose of transfer. A Company cannot close its books for more than 30 days at stretch for a book closure, and not more 45 days in a year. The period between two Book Closure cannot be less than 90 days

What is the difference between book-closure and record-date?

ACC announced a Book Closure (BC) for the period 6th July to 30th July'96. During this period, the company had closed its register of security holders. This was done to determine the number of registered members who were eligible for the Bonus 3:5 and a dividend of 40%. The process of transfer of shares was operational till 5th July'96. The company announced a No Delivery period from 12th June to 9th July'96 before the Book Closure. During this period, trading was permitted in the securities but the trades were settled only after 9th July. Hence, the buyers of the shares were not be eligible for the Bonus 3:5 and a 40% dividend. The first day of the No Delivery period is considered as an Ex - Date since the buyer of the shares is not eligible for the corporate benefits for this BC.

The same logic holds good for Record date, but the two main differences are that : In case of a record date, the company does not close its register of security holders. Record date is a cut off date ( in the above example '5th july96) for determining the number of registered members who are eligible for the corporate benefits [Interim dividend (30%) ].

What is a 'No Delivery' period?

Whenever, a book closure or a record date is announced by a company, the exchange sets up a 'No Delivery' period for that security. During this period, trading is permitted in the security. However, these trades are settled only after the No-Delivery period is over. The start of No-Delivery period is the ex-date of the settlement.The settlement is clubbed with the settlement of the week whose pay-out date falls just after the end of the no-delivery period. This is done to ensure that investor's entitlement for the corporate benefits is clearly determined. No-delivery period generally extends to all weekly cycles touched from 15 days prior to the record date and 4 days subsequent to the record date (both inclusive).

What is an ex-date?

The first day of the 'No Delivery' period is the ex-date viz., if there is any corporate benefit such as rights, bonus, dividend etc. announced for which book closure/record date is fixed, the buyer of the shares on or after the ex-date will not be eligible for the benefits while the seller would be eligible for the same.

What Are Depositary Receipts?

A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.

Since then, DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) (the other most common type of DR), European DRs and international DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in U.S. dollars, but can also be denominated in euros.

How Does the DR Work?

The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. Let us look at an example of how an ADR is created and traded:

Example

Say a gas company in Russia has fulfilled the requirements for DR listing and now wants to list its publicly traded shares on the NYSE in the form of an ADR. Before the gas company's shares are traded freely on the exchange, a U.S. broker, through an international office or a local brokerage house in Russia, would purchase the domestic shares from the Russian market and then have them delivered to the local (Russian) custodian bank of the depository bank. The depository bank is the American institution that issues the ADRs in America. In this example, the depository bank is the Bank of New York. Once the Bank of New York's local custodian bank in Russia receives the shares, this custodian bank verifies the delivery of the shares by informing the Bank of New York that the shares can now be issued in the United States. The Bank of New York then delivers the ADRs to the broker who initially purchased them.

Based on a determined ADR ratio, each ADR may be issued as representing one or more of the Russian local shares, and the price of each ADR would be issued in U.S. dollars converted from the equivalent Russian price of the shares being held by the depository bank. The ADRs now represent the local Russian shares held by the depository, and can now be freely traded equity on the NYSE.

After the process whereby the new ADR of the Russian gas company is issued, the ADR can be traded freely among investors and transferred from the buyer to the seller on the NYSE, through a procedure known as intra-market trading. All ADR transactions of the Russian gas company will now take place in U.S. dollars and are settled like any other U.S. transaction on the NYSE. The ADR investor holds privileges like those granted to shareholders of ordinary shares, such as voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate.

Pricing and Cross-Trading

When any DR is traded, the broker will aim to find the best price of the share in question. He or she will therefore compare the U.S. dollar price of the ADR with the U.S. dollar equivalent price of the local share on the domestic market. If the ADR of the Russian gas company is trading at US$12 per share and the share trading on the Russian market is trading at $11 per share (converted from Russian rubles to dollars), a broker would aim to buy more local shares from Russia and issue ADRs on the U.S. market. This action then causes the local Russian price and the price of the ADR to reach parity. The continual buying and selling in both markets, however, usually keeps the prices of the ADR and the security on the home market in close range of one another. Because of this minimal price differential, most ADRs are traded by means of intramarket trading.

A U.S. broker may also sell ADRs back into the local Russian market. This is known as cross-border trading. When this happens, an amount of ADRs is canceled by the depository and the local shares are released from the custodian bank and delivered back to the Russian broker who bought them. The Russian broker pays for them in roubles, which are converted into dollars by the U.S. broker.

The Benefits of Depositary Receipts

The DR functions as a means to increase global trade, which in turn can help increase not only volumes on local and foreign markets but also the exchange of information, technology, regulatory procedures as well as market transparency. Thus, instead of being faced with impediments to foreign investment, as is often the case in many emerging markets, the DR investor and company can both benefit from investment abroad. Let's take a closer a look at the benefits:

For the Company

A company may opt to issue a DR to obtain greater exposure and raise capital in the world market. Issuing DRs has the added benefit of increasing the share's liquidity while boosting the company's prestige on its local market ("the company is traded internationally"). Depositary receipts encourage an international shareholder base, and provide expatriates living abroad with an easier opportunity to invest in their home countries. Moreover, in many countries, especially those with emerging markets, obstacles often prevent foreign investors from entering the local market. By issuing a DR, a company can still encourage investment from abroad without having to worry about barriers to entry that a foreign investor might face.

For the Investor

Buying into a DR immediately turns an investors' portfolio into a global one. Investors gain the benefits of diversification while trading in their own market under familiar settlement and clearance conditions. More importantly, DR investors will be able to reap the benefits of these usually higher risk, higher return equities, without having to endure the added risks of going directly into foreign markets, which may pose lack of transparency or instability resulting from changing regulatory procedures. It is important to remember that an investor will still bear some foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to most foreign currencies.

Conclusion

Giving you the opportunity to add the benefits of foreign investment while bypassing the unnecessary risks of investing outside your own borders, you may want to consider adding these securities to your portfolio. As with any security, however, investing in ADRs requires an understanding of why they are used, and how they are issued and traded.

Where do most fund managers get their market information?

Many fund managers, whether they manage a mutual fund, trust fund, pension or hedge fund, have access to resources that the "average Joe" investor does not, but the type and quality of information generally remains the same for all investors.

The information that managers use comes from publicly available information in the form of news releases, annual reports and filings with pertinent exchanges. Fund managers will most likely have a team of financial analysts using the latest software to analyze specific firms, markets and economic variables, who will make recommendations and forecasts on future prices and market trends.

Even though these fund managers have access to all of these resources, the conclusions they come to about any particular security or market are potentially no better than what a personal investor can do with a TV remote in one hand and a mouse in the other. The only difference between a fund manager and an individual investor is that the fund manager is highly trained and must adhere to a set of ethical standards.

Fund managers and most analysts go through a formal training process, which will most likely include a CFA designation issued by the CFA Institute. The CFA program involves three rigorous levels of standardized testing, but in order to enroll in the CFA program you must hold, at a minimum, a recognized university degree. Also, to retain a CFA designation, the holder must adhere to the Code of Ethics and Standards of Professional Conduct, or else they may be suspended or expelled from the CFA society. In addition to their education and experience, fund managers will also have a thorough understanding of macroeconomics, international trade and behavioral finance, to name a few. Although it is not necessary to hold a CFA to be a fund manager, it is encouraged.

Although a fund manager's experience and education may provide him or her with an edge, a fund manager's actions may not be as transparent as they should be. The manager may make investments that are contrary to the best interests of the investors of that particular fund. For example, a pension fund manager may leverage the fund to purchase a security (this kind of strategy is illegal is most instances), but the investor will not know the fund manager is doing this. In this scenario, the possibility of losses is greater than if the manager took a non-leveraged position.

Although fund managers are highly trained professionals, they still use the same publicly available information that all investors use, and the conclusions they come to are potentially no better than those achieved by any conscientious investor.

Leverage

What Does Leverage Mean?

1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.

2. The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.

Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.

Investopedia Explains Leverage

1. Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10.

2. Most companies use debt to finance operations. By doing so, a company increases its leverage because it can invest in business operations without increasing its equity. For example, if a company formed with an investment of $5 million from investors, the equity in the company is $5 million - this is the money the company uses to operate. If the company uses debt financing by borrowing $20 million, the company now has $25 million to invest in business operations and more opportunity to increase value for shareholders.

Leverage helps both the investor and the firm to invest or operate. However, it comes with greater risk. If an investor uses leverage to make an investment and the investment moves against the investor, his or her loss is much greater than it would've been if the investment had not been leveraged - leverage magnifies both gains and losses. In the business world, a company can use leverage to try to generate shareholder wealth, but if it fails to do so, the interest expense and credit risk of default destroys shareholder value.

Doing More With Less: The Sales-Per-Employee Ratio

Investment analysts use a variety of key ratios, such as return on equity (ROE), return on assets (ROA), and price-earnings ratio (P/E), to gauge a company's well being. One number that doesn't get a lot of attention is the sales-per-employee ratio. While it does have its limitations, this ratio does give investors some sense of a company's productivity and financial health.

What Is the Sales-per-Employee Ratio?

The name indicates how the sales/employee ratio is calculated: a company's annual sales divided by its total employees. Annual sales and employee numbers are easily located in published statements and annual reports.

The sales-per-employee ratio provides a broad indication of how expensive a company is to run. It can be especially insightful when measuring the efficiency of businesses such as banks, retailers, consultants, software companies and media groups. "People businesses" lend themselves to the sales per employee ratio.

Interpreting the ratio is fairly straightforward: companies with higher sales-per-employee figures are generally considered more efficient than those with lower figures. A higher sales-per-employee ratio indicates that the company can operate on low overhead costs, and therefore do more with less employees, which often translates into healthy profits.

Consider the software maker Qualcomm. In 2003, the company generated $690,000 in sales per employee. By comparison, software giant Microsoft generated about $500,000 in sales per employee. This suggests that Qualcomm is making more of its workforce and demonstrates why the stock market consistently awards Qualcomm a higher valuation than other technology stocks.

Compare Apples with Apples

The sales-per-employee ratio is best used to compare companies that are similar. Retailers and other service-oriented companies that employ a lot of people, for instance, will have dramatically different ratios than software firms. For example, Starbucks Coffee is a highly efficient retailer, but because it employs nearly 74,000 full and part-time staff, its sales-per-employee figure of $55,000 seems to pale in comparison to Qualcomm's $690,000 per employee.

Companies that concentrate on selling and distributing products will typically enjoy much higher sales-per-employee figures than firms that manufacture goods. Manufacturing is typically very labor intensive, while sales and marketing activities rely on fewer people to generate the same sales numbers. In manufacturing, each employee can usually assemble only a certain number of products. Increasing production requires more employees. By contrast, marketing and sales activities can increase without necessarily adding staff. Take the sports footwear maker Nike: since making the decision to outsource its manufacturing to other companies, the firm's sales-per-employee ratio has skyrocketed.

Early-stage businesses typically have low sales-per-employee numbers. Companies involved in developing new technology, for example, often have meager sales-per-employee figures in their early years. Sonus Pharmaceuticals, for instance, generated only $610 per employee in 2003. But the firm's sales-per-employee multiple will grow as its lead drug products, which are still in the trial stage, are expected to gain wider sales eventually.

You should also be careful about employee numbers stated in the financial reports. Some companies employ sub-contractors, which are not counted as employees. This kind of discrepancy can put a wrinkle in your analysis and comparison of sales-per-employee figures.

Trends Are Important

Be sure to watch sales-per-employee ratios over several years to get a reliable idea of performance. Don't jump to conclusions without examining trends over time. A jump in sales-per-employee efficiencies can be just a blip. For instance, big job cuts often translate into a temporary ratio boost as remaining employees work harder and take on extra tasks. But research shows such a boost can quickly reverse as workers burn out and work less efficiently.

A steadily rising sales-per-employee ratio can mean a number of things:

• increasingly streamlined organizations;

• recent capital investment that improves efficiency;

• great products that are selling faster than those of competitors.

Also, a company that consistently generates rising sales with a stable or shrinking work force can usually boost profits more rapidly than one that can't make additional sales without adding more workers. An improving sales-per-employee ratio frequently precedes growth in profit margins. A climbing sales-per-employee number could mean that the company is growing but has not hired more employees to handle the added workload.

Again, be careful. If numbers change dramatically, it's worthwhile to take a closer look.

Conclusion

Although you need to be careful when using this ratio, you can tell a lot about a company and its future from its sales-per-employee figures. Investors can get a quick sense of the company's financial health and of how the company fares against its peers. While the ratio doesn't tell the whole story, it certainly helps.

J

Labor Intensive

What Does Labor Intensive Mean?

A process or industry that requires a large amount of labor to produce its goods or services. The degree of labor intensity is typically measured in proportion to the amount of capital required to produce the goods/services; the higher the proportion of labor costs required, the more labor intensive the business.

Labor intensive industries include restaurants, hotels, agriculture and mining. Advances in technology and worker productivity have moved some industries away from labor-intensive status, but many still remain.

Labor costs are considered variable, while capital costs are considered fixed. This gives labor-intensive industries an advantage in controlling expenses during market downturns by controlling the size of the employee base. Disadvantages include limited economies of scale (you can't pay workers less by hiring more of them), and susceptibility to wage forces within the labor market.

Profit With The Power Of Price-To-Earnings

Perhaps one of the most widely-used stock analysis tools is the price-to-earnings ratio, or P/E. This perpetual prophesier of profit has been used for ages by analysts and still remains one of the most relevant pieces of stock valuation. A simple P/E ratio can reveal the stock's real market value and how the valuation compares to its industry group or a benchmark like the S&P 500 Index. Investors will find that an understanding of this financial term is priceless in properly communicating to other investing professionals.

What is P/E?

A doughnut shop owner's business generates $10,000 in profit per year, and he is hoping to sell his shop for $200,000. His price is $200,000 and his earnings are $10,000 so his price-to-earnings ratio is 200,000/10,000 = 20. The number 20 by itself isn't really very helpful unless you have something to compare it to. A common comparison could be to the stock's industry group (other doughnut shops), a benchmark index and/or the historical P/E range of a stock. You may also be looking at our doughnut shop and thinking that it would take 20 years to recoup your money at the current rate of earnings. Therefore, it would also be important to compare the P/E by its expected future rate of growth in earnings and/or dividends.

Comparing Doughnut Shops

One way to tell if a stock is over or undervalued is to compare it to its sector or industry group. Sectors are made up of industry groups and industry groups are made up of stocks with similar businesses. Industry groups tend to come into favor, which means the price for one doughnut shop rises then most other doughnut shop prices rise. For instance, if some anti-Atkins doctor was to release the "Doughnut Diet" and it caused a new sensation of demand for doughnuts, then every doughnut shop would likely benefit.

In most cases, an industry group will benefit during a particular phase of the business cycle and therefore many professional investors will concentrate on an industry group when their turn in the cycle is up. Remember that the P/E is a measure of expected earnings. Near the end of a period of economic expansion, inflation will usually become a problem; however, basic materials and energy companies will have higher earnings because of the better price they'll get for the commodities they harvest. Toward the end of an economic recession, interest rates will usually be low and consumer cyclical stocks will usually expect higher earnings, because consumers may be more willing to purchase on credit because rates is low.

There are numerous examples of when P/Es will be expected to rise on a particular industry group. An investor could look for stocks within an industry group that is coming into favor and find those with the lowest P/Es as a way to determine which are the most undervalued.

Relative P/E

When a company is in its growth phase, it will usually trade with a much higher P/E than a more mature company would. However, by comparing the current P/E to a company's historical P/E, investors could determine if the stock is trading higher or lower compared to the past.

If the stock is at the higher end of its range, the likelihood of the stock being overvalued is much greater, whereas, if the stock has a P/E at the lower end of its range, then there is a greater likelihood of it being undervalued. Because of the way companies grow, this isn't always as reliable as one may hope. Therefore, investors may choose to only use approximately 10 years of P/E to keep the range in better perspective.

Fundamental and technical analysts have been looking at historical P/Es for over 100 hundred years. Charles Dow noted in his observations, that later became known as Dow Theory, that the bottom of a bear market commonly coincided with P/E ratios on the Dow Jones Industrial Average below 10. Financial bubbles have expanded P/E ratios over time to higher highs (see Figure 1). A quick observation of P/E ratios of the S&P 500 since the late 1800s shows that the average P/E ratio for the S&P 500 is approximately 15 and a P/E above 20 may be considered overvalued for the benchmark index.

The Rising Demand of Doughnuts

In the end, P/E ratios matter most depending on a person's expectation of earnings. Referring back to the doughnut shop example, if our doughnut shop was located in the less-than-thriving metropolis of Neola, Utah and the customers are mostly farmers and ranchers, you would likely view the P/E of 20 to be too expensive because future growth is limited. However, if the doughnut shop is in downtown Chicago where a new high school and police station are being built right next door, than you would likely feel that the future earnings growth is excellent and the doughnut shop is a bargain.

Looking at P/E in terms of future earnings growth can be done with a PEG ratio. The PEG ratio is the earnings divided by the five-year earnings growth rate (there can be variations of the growth rate estimate). For example, a company that has a P/E ratio of 10 and a five-year growth rate of 40%, would have a PEG ratio of 0.25. A PEG ratio of one or lower is considered to be an undervalued stock and likely a good buy.

Price/Earnings To Growth - PEG Ratio

What Does Price/Earnings To Growth - PEG Ratio Mean?

A ratio used to determine a stock's value while taking into account earnings growth. The calculation is as follows:

PEG is a widely used indicator of a stock's potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.

Keep in mind that the numbers used are projected and, therefore, can be less accurate. Also, there are many variations using earnings from different time periods (i.e. one year vs five year). Be sure to know the exact definition your source is using.

Value investors who like to purchase stock with dividends may choose to use the PEGY ratio to determine if a stock is undervalued. The PEGY ratio is similar to the PEG ratio, but factors in the dividend yield. Investors will also look for stocks with a PEGY of one or lower.

PEGY Ratio = (P/E Ratio / Growth Rate + Dividend Yield)

These two ratios will help investors utilize P/E ratios to find excellent investing opportunities.

What Does Price/Earnings to Growth and Dividend Yield - PEGY Ratio Mean?

A variation of the price-to-earnings ratio where a stock's value is further evaluated by its projected earnings growth rate and dividend yield.

Calculated as:

PEGY Ratio = PE Ratio / Projected Earning Growth Rate and Dividend Yield

Watch: Dividend Yields

For stocks that pay a substantial dividend, the PEGY may be an even better measure than PEG. As with the PEG, keep in mind the numbers are based on future projections and, therefore, aren't guaranteed to be accurate.

PEGY is pronounced the same way as "peggy."

Conclusion

A low P/E ratio is only the beginning when it comes to identifying a stock that could be a good buy. A P/E that is low compared to its industry group is another good sign, just as a P/E that is low compared to its own historical range is a good sign. However, a P/E that is low compared to future earnings is even better. Growth stocks with a PEG of one or lower and dividend stocks with a PEGY of one or lower can help investors spot the best investment opportunities whether they are in doughnuts or in something that fattens your wallet instead of your body.

Breaking Down The Balance Sheet

An Introduction To The Balance Sheet

A company's financial statements - balance sheet, income statement and cash flow statement - are a key source of data for analyzing the investment value of its stock. Stock investors, both the do-it-yourselfers and those who follow the guidance of an investment professional, don't need to be analytical experts to perform financial statement analysis. Today, there are numerous sources of independent stock research, online and in print, which can do the "number crunching" for you. However, if you're going to become a serious stock investor, a basic understanding of the fundamentals of financial statement usage is a must. In this article, we help you to become more familiar with the overall structure of the balance sheet.

The Structure of a Balance Sheet

A company's balance sheet is comprised of assets, liabilities and equity.

Assets represent things of value that a company owns and has in its possession or something that will be received and can be measured objectively.

Liabilities are what a company owes to others - creditors, suppliers, tax authorities, employees etc. They are obligations that must be paid under certain conditions and time frames.

A company's equity represents retained earnings and funds contributed by its shareholders, who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment.

The relationship of these items is expressed in the fundamental balance sheet equation:

Assets = Liabilities + Equity

The meaning of this equation is important. Generally sales growth, whether rapid or slow, dictates a larger asset base - higher levels of inventory, receivables and fixed assets (plant, property and equipment). As a company's assets grow, its liabilities and/or equity also tends to grow in order for its financial position to stay in balance.

How assets are supported, or financed, by a corresponding growth in payables, debt liabilities and equity reveals a lot about a company's financial health. For now, suffice it to say that depending on a company's line of business and industry characteristics, possessing a reasonable mix of liabilities and equity is a sign of a financially healthy company. While it may be an overly simplistic view of the fundamental accounting equation, investors should view a much bigger equity value compared to liabilities as a measure of positive investment quality, because possessing high levels of debt can increase the likelihood that a business will face financial troubles.

Balance Sheet Formats

Standard accounting conventions present the balance sheet in one of two formats: the account form (horizontal presentation) and the report form (vertical presentation). Most companies favor the vertical report form, which doesn't conform to the typical explanation in investment literature of the balance sheet as having "two sides" that balance out.

Whether the format is up-down or side-by-side, all balance sheets conform to a presentation that positions the various account entries into five sections:

Assets = Liabilities + Equity

• Current assets (short-term): items that are convertible into cash within one year

• Non-current assets (long-term): items of a more permanent nature

As total assets these =

• Current liabilities (short-term): obligations due within one year

• Non-current liabilities (long-term): obligations due beyond one year

These total liabilities +

• Shareholders' equity (permanent): shareholders' investment and retained earnings

Account Presentation

In the asset sections mentioned above, the accounts are listed in the descending order of their liquidity (how quickly and easily they can be converted to cash). Similarly, liabilities are listed in the order of their priority for payment. In financial reporting, the terms current and non-current are synonymous with the terms short-term and long-term, respectively, and are used interchangeably.

It should not be surprising that the diversity of activities included among publicly-traded companies is reflected in balance sheet account presentations. The balance sheets of utilities, banks, insurance companies, brokerage and investment banking firms and other specialized businesses are significantly different in account presentation from those generally discussed in investment literature. In these instances, the investor will have to make allowances and/or defer to the experts.

Lastly, there is little standardization of account nomenclature. For example, even the balance sheet has such alternative names as a "statement of financial position" and "statement of condition". Balance sheet accounts suffer from this same phenomenon. Fortunately, investors have easy access to extensive dictionaries of financial terminology to clarify an unfamiliar account entry.

The Importance of Dates

A balance sheet represents a company's financial position for one day at its fiscal year end, for example, the last day of its accounting period, which can differ from our more familiar calendar year. Companies typically select an ending period that corresponds to a time when their business activities have reached the lowest point in their annual cycle, which is referred to as their natural business year.

In contrast, the income and cash flow statements reflect a company's operations for its whole fiscal year - 365 days. Given this difference in "time", when using data from the balance sheet (akin to a photographic snapshot) and the income/cash flow statements (akin to a movie) it is more accurate, and is the practice of analysts, to use an average number for the balance sheet amount. This practice is referred to as "averaging", and involves taking the year-end (2004 and 2005) figures - let's say for total assets - and adding them together, and dividing the total by two. This exercise gives us a rough but useful approximation of a balance sheet amount for the whole year 2005, which is what the income statement number, let's say net income, represents. In our example, the number for total assets at year-end 2005 would overstate the amount and distort the return on assets ratio (net income/total assets).

Since a company's financial statements are the basis of analyzing the investment value of a stock, this discussion we have completed should provide investors with the "big picture" for developing an understanding of balance sheet basics.

6 Proven Methods For Selling Stocks

Choosing a time to sell a stock can be a very difficult task. It is especially difficult because, for most traders, it is hard to separate their emotions from their trades. The two human emotions that generally affect most traders with regards to selling a stock are greed and fear of regret. The ability to manage these emotions is key to becoming a successful trader.

Rising Profits

For example, many investors don't sell when a stock has risen 10 to 20% because they don't want to miss out on more returns if the stock shoots to the moon. This is due to their greed and the hope that the stock they picked will be a big winner. On the flip side, if the stock fell by 10 to 20%, a good majority of investors still won't sell because of their fear of regret. If they sell and the stock proceeds to rebound significantly, they'll be kicking themselves and regretting their actions.

So when should you sell your stock? This is a fundamental question that investors constantly struggle with. You need to separate out the emotion from your trading decisions. Fortunately, there are some commonly used methods that can help an investor make the process as mechanical as possible. In this article, I will look at six general strategies to help decide when to sell your stock.

Valuation-Level Sell

The first selling category we'll look at is called the valuation-level sell. In the valuation level sell strategy, the investor will sell a stock once it hits a certain valuation target or range. Numerous valuation metrics can be used as the basis, but some common ones that are used are the price-to-earnings (P/E) ratio, price-to-book (P/B), and price-to-sales (P/S). This approach is popular among value investors who buy stocks that are undervalued. It can be a good signal to sell when a stock becomes overvalued based on certain valuation metrics.

As an illustration of this method, suppose an investor holds stock in Wal-Mart that they bought when the P/E ratio was around 13 times earnings. The trader looks at the historical valuation of Wal-Mart stock and sees that the five-year average P/E is 15.5. From this, the trader could decide upon a valuation sell target of 15.5 time earnings as a fixed sell signal. So the trader has used a reasonable hypothesis to take the emotion out of his decision making.

Opportunity Cost Sell

The next one we'll look at is called the opportunity cost sell. In this method, the investor owns a portfolio of stocks and would sell a stock when a better opportunity presents itself. This requires a constant monitoring, research and analysis on both your own portfolio and potential new stock additions. Once a better potential investment has been identified, the investor would reduce or eliminate a position in a current holding that isn't expected to do as well as the new stock on a risk-adjusted return basis.

Deteriorating Fundamentals Sell

The deteriorating fundamental sell rule will trigger a stock sale if certain fundamentals in the company's financial statements fall below a certain level. This sell strategy is slightly similar to the opportunity cost in the sense that a stock sold using the previous strategy has likely deteriorated in some way. When basing a sell decision on deteriorating fundamentals, many traders will focus mainly on the balance sheet statement with emphasis on liquidity and coverage ratios.

For example, suppose an investor owns the stock of a utilities company that pays a relatively high and consistent dividend. The investor is holding the stock mainly because of its relative safety and dividend yield. Furthermore, when the investor bought the stock, its debt-to-equity ratio was around 1.0 and its current ratio was around 1.4.

In this situation, a trading rule could be established so that the investor would sell the stock if the debt/equity ratio rose over 1.50, or if the current ratio ever fell below 1.0. If the company's fundamentals deteriorated to those levels – thus threatening the dividend and the safety - this strategy would signal the investor to sell the stock.

Down-from-Cost and Up-from-Cost Sell

The down-from cost sell strategy is another rule-based method that triggers a sell based on the amount, in percent, that you're willing to lose. For example, when an investor purchases a stock he may decide that if the stock falls 10% from where he bought it at, he would sell the stock.

Similar to the down-from cost strategy, the up-from cost strategy will trigger a stock sale if the stock rises a certain percentage. Both the down-from-cost and up-from-cost methods are essentially a stop-loss measure that will either protect the investor's principal or lock in a specific amount of profit. The key to this approach is selecting an appropriate percentage that triggers the sell by taking into account the stock's historical volatility and the amount you would be willing to lose.

Target Price Sell

If you don't like using percentages, the target price sell method uses a specific stock value to trigger a sell. This is one of the most widely used ways by which investors sell a stock, as seen by the popularity of the stop-loss orders with traders and investors. Common target prices used by investors are typically ones based on valuation model outputs such as the discounted cash flow model. Many traders will base target price sells on arbitrary round numbers or support and resistance levels, but these are less sound than other fundamental based methods.

Bottom Line

Learning to accept a loss on your investment is one of the hardest things to do in investing. Oftentimes, what makes investors successful is not just their ability to choose winning stocks, but also their ability to sell stocks at the right time. These common methods can help investors decide when to sell a stock. (For additional reading, check out To Sell Or Not To Sell.)