Return on Investment (ROI)

Standard

Return on Investment

A Method of Comparing Investment Opportunities

Any investment has the potential for rewards and risk. Regardless if you are a small investor of a large bank’s portfolio manager, how one approaches the task of evaluating potential opportunities can make the biggest impact on the success of that individual or fund. Today we are going to examine one of the most commonly used ways to quickly assess Return on Investment (ROI) in order to examine its performance as well as compare to similar business models.

What is ‘Return On Investment?

Return on Investment is a performance measure that is used to evaluate how efficient an investment is, or for efficiency comparisons of numerous investments. ROI measures how much return you will receive on an investment relative to the cost of the investment.

To work out the return on investment as a percentage or ratio, you divide the return or benefit of an investment by the cost of the investment.

The formula is as follows:

ROI= (Gain from Investment- Cost of Investment) / Cost of investment

In this case, ‘Gain from investment’ means the proceeds that have been obtained from selling the investment in question.

Because ROI is expressed as a percentage, it allows for easy comparison against returns from other investments, which means you can measure a range of types of investments against each other.

Advertisements

What is Preferred Stock?

Standard

For anyone attempting to do their due diligence on a potential investment opportunity, the task can be a daunting experience. Many investors often misunderstand the confusing legal speak within the SEC filings that publicly traded companies are required to issue. This guide is intended to help investors better comprehend the practice of a preferred stock issuance.

Preferred Stock is something of a hybrid between common stock and bonds or debt. Typically, those shares are paid a regular cash dividend, regardless of company’s financial position to issue a regular dividend to the common shares. Commonly, these types of stocks sell in large blocks, purchased by financial institutions who has several tax advantages over retail investors.

When an investor buys preferred shares, they do so at the par value, a set price that determines the amount the issuer is obligated to pay as a preferred dividend. To determine the preferred dividend’s annual payout, multiply the dividend’s percentage by the par value.

5% preferred stock x $100 par = $5 per year annual dividends

Although preferred shares typically do not show much appreciation they can provide financial institutions with an incentive to stay vested in the underlying security. This type of scenario is the most common example of a Non-Participating Preferred Stock. What this means for the above example is that if 10,000 non-participating shares were issued, regardless of the company’s performance the annual dividend payout will never yield more than the set $50,000. Sounds boring, right?

A simple way to understand the difference between preferred stock and other investment vehicles is to look at how shareholders get treated if the issuer becomes financially distressed. If an issuer does file for bankruptcy and their assets are liquidated to satisfy the bondholders, the preferred stockholders are entitled to any left-over monies before the common shareholders.

Publicly traded companies often need flexibility when it comes to acquiring capital. Preferred stock is issued based on the issuer’s creditworthiness and other related factors. Preferred stock serves as a middle-ground between equity-based common shares, and the debt obligations to bond holders.

Sometimes to entice buyers and compensate for the lack of appreciation in the par value, Participating Preferred Stock is issued for dividend payments more than the price set by the par value.

All preferred stock is either Cumulative or Non-Cumulative. Cumulative is the most characteristic of the preferred stock and derives its name from the accumulation of all delinquent dividend payments owed to the owner

While it is non-cumulative dividends are rare, they do get produced in situations where a company has a previously established history of making the regular dividend payments to the common shareholders.If the issuer cannot pay the preferred dividend, those shareholders are owed their dividend before the common shareholders can receive any expected profit sharing. Those missed payments are known as “in arrears”  and take priority to the common shares claim to the issuer’s assets.

This financial instrument gives investors the opportunity to be shareholder and creditor.The promise of a preferred dividend entitles the preferred stockholders to preferential treatment, second only to the bondholders. Unlike bonds, failure to pay the dividend does not result in default or bankruptcy.

Preferential Treatment Where it Gets Tricky

The motivations for a publicly traded company to issue preferred shares can lead to uncommon occurrences in the issuing terms.

Preferred shareholders can also be granted votings rights if the dividends are in jeopardy of being paid. Often these rare occurrences can lead investors to a better insight into the overall financial picture of a potential investment. That is why it is important always to investigate the motivates of the issuer for offering the preferred shares.

 

 

 

 

 

 

 

 

 

 

 

 

What is ‘Accounting’

Standard

Accounting is the systematic and comprehensive recording of financial transactions pertaining to a business, and it also refers to the process of summarizing, analyzing and reporting these transactions to oversight agencies and tax collection entities. Accounting is one of the key functions for almost any business; it may be handled by a bookkeeper and accountant at small firms or by sizable finance departments with dozens of employees at large companies.

A Review of The Intelligent Investor – By Matthew Waterman

Standard

Book Review: “The Intelligent Investor”, by Benjamin Graham 4th edition with liner notes by Jason Zweig.

I believe I first read “The Intelligent Investor” at some point around 2005. It was really an incredible coincidence that I ran across it during the time I did. I was looking to expand my own knowledge base, and at the same time, I just happened to be working at Countrywide financial, which ended up being one of the largest players in the mortgage meltdown in 2007.

I was just so perfectly prepared for that bear market because of that. I had very recently taken my first two accounting courses in college as well, and had been tinkering with individual stocks before that. What happened was that I was working this part time gig for a few hours each night with this accounting firm, because I didn’t feel like I had a good understanding with what my teacher had taught vs. what made an investment successful .

There used to be an older gentleman who would be in that office from time to time, and I remember that I found out he was into the stock market, and I mentioned how well my Sirius Sattellite Radio had done that day, up something like 5%. The response he gave was something I’ll never forget: “Do you really think that 5 or 10 years down the road, that number would be meaningful?”. Answered honestly, I couldn’t say that I had any idea. He directed me to start reading about Warren Buffett.

So I did. The first book I read about Buffett was a biography, “Buffett: The Making of an American Capitalist” by Roger Lowenstein, and the other was Mary Buffett’s “Buffetology”. Those two books overwhelmingly pointed to Benjamin Graham as the source of Warren’s investment mentality, and so I picked up the 4th edition of “The Intelligent Investor”. I took to the material immediately, and had never seen anything else like it. Inside of just a couple of pages I understood what I was doing incorrectly. I was chasing momtentum and news, and what Graham taught me to do instead was look at the business as if I were the owner, and try to estimate it’s intrinsic worth from there.

Graham changed everything for me. I immediately understood where both my strengths and weaknesses were, and when the 2007 housing market crash hit, I was so well prepared that I took in more than a 400% gain before 2008 ended. That volatility continued well into the next year, and I doubled my holdings inside nearly every couple of weeks during that madness. I haven’t tracked my performance for a while now, but I know that by 2012 I was sitting an an increase approaching 50,000% of my initial capital.

What Graham really hit home with in his writing was on buying companies that earned profits. To that point I had been purchasing stocks on news, and on dips in their charts. I had thought that was what “Buying Low” was. Graham tought me to think about the future of a business, not it’s past, but by using the businesses’ past as your guide.

Graham ‘s core concept is centered around a “Return to mean”. A business that’s been doing the same things for a long time tends to keep doing them, so you get in there and buy them when they are having a temporary, but solvable problem. Alternatively, he gives you tips on how to value the assets on a company’s balance sheet, so that you can know if a true catastrophe is in the cards for a struggling company. You learn to find greater chances for rewards with substantially less risk involved.

More than anything, he teaches you to be fearless in the face of a fearful, easy dismayed stock and bond market. You learn to prepare for these times, and how to hedge your losses when there is risk involved. Best of all, you learn that all of these things are entirely within yourself to control. Graham’s book is so complete that you could probably never read any other and outperform at least 80% of the market easily. With a bit of fine tuning that comes from practice, I think I’ve got this number into a range of 98%.

Since that time, I’ve become a contributor for Seeking Alpha as well as a few smaller sites, and have introduced a couple of new concepts to the field. I have a chart named after me called the “Waterman Life Cross”, and am developing a new method around what I call “Insult Theory”, which is a way of using investor sentiment to guage if there is serious interest in a stock, or if the owners don’t understand the business at all. Graham was the foundation for both methods, and I believe that anything good that comes in the future will also be due to his writings.

Matthew Waterman, Contributor at Seeking Alpha

If you would like to read more please follow Matthew on Seeking Alpha and Twitter.