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Monthly Archives: February 2010

The Difference – Dow vs S&P 500

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The Dow vs The S&P 5000

Dow – A price weighted index

  • The price of a stock determines its weight in the index (30 stocks compose the index).

S&P 500 – A Capitalization weighted index

  • Each stock’s market capitalization determines its weight in the index.
    • Market Cap = Shares outstanding * Stock price

The S&P 500 is generally considered a more accurate gauge of the market’s performance.

  • Greater sample of companies 500 vs 30 stocks in the Dow index
  • Capitalization weight is a more relevant way to measure the size of a company compared to simply looking at the price a company is trading at.

Bottom line – The price of a stock doesn’t provide you with much information about the size and/or value of a company.

The PEG Ratio

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PEG Ratio

PEG = Price/Earnings to Growth

  • (Stock Price / Per Share Earnings)/Earnings Per Share Growth Rate

The PEG ratio is superior to the PE ratio because it can provide insight as to whether or not the high or low PE ratio of a company is justified based on its projected earnings per share growth rate.

Rule of thumb – PEG ratios under 1 are undervalued companies

  • Remember the PEG ratio is a ratio based on projected growth.  If the assumed growth rate is bad, then the PEG ratio data is worthless.

Stock Buybacks

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Stock Buybacks

  • When a company buys back (retires) its outstanding shares the supply of shares shrinks
    • Less supply with demand held constant means upward pressure on the company’s share price.
  • Buybacks are typically seen as a bullish sign buy investors.
    • Reduce the supply of shares outstanding
    • A sign that management thinks the shares are not over-priced
  • Buybacks can be a misuse of company funds.
    • Buybacks have positive aspects, but if other better uses of company funds exist, then management is actually doing a disservice to stockholders when purchasing company stock.
  • The easiest way to find out if a company has purchased or will purchase back shares is to use a major search engine or investing site.  Search for the company name and ‘Stock buyback.’

Market Risk & Beta

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Systematic/Market Risk

  • Risk that applies to the entire market
    • War
    • Recession
    • Interest rate changes
  • You cannot use diversification to avoid this risk.

Unsystematic/Specific Risk

  • Risk that applies to a specific sector/industry.
  • Can be reduced through diversification.

Beta

  • A measure of a stock’s volatility compared to the market.
  • A beta of 1 means it is in-sync with the market.  A beta of greater than 1 means the stock is historically more volatile than the market.  A beta of less than one implies the stock has been less volatile than the market.
  • In general, conservative investors will like low beta stocks and speculators will like high beta stocks.

What’s the Market Cap?

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Market Capitalization

  • Market Cap = # of shares outstanding * Share price
  • Represents what the market believes the dollar value of a company is.
  • Companies are grouped into categories based on their Market Cap.
    • Small Cap: 300m – 2b
    • Mid Cap: 2b – 10b
    • Large Cap: 10b-200b
    • Mega Cap: +200b
  • Growth companies dominate small and mid cap ranges.
  • Value companies dominate the large and mega cap ranges.
  • In tight credit markets, large and mega cap stocks tend to have an easier time finding credit compared to small cap companies.

Practical Advice – Dividends & Sticking to a Strategy

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Dividends

  • Dividends appeal more to investors when interest rates on savings accounts are low (as they are now).
  • As interest rates rise the variance between dividend yields and savings account yields narrow.  Thus, stock dividends look less and less enticing to an investor looking to gain cash flow from his/her investment

Sticking to a Strategy

  • Buy, hold and forget about your investment is not a smart strategy.  You need to make a point to evaluate your holds.
  • When buying you should have in mind a dollar amount that you will sell at (high and low figure).
  • If you have a substantial gain, even on a short-term investment (higher tax rate), don’t feel that you shouldn’t cash in on your investment.
  • Always have a plan.  Don’t let the winds of the market blow you around!

Stocks – Price vs Value

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Price vs Value

  • A $2 stock can cost you more than a $20 stock.
    • If you look at earnings relative to share price, a $2 can cost you more in terms of earnings per share than a higher priced stock. (Reference P/E ratio video)
    • The number of outstanding shares can impact your percentage of ownership and how much control you have in the company (more shares outstanding = a lesser percentage of ownership per share)
      • Ownership has a direct relation to your claim on earnings when distributed through dividends.
    • Stock pricing is not an apples to apples game.  Looking below the surface of share price can expose the true value of each share you’re buying.