What happened in Dubai?

We suddenly found our markets go deep in red this Friday (11/27/2009). There was some buzz about something happening in Dubai that sent the entire world financial markets on a downward spiral. Every minister in Indian government was talking about this. RBI asks all the banks to declare their exposure in Dubai. So what was it that could transpire in something so big? Let's try and ind out.

Dubai has been one of the many economies that lived and thrived on debt. So, when the financial markets around the world were in a boom, Dubai racked up a debt of $ 59 Billion to build lavish townships, to attract people with a great lifestyle.

Now that the boom has gone bust, Dubai is stuck with a glut of real estate that no one wants to buy or rent. Creditors and markets had always assumed that in any such situtation, Abu Dhabi would bail out Dubai. But that assumption was called into question this week, and the resulting fear that Dubai might not be able to pay its bills sent a wave of uncertainty rippling through markets just as investors thought the worst of the global financial instability was over.

News Clippings:

- NYTimes

- Indian Express

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Earnings Per Share (EPS)

It has been quite a few days that I posted here. I was actually not able to decide where to start.After due diligence, I decided to start with the most basic of the fundamental tools: THE EPS a.k.a. Earnings per Share.


Why is EPS so Important

While evaluating two companies, one needs to compare the companies on a common basis. We can't compare them on the basis of their market price as that changes daily and also doesn't represent the total worth of a company. Consider company A having only 100 shares of Rs 10000 each and company B with 10000 shares of Rs 1000 each. Obviously, Company B is the bigger one in size!

Similarly, comparing the earnings of one company to another really doesn’t make any sense, if you think about it. Using the raw numbers ignores the fact that the two companies undoubtedly have a different number of outstanding shares. For example, companies A and B both earn Rs 100, but company A has 10 shares outstanding, while company B has 50 shares outstanding.

EPS comes for your help here! In the above example, Company A has an EPS of 10 as compared to 2 for Company B, making Company A as more profitable for the stock holder. So, you should go buy Company A with an EPS of 10, right? Maybe, but not just on the basis of its EPS. The EPS is helpful in comparing one company to another, assuming they are in the same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some ratios (My next Post). Today, we would only concentrate on EPS.

Definition

The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.

Calculated as:

There are 3 kinds of EPS:

• Trailing EPS – last year’s numbers and the only actual EPS
• Current EPS – this year’s numbers, which are still projections
• Forward EPS – future numbers, which are obviously projections

Diluted EPS


expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. This is because all of these can be converted into shares at a particular date. This reduces the EPS value making the stock look more expensive.


In most cases, the diluted earnings-per-share figure is far more accurate estimation of the total earnings per share and receive special attention when valuing a company.


Hope this helps. Do let us know your feedback through comments. If you liked this post and want to receive regular updates, you can subscribe via email.

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Evaluating Shares

We will try to understand few of the key methods to find out if a company is worth investing or not. With the number of companies in the market today, it is really tough to figure out which is worth investing. This is a time consuming exercise but if followed, it can provide rich dividends.

There are mainly 2 ways of selecting stocks.

1. Fundamental Analysis - This is to know how good is a company and to invest in it for a long term. Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security.
2. Technical Analysis - This follows the price variations of a stock and lets you know if the stock has any short term gains. Technical analysis maintains that all information is reflected already in the stock price. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns.

We will discuss about the Fundamental Analysis today.

Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. When analyzing a stock, futures contract, or currency using fundamental analysis there are two basic approaches one can use; bottom up analysis and top down analysis. The term is used to distinguish such analysis from other types of investment analysis, such as quantitative analysis and technical analysis.

Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives:

• to conduct a company stock valuation and predict its probable price evolution, 
• to make a projection on its business performance, 
• to evaluate its management and make internal business decisions, 
• to calculate its credit risk. 

Even if you don’t plan to do in-depth fundamental analysis yourself, it will help you follow stocks more closely if you understand the key ratios and terms. The main idea behind Fundamental Analysis is Earnings of a company. 

Earnings are profits. It may be complicated to calculate, but that’s what buying a company is about. Increasing earnings generally leads to a higher stock price and, in some cases, a regular dividend.

When earnings fall short, the market may hammer the stock. Every quarter, companies report earnings. Analysts follow major companies closely and if they fall short of projected earnings, sound the alarm.

But only earnings are not enough to know if the company is worth investing. There are a number of fundamental analysis tools (read financial ratios), that we would discuss in the next few posts.

Keep checking this space for updates!

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What is Face value and book value?

Past few posts we have been metioning this word (face value) a lot. So, what is face value? How is it different from the market value of the share? Why do we need this? How does it matter to me as a share holder? We will try to answer some of these in this post.

Face Value

By the definition of it, Face value is the value of a coin, stamp or paper money, as printed on the coin, stamp or bill itself by the minting authority. While the face value usually refers to the true value of the coin, stamp or bill in question (as with circulation coins) it can sometimes be largely symbolic, as is often the case with bullion coins. For example, a one troy ounce (31 g) American Gold Eagle bullion coin was worth and used to sell for about $670 USD at current market prices (as of July 17, 2006) and yet had a face value of only $50 USD.

For a share this is decided by the company issuing it, at the time of initial offering .It is mentioned on the face of share, Bond certificate or other financial instrument. Face value has nothing to do with market value of the share. Market value of shares changes depending on several conditions. Face value changes only when splitting takes place.

Let me use an example. Suppose,  you want to start a Company with the Capital of Rs. 1,00,000. Now, to arrange this money you take help from  friends and relatives. In exchange, you issue shares of your company, it can be 100 shares, each of the Face Value of Rs. 1,000; or 1,000 shares of Rs. 100 each any such value.

Now let us bring in other value, the Book Value.

Book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities

Suppose your company grows 10 times in a given period of time, and it is worth Rs. 10,00,000. The price of the share of your Company will also grow 10 times, i.e. the book value of a share of the face value of Rs. 10 will become Rs. 100. In case of a loss on the other hand, if your company is  worth only Rs. 10,000, the book value of the share of face value Rs. 10 will become Re.1 only. The Shares are first valued on their Book Value and then by the future prospects or risks involved. If the future prospects are good, I will buy a share (issued by you for Rs. 10 FV, now at Rs. 100 BV) for Rs. 120 or Rs 280 (market value). This will depend on the Market, at what price the holder of the share in your company, is willing to sell. And, suppose, your Company is making losses, I will not buy the share of FV Rs. 10, now available at Re. 1, even if the holder agrees to sell at Re. 0.40. And that is the reason why the shares of different companies sell at different prices.

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Results of the Poll

Hello Readers!!!


Time for the results of the poll we've been running for the past one month. The poll was to see what should we post more on? There were 21 votes in total. The results are as follows:

• Financial Literacy (Accounting) 5 (23%)
• Insurance 1 (4%)
• Investments (Mutual Funds, Stocks) 11 (52%)
• Taxation 4 (19%)

For your information, we have already started posting on Investments. This would be more of a fundamental basics series. Please see Investments on the blog.


Thanks a lot for your responses and showing interest. Keep watching this space for more information. You can also subscribe to us on email, to recieve updates regularly.

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