Investing Feeds

In what I hope will be a longer series of tutorial style blogs, this article is designed to give an overview of the history and current developments in Investment Theory. Investment Theory is really a subset of Economics, utilizing, at times, quite complex mathematical concepts to represent the behavior of the Markets. What is important to understand right from the start is that whilst theory is useful, and used extensively by analysts in interpreting the markets, it models itself on what is commonly held to be a perfect world, in which little or no uncertainty exists. Of course in the real world, and in real markets, plenty of uncertainty exists, and no market behaves in a perfect way. This is because investors do not act in a mathematically rational manner (looking at statistical information of takeovers in the UK for, say, fifty years will suggest that the majority of the takeover valuations were over priced and therefore not rational investment decisions) People invest for reasons other than maximizing wealth, for a sense of power, because acquisitions have more benefits than financial or just because they are badly informed. If all of the investment decisions were made by the careful application of econometrics, and those econometrics were perfect in every way, then the markets would behave in a ‘perfect’ way, and predicting the outcomes of investment decisions would be (comparatively) easy.

The most cutting edge theorists and analysts utilize Chaos Theory (see E.E. Peters, Chaos and Order in the Markets, for a good introduction to this subject), and a derivation of the Nash Equilibrium or ‘game theory’ is also popular at the moment. These subjects do require a deep understanding of the underlying mathematical concepts, and therefore a Degree in Mathematics. There are, however, many other resources, which although do require the use of mathematics, are far simpler, and are based on widely held theoretical principals. Chief amongst these is the use of Net Present Value (NPV) to vet potential investments. In this series I will be explaining the theory and practice of NPV as well as introducing the classic theories of Finance, from Fisher’s Separation Theorem (1930), The Gordon Growth Model (1960) and the work of Modigliani and Miller.

Finance has a language and life all of its own, and potential investors, especially if they are new to the market, are often at a loss to understand all of the different terminology and analysis which goes on, both in the Financial Press, and in technical books on the subject. In this article, and in subsequent ones to follow, an attempt will be made to take one concept at a time and dispel some of the myths and jargon surrounding it.
The P/E Ratio appears in all share listings in any financial press, it is a good idea that you look at a website whilst reading this article, which contains listings (www.ft.com is always a good one). Essentially it is a mathematical representation of the earnings (total post tax profit of a company that is attributable to shareholders i.e. that could be paid as a dividend) and the Price of that share. Essentially to reach the P/E Ratio an analyst takes the Earnings per Share (Total profit attributable to shareholders divided by total number of shares in circulation) and the current share price and represents them as a ratio thus

P/E = Price (P)/Earnings per Share (EPS)

The resulting figure is a measure of, amongst other things, the amount paid for a certain level of potential profit. Following a simple example you have the choice of investing in two companies A&B; A has a PE Ratio of 10. B has 8; both have EPS of $0.5. What the difference in the PE Ratio is telling us that there is a lower investment needed (and therefore less risk involved) in investing in company B, to achieve the same level of reward. By rearranging the formulae to its reciprocal, analysts arrive at the earnings yield, which, expressed as a percentage is useful to compare your stock against other stocks. If a stock has a higher Earnings Yield that yours, or you’re potential, it may make for a better investment, especially when that stock is in a broadly similar line of business.

As with all investing advice, take care and definitely only invest what you can afford to lose in the worst case scenario, PE Ratios cannot predict an Enron, or Northern Rock for example and what looks good on paper, or in Theory, can be fundamentally flawed.

Say what? U.S. blue chips? What are those? Well, the U.S. is what you think it is “United States”. The blue chips part refers to blue chip stocks. So what are blue chip stocks? Well, this explanation by Joshua Kennon as published on about.com is pretty clear and concise:

A “blue chip” is the nickname for a stock that is thought to be safe, in excellent financial shape and firmly entrenched as a leader in its field. Blue chips generally pay dividends and are favorably regarded by investors. A few examples of blue chips are Wal-Mart, Coca-Cola, Gillette, Berkshire Hathaway and Exxon-Mobile.

So why shouldn’t you limit yourself to U.S. blue chip stocks? Well, find out from the Motley Fool as they are the ones issuing the advice in their article “The World’s Best Dividend Stocks“

Investing isn’t for everyone. In a way it’s a game, so it makes sense that you should only play the game if you know how. The thing with investing is that everyone doesn’t become good at it just by knowing the basics of how to do it. It’s like Chess. You can know the mechanics of the game but that doesn’t mean you’ll be good playing Chess. Knowing the mechanics doesn’t make you a grandmaster. If becoming a wealthy investor like Warren Buffet was as simple as knowing the ABCs and 123s of investing there’d be a significantly greater number of billionaire investors out there.

But we’re not aiming to becoming Warren Buffet right? We just want to get into investing on a small scale for now; but we’re not sure if it’s worth it to maintain that sharebuilder account. That’s $600 per year that we could just keep in a savings account for a rainy day. Why should we be risking it just so we can be able to brag that we have a stock portfolio? What’s really the big deal about investing?

Realistically, small timers like you and me won’t get rich investing. It’s not like we can afford to invest on a large scale. We don’t have that kind of money to risk. We’re 9-5ers living hand to mouth. Most of us can’t afford to spend $30 to buy one share of home depot stock much less to spend $640 on a share of Google. So what does that mean? Well, investing isn’t for everybody; and not everybody who invests profits from their investments. Sharebuilder.com’s motto is, there’s an investor in everyone, even you. That may be so; but the investor in you might not necessarily be a good investor and you might end up on the losing end of the game, which is fine as long as you respected your risk tolerance to begin with and invested only what you can afford to lose.

Investing can be fun when you see your money growing; but not so much fun when you see it deflating. Imagine if you’d been able to afford 1000 shares of Google stock back when a share was $85? You’d have spent $85000 and the market value of your 1000 shares today would be $644710.

So the big deal about investing is that sometimes it can pay off big time; but sometimes it can cost you big. Unless you can afford to lose your money, you shouldn’t invest it.

Wondering what’s the safest way to invest tax free? 

The safest way to invest tax free is to check out the latest ISA rates and open an account today.

Before you start investing, you should understand the concept of investing. Investing is a form of the word invest. Other forms of the word include investment and investor. The word invest and its derivatives have multiple meanings. We are concerned with investing as related to the act of committing money in order to earn a financial return, or more simply putting a certain amount of money to use with the goal of making it grow into more money.

There are different ways of growing money by investing it. Some ways of growing money through investing include putting money into a savings account, investing in stocks, investing in bonds, investing in mutual funds, investing in businesses, investing in real estate.

The business of investing money to make more money has made billionaires of notable investors like Warren Buffet, George Soros and Carl Icahn; but not everyone who invests money will grow their invested dollars into millons or billions of dollars.

From INVESTINGBONDS.COM - A bond is a debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it “matures,” or comes due.

Among the types of bonds you can choose from are: U.S. government securities, municipal bonds, corporate bonds, mortgage and asset—backed securities, federal agency securities and foreign government bonds.

A mutual fund is simply a collection of stocks and/or bonds. Most mutual funds are “actively managed,” meaning the mutual fund shareholders, through a yearly fee, pay a mutual fund manager to actively buy and sell stocks or bonds within the fund.

Though you would think that mutual funds provide benefits to shareholders by hiring alleged “expert” stock pickers, the sad truth of the matter is that the vast majority of mutual funds underperform the average return of the stock market.

Over time, because of their costs, approximately 80% of mutual funds will underperform the stock market’s returns. Currently, most mutual funds do not make their fees very easy for shareholders to understand. (Read more on fool.com.)

Ok, so you want to invest; but you’re completely clueless about investing; and all the investing websites on the Internet seem to be written for people who already understand something about the way the whole thing works. You understand nothing. You’re like a child just ready for kindergarten. You’re ready to be taught your ABCs and 123s, but the investing for beginners resources online are teaching investing basics in a foreign language. So, even though what they’re teaching is basic investing, you still can’t understand any of it because you don’t understand the language.

Well, stick with us because, over the next several weeks we’re going to talk investing in true “beginner” language.