Magic of Compounding!!

Buffett , according to his letter to shareholders, “only” provided around 20% return on average, compounded, per year.


20% does not sound much. But when compounded over 60 years, it brought him from a few million dollars to top 3 richest person on the planet.


Mostly this is because when you invest in stock, you don’t pay capital gain tax until the year you sell the stock. So if you never sell it, you never have to pay tax on it.


Let’s assume someone buys and sell every year a company that increase in value by 15% a year. Assume Capital Gain tax is 30% for short term investment and 20% for long term investment.


Here is the difference between the two’s wealth after 60 years:

Even if Buffett still have to pay 20% tax on his 6.19 times greater wealth after 60 years, he is still 5 times richer than buy and sell investor.

So the key to minimize your tax and maximize your compounding is finding great companies that grow in very long term, then never selling it for quick short term profit.

When to Sell your Stock

When to Buy a Stock

For investors, finding a stock to buy can be one of the most fun and rewarding activities. It can also be quite lucrative – provided you end up buying a stock that increases in price. Below are five tips to help you identify when to purchase stocks so that you have a good chance of making money from those stocks.

When a Stock Goes on Sale:

When it comes to shopping, consumers are always on the lookout for a deal. There are various examples of low prices spurring voracious demand for products – we've all seen on TV. However, for some reason, investors don't get nearly as excited when stocks go on sale. In the stock market, a herd mentality takes over and investors tend to avoid stocks when prices are low.

The end of 2008 and early 2009 were periods of excessive pessimism, but in hindsight, were times of great opportunity for investors, who could have picked up many stocks at beaten-down prices. In fact, the period of time after any correction or crash has historically been great times for investors to buy in at bargain prices.

When It Hits Your Buy Price:

In investing, it is important to estimate what a stock is worth. That way, investors will know whether it is on sale and likely to rise up to this estimated value. Coming to a single stock-price target is not important. Instead, establishing a range at which you would purchase a stock is more reasonable. Analyst reports are a good starting point, as are consensus price targets, which are averages of all analyst opinions. Most financial websites publish these figures. Without a price target range, investors would have trouble determining when to buy a stock.

When It Is Undervalued:

There is a lot of information needed for establishing a price target range, such as if a stock is being undervalued. One of the best ways to determine the level of overvaluation or undervaluation is by estimating a company's future prospects. A key valuation technique is a discounted cash flow analysis, which takes a company's future projected cash flows and discounts them back to the present. The sum of these values is the theoretical price target. Logically, if the current stock price is below this value, then it is likely to be a good buy.

Other valuation techniques include comparing a stock's price-to-earnings multiple to that of competitors. Other metrics, including price to sales and price to cash flow, can help an investor determine whether a stock looks cheap compared to its key rivals.

When You Have Done Your Own Homework:

Relying on analyst price targets or the advice of newsletters is a good starting point, but great investors do their own homework on a stock. This can stem from reading a company's annual report, reading its most recent news releases and going online to check out some of its recent presentations to investors or at industry trade shows. All this data can be easily located at a company's corporate website under its investor relations page.

When to Patiently Hold the Stock:

Assuming you've done your homework, properly identified a stock's price target and estimated if it is undervalued, don't plan on seeing the stock you bought rise in value anytime soon. It can take time for a stock to trade up to its true value. Analysts who project prices over the next month, or even next quarter, are simply guessing that the stock will rise in value quickly.

It can take a couple of years for a stock to appreciate closer to a price target range. It would be even better to consider holding a stock for three to five years – especially if you are confident in its ability to grow.

The Bottom Line

Legendary stock-picker Peter Lynch recommends that investors buy what they know, such as their favorite retailer at their local shopping mall. Others can get to know a company by reading up on it online or talking to other investors. Combined with the above tips, applying your own common sense in choosing when to buy a stock can produce the most profitable results. Put in some time for reading & researching on the subject, successs will not be far away..

Stock Price Variation Explained- Part-2

Stock prices change everyday by market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall.

Understanding supply and demand is easy. What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and just about any investor you ask has their own ideas and strategies.

That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth. Don't equate a company's value with the stock price. The value of a company is its market capitalization, which is the stock price multiplied by the number of shares outstanding. For example, a company that trades at $100 per share and has 1,000,000 shares outstanding has a lesser value than a company that trades at $50 but has 5,000,000 shares outstanding ($100 x 1,000,000 = $100,000,000 while $50 x 5,000,000 = $250,000,000). To further complicate things, the price of a stock doesn't only reflect a company's current value–it also reflects the growth that investors expect in the future as explained by me in other topics of the blog.

The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, they aren't going to stay in business. Public companies are required to report their earnings four times a year (once each quarter). Wall Street watches with rabid attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection. If a company's results surprise (are better than expected), the price jumps up. If a company's results disappoint (are worse than expected), then the price will fall.

Of course, it's not just earnings that can change the sentiment towards a stock (which, in turn, changes its price). It would be a rather simple world if this were the case! During the dot-com bubble, for example, dozens of Internet companies rose to have market capitalizations in the billions of dollars without ever making even the smallest profit. As we all know, these valuations did not hold, and most all Internet companies saw their values shrink to a fraction of their highs. Still, the fact that prices did move that much demonstrates that there are factors other than current earnings that influence stocks. Investors have developed literally hundreds of these variables, ratios and indicators. Some you may have already heard of, such as the P/E ratio , while others are extremely complicated and obscure with names like Chaikin Oscillator or Moving Average Convergence Divergence (MACD) .

So, why do stock prices change? The best answer is that nobody really knows for sure. Some believe that it isn't possible to predict how stocks will change in price while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know as a certainty is that stocks are volatile and can change in price extremely rapidly.

THE IMPORTANT THINGS TO NOTE:

1. At the most fundamental level, supply and demand in the market determine stock price.
2. Price times the number of shares outstanding (market capitalization) is the value of a company. Comparing just the share price of two companies is meaningless.
3. Theoretically earnings are what affect investors' valuation of a company, but there are other indicators that investors use to predict stock price. Remember, it is investors' sentiments, attitudes, and expectations that ultimately affect stock prices.
4. There are many theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything.

Operating Performance Ratios

Operating performance ratios are tools which measure the function of certain core operations for an organization or business. Particularly, these ratios reveal information about how efficiently that organization is using resources to generate sales and cash. A company with strong performance ratios is able to utilize a minimum resource pool to generate high levels of sales, as well as a significant cash inflow. In this tutorial, we’ll examine some of the most commonly used operating performance ratios. By reading this blog, you should come away with a general sense of what these measures are, how they are determined, and what information or insight they can provide to those within a company or interested in investing.

3 Main Operating Performance Ratios

There are three primary operating performance ratios we will consider. They include the following:

1. Fixed-asset turnover

2. Sales/revenue per employee

3. Operating cycle

Each of these ratios utilizes different inputs to measure varied portions or segments of a business’ overall performance.

(1) Fixed Asset Turn Over Ratio:

Before we can begin to consider what fixed-asset turnover is, it’s helpful to review what fixed assets are in the first place. A fixed asset is any tangible piece of property, used over the long term, which a company owns and uses in its general operations. They are also known as capital assets like Property, Plant, and Equipment (PP&E).

Although fixed assets represent only one type of assets a company owns, in many cases they are the largest share of the total asset pool. Fixed-asset turnover, then, is a ratio which aims to measure how productive a company’s fixed assets are when it comes to generating sales. The higher that the yearly turnover rate on these assets is, the better the company is at managing them and using them to generate sales.

The formula for fixed-asset turnover is as follows:

Fixed-asset turnover ratio = Revenue/PP&E

For a hypothetical company with annual revenue of $1 million and average fixed assets, or PP&E, of $200,000, the fixed-asset turnover ratio would be as follows:
$1,000,000/$200,000 = 5

To calculate a company’s fixed-asset turnover ratio, it’s useful to look to a company’s income statement for revenue figures and to a balance sheet for PP&E details.

Variations

There are ways to vary the fixed-asset turnover ratio to reflect other types of efficiency. For instance, some asset-turnover ratios make their calculations based on total assets. While it could be argued that this provides a fuller picture of a company’s activity, some analysts prefer fixed-asset turnover ratios because they represent a sizable component of the  balance sheet and management decisions over different capital expenditures. The idea, then, is that capital investment and its results is, in fact, a better indicator of performance than what is evidenced in overall asset turnover.

It’s important to keep in mind that fixed-asset turnover ratios are relative. There is no specific number or threshold above which a company is doing a successful job at generating revenue from its fixed asset investments. Thus, a single calculation of fixed-asset turnover ratio is not particularly useful; rather, comparing this ratio for a single company over time or between similar companies is far more helpful.

Before placing too much trust in this particular ratio, it’s also important to keep in mind that different companies in varying industries have vastly disparate investments in fixed assets. For example, tech companies often have low fixed-asset bases relative to heavy manufacturing companies. Thus, a fixed-asset turnover ratio for a leading tech company is a less useful means of gauging performance than a similar ratio would be for a heavy manufacturing company.

Higher fixed-asset turnover ratios are often the result of comparably low investments in PP&E, rather than an indication of high sales. Companies which are not capital intensive, they are better able to generate high levels of sales on relatively low capital investment. However, some industries, such as natural resource companies, tend not to experience this.

(2) Sales/ Revenue per Employee:

While fixed-asset turnover ratio is a measure of a company’s use of its fixed assets as a means of generating sales, sales/revenue per employee examines the business benefit on the level of individual personnel. This is not to say that this ratio should be (or is) used as a way of determining the performance of individual employees. Rather, it still reflects the larger decisions of a company’s management. However, it is calculated by breaking down sales or revenue that the company earns as compared with the number of employees working for at company.

As in fixed-asset turnover, certain types of companies are naturally inclined to enjoy higher or lower ratios. The higher the ratio is, the better the company in question is at generating revenue given the number of employees that it maintains. Labor-intensive businesses like mass market retailers tend to be less productive according to this metric as compared with high-tech, high-product-value manufacturers.

Here is the formula for calculating sales/revenue per employee:

Sales/Revenue Per Employee = Revenue/Number of Employees (Average)

For a hypothetical company generating $2 billion in sales and employing an average of 5,000 employees for the same period, the sales/revenue per employee calculation would thus be as follows:

$2,000,000,000/5,000 = $400,000

To determine the figures to input for any given company, once again it is helpful to look to the company’s financials. The sales or revenue figure can be surmised from the income statement, while the average number of employees for that period is available in the annual report or Form 10-K.

Variations

It is also possible to determine an earnings per employee ratio by using net income instead of net sales or revenue.

Like the other operating performance ratios a single calculation of sales/revenue per employee is far less useful than several ratios which can be compared against one another. Look to how a company’s sales/revenue per employee changes from year to year, for example, or how it stacks up against ratios for similar companies or competitors.

It is less useful to compare companies in very different sectors or industries using this performance metric. Take, for example, a comparison of Microsoft and Wal-Mart, two major companies in different industries. Microsoft relies on technology and innovation to drive revenues, requiring a relatively small personnel complement in order to accomplish these goals. A massive retail store like Wal-Mart, on the other hand, is quite labor-intensive and employees many more workers. Thus, Microsoft may be likely to have a sales per employee ratio that is significantly higher than that of Wal-Mart. This is largely a reflection of the fundamental differences in how these companies operate.

Used appropriately, sales or revenue per employee can be a useful metric to assess personnel productivity for a company. It is best used as a tool for comparing industry competitors or a company’s performance across many years.

(3) Operating Cycle:

Operating cycle is the third type of operating performance ratio we’ll examine in this tutorial. It makes use of receivables, inventory, and payables and aims to represent management performance efficiency. It is often compared with the cash conversion cycle because it makes use of the same component parts. What is different, though, is that an operating cycle analyzes these components from the perspective of how well the company is managing operational capital assets, rather than from the impact those components have on cash.

The formula for an operating cycle calculation is as follows:

Operating Cycle (Days) = DIO + DSO – DPO

DIO = Days Inventory Outstanding

DSO = Days Sales Outstanding

DPO = Days Payable Outstanding

Components

DIO

To determine a company’s operating cycle, analysts must first calculate the various components used in the formula above. To compute DIO, follow these steps:

1) Divide the cost of sales (available on a business’s income statement) by 365 in order to find a cost of sales per day figure.

2) Calculate the average inventory figure by adding the year’s beginning (or previous year’s ending) amount and the ending inventory figure (both of these are available in the balance sheet); then, divide by 2 to obtain the average amount of inventory for the time period in question.

3) Divide the average inventory figure from step 2 by the cost of sales per day figure from step 1.

A company with cost of sales of $760 million and average inventory of $560 million, say, would have a DIO as follows:

$730 million/365 = $2 million (cost of sales per day)

DIO = $560 million/$2 million = 280 (days inventory outstanding)

DSO

DSO can be computed using net sales and accounts receiable figures and with the following sequence of steps:

1) Divide net sales (available on a company’s income statement) by 365 to determine a net sales per day figure.

2) Calculate the average accounts receivable figure by adding the year’s beginning (or previous year-end) amount and the ending accounts receivable amount, then divide by 2 to obtain the average over the time period in question.

3) Divide the average accounts receivable figure by the net sales per day figure.

The process of determining DSO is very similar to that for calculating DIO, although it uses different figures.

DPO

Like DIO and DSO, the process for determining DPO is straightforward. In this case, though, you’ll need the cost of sales and accounts payable figures for the company and time period in question. Use the following steps to calculate DPO:

1) Divide the cost of sales (available on the income statement) by 365 to determine a cost of sales per day figure.

2) Calculate the average accounts payable figure by adding the year’s beginning (or previous year-end) amount and the ending accounts payable amount, then divide by 2 to determine the average.

3) Divide the average accounts payable figure by the cost of sales per day figure.

Once you have DIO, DSO, and DPO figures, you can then plug them into the formula at the top of the chapter to determine a company’s operating cycle.

Variations

It’s common to express the three primary components of the operating cycle (DIO, DSO, and DPO) in terms of turnover as a times (x) factor. A days inventory outstanding of 280 days would therefore be expressed as turning over 1.3x annually (because 365 days/280 days = 1.3 times). Some analysts prefer the use of actual days as it is more literal and easier to understand from a conceptual standpoint.

Let’s compare two hypothetical companies with figures as follows:

	Company A	Company B
DSO	58 days	105 days
DIO	280 days	294 days
DPO	63 days	145 days
Operating Cycle	275 days	254 days

In terms of collecting on receivables, it appears from the DSO figures that company A is significantly more operationally efficient than company B. Common sense would dictate that the longer a company has money which remains uncollected, the greater the level of risk that it is taking. Is company B remiss in not collecting its receivables more efficiently? Or perhaps is it trying to add market share by allowing its customers easier payment terms?

These two companies have almost identical days inventory outstanding. In this case, both companies have DIO figures which are higher than the average company across industries. This, then, is likely a reflection of the industry in question, rather than poor efficiency. However, in order to get the fullest picture, it would be helpful to compare these two DIO figures against those of other companies in the same industry.

When it comes to DPO, company B has a major advantage. It is stretching out its payments to suppliers far beyond what company A is able to do. In a sense, it is more efficient at using other people’s money, but the reason for this is not immediately clear from these figures alone. An analyst would likely want to know what that means for the credit reputation of each of these companies, and why they are different.

Shorter Is Better?

It’s easy to assume that shorter is better when it comes to a company’s cash conversion cycle or its operating cycle. This is true in the case of the former, but not necessarily the case in the latter. Of course, there are many variables attached to the management of receivables, inventory, and payables, and these require many decisions on the part of managers.

For example, short payment terms may restrict sales. Minimal inventory levels may mean that a company is unable to fulfill orders on a timely basis, which likely means that some sales are lost. Therefore, it would appear that if a company is experiencing solid sales growth and reasonable profits, its operating cycle components should reflect a high degree of historical consistency. With that, we reach the end of our tutorial on operating performance ratios with a reminder: consistency of these ratios across a company’s history is one of the most important measures of success.

Market Capitalisation Vs Book Value

Understanding the difference between book value and market value is a simple yet fundamentally critical component of any attempt to analyze a company for investment. After all, when you invest in a share of stock or an entire business, you want to know you are paying a sensible price or the other way, for getting what actually are you paying for.

Book Value (BV) literally means the value of the business according to its "books" or financial statements. In this case, book value is calculated from the balance sheet and it is the difference between a company's total assets and total liabilities. Note that this is also the term for shareholders' equity. For example, if Company ABC has total assets of $100 million and total liabilities of $70 million, the book value of the company is $30 million. In a very broad sense, this means that if the company sold off its assets and paid down its liabilities, the equity value or net worth of the business, would be $30 million. Also the BV is explained well in other sections of the blog.

Market Value is the value of a company according to the stock market. Market value is calculated by multiplying a company's shares outstanding by its current market price. If Company ABC has 1 million shares outstanding and each share trades for $70, then the company's market value is $70 million. Market value is most often the number analysts, newspapers and investors refer to when they mention the value of the business.

Implications of Each

Book value simply implies the value of the company on its books, often referred to as accounting value. It's the accounting value once assets and liabilities have been accounted for by a company's auditors. Whether book value is an accurate assessment of a company's value is determined by stock market investors who buy and sell the stock. Market value has a more meaningful implication in the sense that it is the price you have to pay to own a part of the business regardless of what book value is stated.

As you can see from our fictitious example from Company ABC above, market value and book value differ substantially. In the actual financial markets you will find that book value and market value differ the vast majority of the time. The difference between market value and book value can depend on various factors such as the company's industry, the nature of a company's assets and liabilities, and the company's specific attributes. There are three basic generalizations about the relationships between book value and market value:

• Book Value Greater Than Market Value: The financial market values the company for less than its stated value or net worth. When this is the case, it's usually because the market has lost confidence in the ability of the company's assets to generate future profits and cash flows. In other words, the market doesn't believe that the company is worth the value on its books. Value investors often like to seek out companies in this category in hopes that the market perception turns out to be incorrect. After all, the market is giving you the opportunity to buy a business for less than its stated net worth.
• Market Value Greater Than Book Value: The market assigns a higher value to the company due to the earnings power of the company's assets. Nearly all consistently profitable companies will have market values greater than book values.
• Book Value Equals Market Value: The market sees no compelling reason to believe the company's assets are better or worse than what is stated on the balance sheet.

It's important to note that on any given day, a company's market value will fluctuate in relation to book value. The metric that tells this is known as the price-to-book ratio, or the P/B ratio:

P/B Ratio = Share Price/Book Value Per Share

(where Book Value Per Share equals shareholders' equity divided by number of shares outstanding)

So one day, a company can have a P/B of 1, meaning that BV and MV are equal. The next day, the market price drops and the P/B ratio is less than 1, meaning market value is less than book value. The following day the market price zooms higher and creates a P/B ratio of greater than 1, meaning market value now exceeds book value. To an investor, whether the P/B ratio is 0.95, 1 or 1.1, the underlying stock trades at book value. In other words, P/B becomes more meaningful the greater the number differs from 1. To a value-seeking investor, a company that trades for a P/B ratio of 0.5 implies that the market value is one-half of the company's stated book value. In other words, the market is selling you each $1 of net assets (net assets = assets - liabilities) for 50 cents. Everyone likes to buy things on sale, right?

Which Value Offers More Value?

So which metric - book value or market value - is more reliable? It depends. Understanding why is made easier by looking at some well-known companies.

Coca-Cola:

The Coca-Cola Co. has historically traded at a P/B ratio of 4 to 5. This means that Coca-Cola's market value has typically been 4 to 5 times larger than the stated BV as seen on it's balance sheet. In other words, the market values the firm's business as being significantly worth more than the company's value on its books. You simply need to look at Coca-Cola's income statement to understand why. Coca-Cola is a very profitable company. Its net profit margin exceeds 15%. In other words, it makes at least 15 cents of profit from each dollar of sales. The takeaway is that Coca-Cola has very valuable assets - brands, distribution channels, beverages - that allow the company to make a lot of money each year. Because these assets are so valuable, the market values them far more than what they are stated as being worth from an accounting standpoint.

Another way to understand why the market may assign a higher value than stated book is to understand that book value is not necessarily an accurate value of a company's net worth. Book value is an accounting value, which is subject to many rules like depreciation that require companies to write down the value of certain assets. But if those assets are consistently generating greater profit, then the market understands that those assets are really worth more than what the accounting rules dictate. Other high-quality companies such as Johnson & Johnson, Pepsi and Procter and Gamble also possess market values far greater than book values.

Wells Fargo:

Wells Fargo is one of the oldest and largest banks in the U.S. It typically trades for a P/B of 1, give or take a few percent. In other words, the market values Wells Fargo at or close to its book value. The reason here is simple, and it is explained by the industry Wells Fargo operates in. Financial companies hold assets that consist of loans, investments, cash and other financial securities. Since these assets are made of dollars, it's easy to value them: a dollar is worth a dollar. Of course we know that some financial assets can be better than others; for example, a good loan versus a bad loan. A good loan is one that is paid in full and the bank recoups 100 cents on the dollar. A bad loan can stick the bank with a loss and recoup 50 cents on the dollar. That's why whenever banks experience a financial crisis, as we saw in the subprime meltdown in 2008, their market values crash below book value. The market loses faith in the value of those assets.

On the other hand, financial institutions like American Express, which have a long history of extending out good credit, will trade at a modest premium to book value. Banks that the market views as having made bad credit decisions will trade below book. But in general terms, you will never see banks trading for multiples of book value like you would see in Coca-Cola because of the nature of the assets.

When The Values Matter

To determine how book value relates to market value, look at the income generated by the company's assets. A company than can generate a relatively high income level from its assets will typically possess a market value that's far higher than its book value. This is called the company's return on assets or ROA. Coca-Cola's ROA is typically around 7% to 8%. This means each dollar of Coke's assets generates 7 to 8 cents of profit. Wells Fargo has an ROA of 1% to 2%, earning 1 to 2 cents from each dollar of assets. Because Coca-Cola's assets generate more profit per dollar, its assets will be valued much higher in the marketplace. What this also means is that in the case of companies like Coca-Cola, book value is not as meaningful as it would be for a company like Wells Fargo.

The Bottom Line

Book value, like almost all other financial metrics, has its usefulness. But as is often the case with financial metrics, the real utility comes from understanding the advantages and limitations of book value. An investor must use that understanding to determine when book value should be used, and when it should be disregarded in favor of other meaningful parameters when analyzing a company.

What do large companies get from a higher market cap?

Typically a higher market cap means a higher stock price. A higher stock price is useful for a few things:

a) Self-defense when the stock price is very low, the entire company could be bought cheaply by a competitor. Some companies will put a high priority on increasing their share price if they are in danger of this happening.

b) Making acquisitions: the reverse is that the company can acquire others and pay with shares. If the shares are trading at a high price this is easier.

c) Raising capital: if the company issues more shares it can bring in a lot of capital. Facebook reportedly sold more shares than they needed to during their IPO, because they realized the price they would get was a great deal for them and they wanted to get as much capital as possible.
- Reputation and influence: a higher market cap typically means that people pay more attention to the company and its executives. Though less tangible, being an industry leader may have many benefits for the company.

What is 'Block Deal'?

Block deal is a trade, with a minimum quantity of 5 lakh shares or minimum value of Rs. 5 crore, executed through a single transaction, on the special "Block Deal window".

Usually block deal happens when two parties agree to buy or sell securities at an agreed price between themselves and inform the stock exchange.