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| Sunday, 27 April 2003 |
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Business |  |
| News Business Features Editorial
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Investing wisely in the stock market In an increasingly turbulent financial world, it is wise to know that there are always winners - provided they make smart investments. Although stock markets may experience short-term fluctuations, in the longer term they can be considered an attractive investment. Investors who consistently put money into stock markets as a way of accruing longer term gains typically end up with gains that are significantly above other financial instruments with similar risk profiles. Meanwhile those investors who are keen to explore short-term profit taking have to contend with a higher degree of risk. However, according to a Colombo Stock Exchange (CSE) news release, there is no such thing as a risk-free investment. For banks, risk is often managed to such a degree that it becomes a negligible factor. However, investment instruments such as savings accounts or fixed deposits have fundamental flaws so that they become obstacles to effective long-term investment. One such obstacle is created when an economy's inflation rates are higher than or on-par with the interest rates on offer. So savings and fixed deposits cease to become effective investment tools as the money invested now could have the same, or even less, purchasing parity in a few years. Therefore, gaining interest from such instruments on invested capital could sometimes lead to losing value. In Sri Lanka, for example, the most recent inflation rate is 10 per cent while the most customer-oriented offer from such instruments offer eight per cent interest earnings to savings account holders and 10 per cent to fixed deposits. Shares are admittedly riskier, but in the longer term, that risk stabilises to a marginal degree, which can be minimised, if the risk is managed. The advantages of stock markets such as versatility, profitability and liquidity are very attractive to most corporate investors. Smaller investors can also access these advantages if they take the following added steps, the release said. An important element of sensible investment is to know the market. This aspect is the best advice because currently most small investors make investments based on speculative insight. There are better ways to go about it. Even if investors give their capital to investment professionals, they should know how to track investments and veto the choices of some of their investment advisers. A knowing-the-market attitude is primarily advantageous when it comes to picking stocks to build a diversified portfolio since forewarned means investors are prepared and can cut risk and optimise growth.There are certain tools that can help determine the quality of a share, and a company. These should be ideally the first steps in gathering the right information to formulate and implement stock buying decisions. Earnings Per Share (EPS) - Calculated by earnings divided by total number of shares so gain can be judged at an individual share level. It is calculated by Net Profit After Tax, less Preference Share Dividends, less Interest, the total of which is then divided by time weighted average number of ordinary shares in issue and ranking for dividends. What an investor can learn from this is that the higher the EPS is, the more value the ordinary share is accruing. For example, if a company has an EPS of Rs. 10.00 and it is compared to an industry benchmark of Rs. 8.00, then the value of share is good. This suggests the share in question is doing much better than industry standards. Return On Equity - Indicates the rate of return earned on the amount invested by the shareholders. It is calculated by the earnings available to ordinary shareholders, divided by total shareholders' equity (equity portion of the balance sheet). Price to Earnings - This ratio is used to assess the amount that investors are willing to pay for each monetary unit of earnings. It is calculated by dividing the Market Price Per Share divided by Earnings Per Share. The message given to an investor is that the higher the ratio, the more likelihood of earnings in the future or the share is less risky in nature. Therefore, investors may be willing to pay a larger multiple of its earnings at that point in time because they anticipate it is very likely to be a good investment. The ratio may be higher because it is poised in a potential bed of activity like in a sector such as technology stocks. Dividend Payout Ratio - This is used to find out the percentage of profit that is paid out as dividends. It is calculated by dividing the Dividends Per Share by Earnings Per Share (dividends per share is calculated by taking the total dividends, divided by the total ordinary shares in issue and ranking for dividends). Another form of reducing the risk factor is using a diversified portfolio from varying sectors such as Banks, Manufacturing, Hotels and Plantations. It is also essential that they be at different risk levels ranging from low risk - low return to high risk - high return. It is also a good idea to consider at least as part of your portfolio, companies that have submitted themselves for a credit rating, the CSE advised. It is also sound business sense to look through each company's books for strengths and weaknesses as well as analyse its books with several key financial ratios such as the Cash Ratio and Inventory to Net Working Capital or other liquidity ratios. Other sets of ratios can also be of immense value in analysing companies, ratios such as activity and leverage ratios indicate how companies leverage debt and how often turnover is recycled. It is also important that cash flows and liquidity are checked often because it is the heart of any business. Company culture and values should be considered and even marketing plans and financial plans if accessible with questions such as 'How much does a company reinvest from retained earnings so as to grow' and is reinvestment being planned or being planned for?' Sound investment advice from reputed and accredited financial and investment analysts and stockbrokers of member firms of the stock exchange. These professionals can advise newcomers about the available shares and investment options and are knowledgeable in building the ideal diversified portfolio (mix of instruments such as shares and fixed income instruments) for an individual investor, it said. Unit fund managers may be another option to investing in the stock exchange, and this option is also the best for investors who only have minimal investment capital. Unit trusts are funds in which an investor buys units and this unit increases and decreases depending on the fund value and gives dividends like in shares. The only difference is that unit trusts consist of funds which have a diversified portfolio of investment instruments which is overseen by experienced managers. Investors are even given the choice of security and profitability in their investments, and there are funds with low risk - low growth and high risk - high growth options. |
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