Monday, March 30, 2009

What Causes Stock Prices To Move?

Knowing the answer to this will enable you to buy and sell at the right time.

STOCK investing is perhaps the most talked about form of investing. Stocks create hype because they are volatile and sensitive to various factors. With the current economic landscape and dismal performance of bourses worldwide, we can observe that stock prices are affected on a much larger scale than usual. So, if you are wondering what makes stock prices go up or down, read on to find out.

Knowing the answer to this will enable you to buy and sell at the right time. Unfortunately, there is no one definite answer to this simple question. Various factors influence stock price movements. However, certain primary factors have a major impact on the movement and as an investor, you need to pay attention to these factors as guidance in making the right call to "buy" or "sell".

Demand and Supply

This golden rule of economics holds true even when it comes to the stock market. When demand for stocks is greater than supply, stock prices will go up. This happens when everyone starts to chase after stocks but only very few are willing to sell. This in turn, pushes the prices of stocks up further. On the flip side, when supply is greater than demand, everyone rushes to sell off their stocks, but only a few buyers are interested. This results in stock prices being depressed.

Bearing this in mind, you then need to know what causes the demand or supply to go up or down.

Economic situation

* Economic situation Stock market performance is actually a leading indicator of our economic situation. This means that the stock market will reflect the market expectations of our economy a few months down the line. As such, if the market expects the economy to boom, you will start to see stock prices increasing much earlier than the actual boom and the opposite applies when recession hits. Bearing this in mind, as investors, you need to be sensitive to signs that provide any form of indication on the future direction of the economy.

For example, when inflation rate creeps up; there is a possibility that the interest rate will go up as well to help cool the economy. The stock market in turn, will react negatively given such an expectation. On the other hand, when the economy is at the bottom of its cycle and the interest rate is lowered to stimulate economic activity, you will see that stock market will react positively to it. This positive reaction is attributed to the expectation that the economy is on the road to recovery.

Company performance

* Company performanceLogically, the stock price of a company should go up if its financial performance is good, and vice versa. However, you will notice that most of the time, when the financial results are announced, as long as they reflect analysts' expectations, regardless of whether the reports bear good or bad news, stock prices will usually not show much movement. It is only when the results come as a surprise to the market that you will see a blip in the price. Basically, this is because the existing stock prices already reflect the current market expectation. This tells you that you need to pay attention to the company's business fundamentals, as this is the critical factor that is going to influence the company's stock price in the long run. As an investor, you should be mindful of the company's business direction and projects that it is involved in, that have the potential of bringing growth to the business. You have keep a watchful eye on its financial performance and management's strength, in order to make a good investment decision.

Market rumours

* Market rumoursThis is a major contributor to the stock market's short term volatility. There is a famous saying in the stock market, 'buy on rumours, sell on facts'. Investors tend to over-react or react hastily to the slightest market rumours. Often times, they will panic and rush to sell on negative rumours, resulting in the drop of the stock price. Investors could take the opportunity to buy at that particular time if they know that the company is fundamentally strong and the likelihood of the negative rumours being accurate is low; or the situation is not as bad as it is made out to be. By carefully scrutinising market rumours, you are able to make sound investment decisions instead of just following the crowd, that could lead to dire consequences.

Political instability

* Political instabilityNaturally, if a country is experiencing political unrest, the stock market will inevitably have to deal with some setbacks. In cases of instability, foreign investors react by pulling out their funds which may trigger panic selling from all parties. You will need to assess whether the unrest is just a short-term event or carries with it a longer lasting impact. This is crucial in assessing your risk should you choose to continue holding on to your position, as opposed to taking quick action to leave the market.

The above are only a few major drivers that will cause the stock prices to move. However, most of the time, the investor psychology effect of over reacting makes market movement more prominent than it should be. One of Benjamin Graham's investing principles encourages us to look at market fluctuations as our friend rather than our enemy, as market movements sometime create buying opportunities for true investors. Therefore, as an informed and knowledgeable investor, avoid getting into "panic mode". Always remember, understand and evaluate the situation by using your own judgement to ensure that you make intelligent investment decisions.

Wednesday, March 25, 2009

Measuring Company’s Financial Health


DESPITE the recent strong stock market rally as a result of the current tough economic environment, some investors may still doubt the financial health of some listed companies.

At present, apart from some common financial ratios such as debt-to-equity and interest coverage ratios, investors are looking for a ratio that can provide an indicator on the potential bankruptcy risk for any listed companies.

In this article, we will look into a method called Altman’s Z-Score, which can help us determine the bankruptcy risk of a company.

The Altman’s Z-Score Method was developed by Dr Edward I. Altman in 1968. It is a multivariate formula to measure the financial health of a company on whether it will enter into bankruptcy in the coming two years.

This method uses five common business ratios: earnings before interest and tax (ebit)/total assets ratio; sales/total assets ratio; market value of equity/market value of total liabilities; working capital/total asset ratio and retained earnings/total assets.

The Z-Score is computed using a weighted system based on the formula below:-

Z= 3.3X1 + X2 + 0.6X3 + 1.2X4 +1.4X5

Where:

X1 = ebit/total assets
X2 = sales/total assets
X3 = market value of equity/total liabilities
X4 = working capital/total assets
X5 = retained earnings/total assets

According to Altman, if the score is 3.0 or above, bankruptcy is not likely. If the score is 1.8 or less, potential financial embarrassment is very high.

A score between 1.8 and 3.0 is the grey area where the company has a high risk of going into bankruptcy within the next two years from the date of the given financial figures.

Hence, we can conclude that we should look for companies with higher Z-Scores for investing.

We have computed Z-Scores for two listed companies, Company A and Company E. Company A is consumer-based whereas Company E is property-based. We notice that Company A has a strong Z-Score value of 5.78 versus a very low 0.62 for Company E. Based on Z-Score, Company A is very unlikely to go bankrupt (5.78>3.00) whereas the chances of Company E going into bankruptcy is very high (0.62<1.80).

The reason behind the very low Z-Score value for Company E was because it had a very low market value over its total liabilities as compared to the high market value for Company A. In fact, Company E is currently having financial difficulties and is under PN17 (Practice Notes 17).

In short, companies with higher profit margins, sales, market value, working capital and retained earnings against their total assets will command a higher Z-Score.

This method is popular in the Western countries where some accountants found it quite reliable and accurate.

In the Malaysian context, according to a user manual published by Dynaquest Sdn Bhd, they found that the cut-off at around 1.5 is a better measurement of the likelihood of bankruptcy as compared to the 1.8 stated by Altman.

It may appear that companies selling at higher market value are safer than companies with lower market value. However, sometimes we may be tempted to nibble companies with lower stock prices.

We should be aware that the current very low stock prices for certain companies may indicate to us that the coming financial results of these companies might be quite disappointing.

However, we should be aware that Z-Score does not apply to every situation. We may want to use additional financial ratio like debt-to-equity ratio to complement this method.

Monday, March 09, 2009

Global Recession Could Last Till End 2010 Or Longer

NEW DELHI (AFP) - - The US professor nicknamed "Dr. Doom" for forecasting the financial crisis has said the global recession will last all of this year and probably next, India's Mail Today reported Saturday.

New York University professor Nouriel Roubini said that in the best-case scenario, the recession will continue through 2010 in advanced economies while job losses will persist for an additional year, the paper reported.

He said world governments are falling behind the curve in tackling the crisis with "policymakers moving in the right direction -- but (doing) too little too late."

Speaking at a New Delhi conference, Roubini warned that the United States, Europe and Japan must "get their act together" to avoid the global economy sinking further.

"People were hoping it would be a V-shaped recession -- a sharp fall, followed by an equally quick recovery," he said.

"But we are in the middle of an ugly U-shaped recession," he said Friday.

Roubini said the bottom of the 'U' -- the length of time the world economy will continue to contract -- would last a minimum of three years starting from December 2007.

But he said there was a "one-in-three chance" that recession would turn into an 'L' -- a prolonged period of stagnation or shrinking output, coupled with falling prices as demand dries up.

As early as 2005, Roubini said US home prices were riding a speculative wave that would soon sink the economy, but was dismissed as a doomsayer.

In Delhi, he said the problems of the financial system and financial institutions were getting worse, but that the outlook could be improved by governments taking charge of insolvent banks, cleaning them up and then selling them to private investors.

"People say when the US sneezes, the rest of the world catches cold. In this case, the US is just not sneezing, it has a severe case of chronic pneumonia."

"We all sink or swim together," he said, adding there is no way policy action in emerging economic giants India and China can pull the global economy out of the slump.

Friday, March 06, 2009

Dow Plunges to New Low

NEW YORK, March 6 — Investors fled Wall Street again, driven by worries about the big banks in the United States and General Motors Corp.

Stocks ended at 12-year lows yesterday, more than wiping out the previous day's rally. Investors wrestled with more disheartening economic data, new concerns about GM and relentless uncertainty about the financial system. Short selling ahead of the government's employment report today exacerbated the losses, slashing 281 points from the Dow Jones industrials and sending all the major indexes down more than 4 per cent.

Stocks fell in every industry, with beleaguered banks posting some of the steepest drops. Citigroup Inc, still shaky despite receiving billions in government aid, at times sank below US$1 and finished down 10 per cent at US$1.02. General Motors, meanwhile, ended with a loss of 15 per cent at US$1.86 as it warned of possible bankruptcy.

"Citigroup going below a buck today was a little scary," said Mark LeStrange, director of sales at Source Trading.

"To say that we're cheap here and it's a good value, it sounds right, but in all reality we could go 50 per cent lower," he said. "Nobody has any idea how low we can go."

The Standard & Poor's 500 index is now down 56.4 per cent from its peak in October 2007, making it the second worst slide for the index since its fall of 86.2 per cent from 1929-32.

The latest torrent of selling came ahead of the February Labour Department report that is likely to show hundreds of thousands of jobs were lost. Even some positive news, including some better-than-expected retail sales and factory orders, was not enough to stoke investor confidence.

The reports failed to show a significant improvement and so the market gave back a big gain from Wednesday, said Doreen Mogavero, president of brokerage Mogavero, Lee & Co.

"The economic data is still obviously a huge worry," she said.

Short sellers also dragged on the market, analysts said. Short sellers place bets that a stock will fall, and rising short positions on a stock can intensify its decline.

"Just go out kill them. It's the easiest way to go out and make a buck," said Stephen A. Lieber, chief investment officer at Alpine Woods Capital Investors LLC in Purchase, New York, referring to short sellers.

The Dow fell 281.40, or 4.1 per cent, to 6,594.44, its lowest close since April 1997.
Broader indicators also tumbled. The S&P 500 index dropped 32.95, or 4.6 per cent, to 679.92, its lowest close since September 1996. The Nasdaq composite index fell 52.30, or 3.9 per cent, to 1,301.44.

The Russell 2000 index of smaller companies fell 21.49, or 5.8 per cent, to 349.77.
On the New York Stock Exchange, only 235 stocks advanced while 2,887 fell. Volume came to a heavy 1.89 billion shares.

Robert Pavlik, chief market strategist at Banyan Partners LLC in New York, agreed that short selling is driving the market and that the drubbing is keeping away investors who would be attracted by beaten down stocks.

"Long-term investors would really step in if prices got too low or oversold and begin to do some bargain hunting. But with all the uncertainty that has been created, long-term investors are not stepping in," he said. "What incentive do long-term investors have stepping? Traders rule the roost."

Stocks fell initially after China deflated investors' hope that it would take new steps to stimulate its economy, but the discouraging economic data sent stocks even lower. The hope that China would unveil more government spending to help its economy was a major factor behind the market's bounce on Wednesday, which sent the Dow Jones industrials up nearly 150 points after a five-day slide.

"It's been this continuous (cycle of) hope leads to disappointment," said Todd Salamone, senior vice president of research, Schaeffer's Investment Research in Cincinnati.

Since the Dow and the S&P 500 index ploughed through their November lows last week, dashing hopes that the market had indeed hit a bottom, investors have been left wondering how much more the market can fall. At the same time, there is a contingent of investors with a "why sell now" mentality who are fearful of missing the next rally, Salamone said.

"A lot of people are banking we can't go much further, but if you look to the '30s, we could indeed go a lot lower," he said, referring to Wall Street's huge losses during the Great Depression.

Discouraged by little evidence that Washington's efforts to stabilise the economy are working, investors have lost faith in the administration, he said.

"At this point, you've got to be asking will anything help?" Salamone said. "The fact could very well be that the government can't do very much."

Among yesterday's gloomy reports, the Commerce Department said orders for manufactured goods fell by 1.9 per cent during the first month of the year. While this was better than the 3.5 per cent drop economists had expected, it marked a record sixth straight month of declines.

Data showing that initial unemployment claims fell more than anticipated last week failed to buoy stocks. Economists surveyed by Thomson Reuters/IFR predict the Labour Department will report that US employers slashed 648,000 jobs in February — more than the 598,000 cut in January.

Rising unemployment is of particular concern because it means many consumers have less to spend. And consumer spending, which accounts for more than two-thirds of US economic activity, is crucial to helping the economy turn around. A handful of better-than-expected retail sales reports, including one from Wal-Mart Stores Inc, weren't enough to convince investors that consumer spending is improving.

The future of General Motors also plagued investors. The automaker said in its annual report that auditors raised serious doubt about its ability to continue operating. GM has already received US$13.4 billion in federal loans, and is seeking a total of US$30 billion from the government. GM dove to US$1.86.

Negative comments from Moody's Investors Service weighed on already depressed financial stocks. Concerns about capital levels led the ratings agency to downgrade the ratings of Bank of America Corp and Wells Fargo & Co. Moody's also lowered the outlook on JPMorgan Chase & Co's ratings to negative. Bank of America shares dropped 42 cents, or 11.7 per cent, to US$3.17; Wells Fargo plunged US$1.54, or 15.9 per cent, to US$8.12; JPMorgan tumbled US$2.70, or 14 per cent, to US$16.60.

Overseas, Britain's FTSE 100 fell 3.2 per cent, Germany's DAX index dropped 5 per cent, and France's CAC-40 fell 4 per cent. Earlier, Japan's Nikkei stock average rose 2 per cent after Wall Street's Wednesday rally, but Hong Kong's Hang Seng index fell 1 per cent. — AP