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What Determines A Stock’s Value?

The biggest question in investing is whether the stock market-or a sector, industry, or specific stock-is going to go up or down in the months ahead. “I don’t blame anyone for asking that question,” says Brad Sorensen, Director of Market and Sector Analysis at the Schwab Center for Financial Research. “It’s the one we all want answered.” Of course, no one knows for sure which direction the stock market will go-especially in the short term. That’s because a wide number of variables, many of which can’t be predicted, can make the markets move in one direction or the other and render useless even the best research and analysis. These variables can include regulatory changes, extreme weather or natural disasters, changes in management-the list goes on. That doesn’t mean investors can’t make intelligent, informed guesses . While no one can predict the market’s exact ups and downs, investors have the potential to boost their investment returns over the long term if they can identify sectors or stocks that are undervalued or overvalued. Valuing the Market At any given point in time, the stock market’s value is the sum of all of the shares outstanding multiplied by their prices. If we all agreed that this value was fair, then stock prices would be static, stuck in place until an outside variable-say, the release of new economic data-changed investors’ minds. But the reality is that we don’t all agree, and that’s why there are so many ways to value the market. One is to compute the value of the entire stock market (total market capitalization) relative to U.S. gross national product. Another way is the Q ratio. It starts with total market capitalization and divides that number by the replacement cost, or the amount of money a company would have to spend to replace an asset, added up across all companies and industries. A third method, used by Morningstar, calculates fair value assumptions using a proprietary discounted cash flow model. The model assumes that each stock’s value is equal to the total of the free cash flows the company is expected to generate in the future, discounted back to the present. Tallied up, these individual valuations help determine whether the market as a whole is over- or undervalued. Evaluating Individual Stocks Many investors look at common, well-known metrics to determine how a stock is likely to perform. One of investors’ most widely used tools in this respect is the price-to-earnings (P/E) ratio-the measure of a stock price compared to its per-share earnings. “The P/E ratio is a familiar metric for many investors, as there tends to be a lot of information out there about earnings,” Brad says. “But it’s far from being a perfect measure, and it’s only one piece of the puzzle.” For example, many P/E ratios are retroactive measures-meaning they reflect a current price against a trailing 12-month profit. That’s useful, but investors generally aren’t buying a company’s past. Instead, they are investing in the future, trying to capture growth. Price-to-book (P/B) ratio is another popular tool for measuring the price of a stock or index against its per-share book value (total assets minus intangible assets and liabilities). A low P/B ratio-typically less than 1-could indicate that a stock is undervalued. This metric is popular among value investors, who search for securities that trade below their intrinsic net worth. But, like P/E ratios, P/B ratios have their limitations. For instance, a P/B ratio tends to be more useful for companies with a lot of hard assets on their books, such as factories or equipment. The ratio says less about companies with significant non-physical assets, such as intellectual property and brands. Brad says that it’s not wrong for investors to consider P/E or P/B ratios as part of their research, but that they shouldn’t rely on this data alone. There are plenty of metrics-such as cash flow and debt ratios-that an investor can use to measure value. Brad also recommends that investors pay close attention to sales growth-especially in today’s market. “Many companies stayed afloat during the recent market downturn by cutting costs everywhere they could,” Brad says. “Going forward, companies will have to rely on sales growth in order to maintain viability and profitability.” Analyzing Sectors For sector analysis-the area that Brad focuses on-determining trends means incorporating macro-economic data points and other factors that might impact a particular industry. When analyzing the technology sector, for example, Brad and his team track the age of current equipment and whether companies have the cash to invest in new technology. They also examine whether the environment is favorable for financing purchases. Some sectors-such as financials, which include banks, investment firms, mortgage companies, and insurers-are more complicated than others to analyze. “These businesses are vulnerable to regulatory and interest rate changes, and even natural disasters,” Brad says. “There are hundreds of data points to consider.” Historical Insights While it’s important to look ahead in an attempt to gain insight into where a company or sector is heading, Brad suggests investors pay attention to historical valuation levels. “It’s critical to look at investments relative to how they have traded and performed at different points during economic cycles,” he says. “An investment’s past performance doesn’t guarantee its future returns, but historical data can provide clues as to what might happen.” As a result, Brad and his team constantly update valuation models and forecasts based on incoming economic data, and-at least monthly-look back in time to see if a stock or sector is trading in a pattern that could help inform future movement. “It’s a juggling act-looking back and evaluating possible future scenarios simultaneously, and taking in as much information as possible to help make informed decisions down the road,” he says. Making Sense of the Data With so many different data points to consider, some investors might find it difficult to track down and synthesize information about a specific investment or a particular area of the market. Brad Sorensen and his colleagues at the Schwab Center for Financial Research spend much of their time evaluating and rating stocks and sectors in order to provide Schwab clients with objective, comprehensive research to help them make informed decisions. One result of their efforts is the collection of approximately 3,000 Schwab Equity Ratings® . Available to Schwab clients, these A-F grades can help condense and simplify large amounts of data based on a 12-month outlook. Conclusion Though no one can consistently and accurately predict what the market does next, knowing how stocks are valued can help you find opportunities. By identifying sectors or stocks that are undervalued or overvalued, you may be able to boost investment returns over the long term. Important Disclosures The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. Investing involves risk, including loss of principal. Sector investing may involve a greater degree of risk than an investment with broader diversification. Schwab Equity Ratings use a scale of A, B, C, D and F, and are assigned to approximately 3,200 U.S.-traded stocks headquartered in the United States and certain foreign nations where companies typically locate or incorporate for operational or tax reasons. Schwab’s research outlook is that A-rated stocks, on average, will strongly outperform, and F-rated stocks, on average, will strongly underperform the equities market during the next 12 months. Schwab Equity Ratings are not personal recommendations for any particular investor. Before buying, investors should consider whether the investment is suitable for themselves and their portfolio. Schwab Equity Ratings should only constitute one component in your own research to evaluate stocks and investment opportunities. From time to time, Schwab may update the Schwab Equity Ratings methodology. Schwab Equity Ratings and the general buy/hold/sell guidance are not personal recommendations for any particular investor or client and do not take into account the financial, investment or other objectives or needs of, and may not be suitable for, any particular investor or client. Investors and clients should consider Schwab Equity Ratings as only a single factor in making their investment decision while taking into account the current market environment. Schwab Industry Ratings provide Schwab’s outlook for industries based on Global Industry Classification Standard (GICS®) groupings, such as Beverages, Pharmaceuticals and Software. Schwab Industry Ratings are assigned using an A, B, C, D and F rating scale and can be particularly helpful in evaluating which industries investors may want to emphasize within a specific sector. They can also be used in conjunction with Schwab Equity Ratings to help fill in gaps in a portfolio. See Schwab.com for more information. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc. Morningstar, Inc., is not affiliated with Charles Schwab & Co., Inc. ©2015 Charles Schwab & Co., Inc. ( Member SIPC ) All rights reserved. (0214-0042)

More Pain Ahead For Basic Materials ETFs In 2016?

It’s been years since basic materials ETFs last saw their days of glory. As for the last few years, the space has been an area of concern, thanks to a surging greenback, massive crash in oil prices and hard landing fears in China. Moreover, supply glut has been a long-lasting issue for this space. Things were fragile for long in China given the protracted slowdown in the domestic manufacturing sector, credit crunch concerns and a property market slowdown. As a result, the Chinese economy has been undergoing a tumultuous phase for the last few months. To shore up the ailing economy and the turbulent market, the Chinese government took several measures; but nothing could really heal the pain. Since the Chinese economy accounts for about half of the global consumption of industrial commodities and is the second biggest purchaser of oil, a further slowdown in the Chinese economy would mean weaker demand for commodities. In any case, most developed economies are presently in a state of slowdown and thus require lesser commodities for weak demand. Also, the strength in the greenback owing to Fed policy tightening marred the broader commodity prices as most of these materials are priced in the U.S. dollar. Also, a hike in interest rates tends to boost investors’ interest in income-generating assets and thus hurts the investment demand for non-yielding commodities. So, all in all, fears of softening demand amid abundant supplies have led to a broad-based meltdown in commodities prices. Commodities at Multi-Year Lows Copper prices have already plunged to a new six-year low on Chinese economic issues. Events in China are major contributors as the country is the world’s biggest consumer of this industrial metal, making up roughly 40% of global copper demand. Thus, a prolonged manufacturing slowdown in the world’s second largest economy cast a dark cloud over the red metal. Iron ore fell to a five-and-a-half year low in December 2015 and analysts predict that the rout can deepen further as ” Chinese steel mills rebuild the inventory.” Nickel prices plummeted to a 12-year low on low demand from “the stainless steel sector , the dominant source of demand for nickel.” Most agricultural commodities are also in the red. The oil price rout is getting more and more acute lately with Brent crude having slipped to a 12-year low and WTI crude falling to a seven-year low. Analysts expect the pressure to remain in place. ETFs to Lose More in 2016 iShares U.S. Basic Materials ETF (NYSEARCA: IYM ) – Down 20% in the last one year (as of January 12, 2016) and about 9.6% year to date. The fund is the most exposed to chemicals though steel, gold and aluminum take about 10% of the fund. SPDR Materials Select Sector Fund (NYSEARCA: XLB ) – Down 16.4% in the last one year (as of January 12, 2016) and about 9.2% year to date. The fund puts 73.8% off its assets in the chemical sector followed by 9.5% of assets in the metals & mining sector, and 8.7% in containers and packaging sector. The fund is heavy on Du Pont (NYSE: DD ) (11.4%) and Dow Chemical (NYSE: DOW ) (11.2%). SPDR S&P Metals & Mining ETF (NYSEARCA: XME ) – Down 53.9% in the last one year (as of January 12, 2016) and about 15% year to date. Steel occupies almost half of the portfolio followed by 10% in aluminum, diversified metals and gold each. iShares MSCI Global Metals & Mining Producers ETF (NYSEARCA: PICK ) – Down 50.4% in the last one year (as of January 12, 2016) and about 15.8% year to date. Materials hold about the entire fund though consumer services and consumer durables take a slight portion of the ETF. The fund’s main focus is on companies like BHP Billiton (NYSE: BHP ), Rio Tinto (NYSE: RIO ) and Glencore ( OTCPK:GLNCY ). Bottom Line With the operating backdrop in 2016 expected to be no different than 2015, the basic materials sector will replay the same pattern that we saw in the recent past. At Zacks, we have most of the materials ETFs as Sell-rated at the time of writing. Original Post

Why Invest In Dividend Aristocrat ETFs Now?

There is hardly a market scenario where dividend investing fails to soothe jittery investors’ nerves. Though many thought that the bull market for dividend investing will end with the start of the Fed policy tightening and the resultant rise in bond yields, in reality, the popularity of dividend investing has shot up in recent times. This was because of the sharp rise in global growth issues, which is why equity markets are running a high risk of volatility and bond yields remained in check despite the Fed liftoff. The demand for safe havens and value investing has lit up. Investors hungry for yields are running to high-yielding options in the quest for regular current income, which can make up for capital losses. Agreed, benchmark yield-beating options will be in focus given the ongoing Fed policy tightening. But in the present volatile market, dividend aristocrats – which are more stable, mature and profitable companies consistently raising dividends or going for high payouts – may serve up investors’ objective more efficiently. Why Dividend Aristocrats Are Superior Bets Now? These dividend aristocrat companies are generally apt for value investing. Since volatility is expected to pull the string ahead, what could be a better option than superior dividend investing for capital appreciation and some smart yields? In a market crash, these dividend aristocrats stand out and even navigate through volatility. As per the latest study carried out by Reality Shares, companies that initiated or hiked their dividends have beaten those that kept their dividends same, paid no dividend at all, or cut or scrapped dividends in the 1999-2015 time frame. This can be corroborated by the gains during the above-mentioned period, as dividend initiators and growers earned 5.4% return, the highest among the dividend players. All dividend payers took the second spot with 4.29% gains, followed by 1.92% gains enjoyed by dividend distributors with the same dividends. However, no-dividend payers or dividend cutters and scrappers recorded losses of 0.8% and 5.99% respectively, as per the document. Below, we highlight four dividend aristocrat ETFs which may give a relatively stable performance in the coming months amid further Fed rate hike bets, developed market woes and China’s hard-landing fears, and the occasional global market rout. Vanguard Dividend Appreciation ETF (NYSEARCA: VIG ) VIG follows the Dividend Achievers Select Index, which is composed of common stocks of high-quality companies that have a record of increasing dividends for at least 10 years. The $18.2 billion fund is currently home to 179 securities. The ETF is heavy on Industrials (22.4%) and Consumer Goods (21.6%). With an expense ratio of 0.10%, this is one of the cheapest funds in this space. It yields 2.46% annually, and was down 6.7% in the last one year (as of January 11, 2016). VIG has a Zacks ETF Rank #2 (Buy). SPDR Dividend ETF (NYSEARCA: SDY ) This fund provides exposure to the 101 U.S. stocks that have been consistently increasing their dividend every year for at least 25 years. It follows the S&P High Yield Dividend Aristocrats Index, and has amassed $12 billion in AUM. Volume is solid, exchanging more than 765,000 shares in hand, while the expense ratio comes in at 0.35%. The product is widely diversified across components, as each security accounts for less than 2.46% of total assets. Financials is the top sector, taking up one-fourth of the portfolio, while Industrials (14.7%), Consumer Staples (13.9%), and Utilities (12%) round off the next three spots. The fund was down nearly 10.4% in the last one year (as of January 11, 2016). SDY yields 2.80% and has a Zacks ETF Rank of 3 (Hold). Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) This $2.9 billion fund tracks the Dow Jones U.S. Dividend 100 Index, which measures the performance of high dividend-yielding U.S. stocks that have a record of consistently paying dividends. The 106-stock fund charges a meager 7 bps in fees. Consumer Staples is the fund’s focus sector with about 23% exposure, followed by IT (19.3%). SCHD yields 3.13% annually (as of January 11, 2016) and lost 7.1% in the last one year. It also has a Zacks ETF Rank #3. WisdomTree U.S. Dividend Growth ETF (NASDAQ: DGRW ) This fund tracks the WisdomTree U.S. Dividend Growth Index and offers diversified exposure to U.S. dividend-paying stocks with both growth and quality characteristics. It has gathered $594.5 million in its asset base. The ETF charges 28 bps in fees per year from investors. DGRW holds 300 securities in its basket, with each holding less than 4.16% share. From a sector look, it provides double-digit allocation to Consumer Discretionary (20.11%), IT (19.48%), Industrials (19.23%), Consumer Staples (18.59%) and Healthcare (14.95%). The fund has shed 6.1% in the year-to-date time frame and has a Zacks ETF Rank of 3. Original Post