Tag Archives: investment

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

What Do Rising Rates Mean For Closed-End Funds?

It’s a misconception that rising rates make it difficult for closed-end funds to deliver competitive results By Christopher Dahlin, UIT Product Strategy and Development Specialist It’s not a stretch to characterize closed-end funds as an often misunderstood investment vehicle. Perhaps that’s because the closed-end fund universe is smaller than those of open-end mutual funds and exchange-traded funds (ETFs), or because their market price and net asset value (NAV) frequently fluctuate. Whatever the reason, closed-end funds occasionally get lumped together as one asset class, even though they invest in a wide array of securities across styles and strategies, just as open-end mutual funds and ETFs do. But the prevalent misconception that closed-end funds generally have difficulty delivering competitive returns in a rising rate environment is of particular importance in light of the Federal Reserve’s (Fed) recent rate hike and the likelihood of more to come. Rising rate fears widen discounts Some investors believe that because many closed-end funds employ financial leverage – which is typically tied to short-term interest rates – increased borrowing costs may inhibit total return-producing capabilities. The graph below illustrates this bias. Starting about the time of 2013’s “taper tantrum” – shorthand for the market’s reaction to then-Fed Chairman’s Ben Bernanke’s indication of possible tapering of its stimulus program – and leading up to the Fed’s recent decision to raise the federal funds rate, fears of the first rate increase since 2006 have led to a broad sell-off among closed-end funds, causing discounts to widen considerably. During this period, the average closed-end fund progressed from trading near NAV to approximately 10% discounts, valuations not seen since The Great Recession. Taper tantrum to rate rise: Valuations not seen since The Great Recession Source: Morningstar Traded Fund Center, Jan. 24, 2013, through Dec. 16, 2015. The CEF average discount is a daily unweighted average of the entire domestically-traded closed-end fund universe. Past performance is not a guarantee of future results. Historical perspective: Returns and rising rates What’s interesting is that, contrary to the recent investor exodus preceding the rate increase, history indicates closed-end funds are capable of producing competitive returns during periods of rising interest rates. Investors need look no further than the last Fed tightening cycle in 2004 for evidence of such closed-end fund outperformance, from both an NAV and market price perspective. As the graph below indicates, closed-end fund valuations widened considerably prior to the Fed’s first 2004 rate increase similar to today’s market. Déjà vu: Closed-end valuations widened prior to the 2004 tightening cycle Source: Morningstar Traded Fund Center, Jan. 1, 2004, through Sept. 29, 2006. The CEF average discount is a daily unweighted average of the entire domestically-traded closed-end fund universe. Past performance is not a guarantee of future results. However, entering that tightening cycle with such large discounts actually allowed closed-end fund discounts to subsequently narrow throughout much of the period and produce outperformance across various asset classes on both NAV and market price, as show in the graph below. Narrowing discounts resulted in outperformance during the previous tightening cycle Source: Morningstar Traded Funds Centre. Index returns: S&P 500 Index, BofA Merrill Lynch Municipal Master Index and BofA Merrill Lynch US Corporate Master Index. Closed-end fund returns: US general equity peers, national municipal bond peers and investment-grade corporate bond peers. Past performance is not a guarantee of future results. An investment cannot be made directly in an index. Using leverage to enhance returns While borrowing costs did increase for most closed-end funds during the Fed’s last period of increasing interest rates, many managers were able to overcome that obstacle by delivering strong investment returns, as shown above. Although monitoring borrowing costs is an important consideration in closed-end fund investing, it’s not the only variable used to determine the effectiveness of leverage. It’s important to note that leverage is a tool that generally magnifies investment returns; as long as the cost of leverage is less than the total return generated by the investments within the fund, leverage may add positively to performance. When evaluating closed-end funds, it’s important to consider both the return potential of the underlying investments as well as the current premium/discount levels relative to historical levels to determine the current valuation of the closed-end fund itself. Although financial history never repeats itself exactly, it does often rhyme. Many closed-end funds today appear to be following a pattern similar to the last time the Fed initiated a cycle of increasing interest rates. Closed-end fund discounts within many sectors are trading in excess of their historical levels. Depending on an investor’s outlook for a particular asset class, this may be an opportune time to take a closer look at closed-end funds. Important information The S&P 500® Index is an unmanaged index considered representative of the US stock market. The BofA Merrill Lynch Municipals Master Index measures total return on tax-exempt investment grade debt publicly issued by states and US territories, including price and interest income, based on the mix of these bonds in the market. The BofA Merrill Lynch US Corporate Master Index tracks the performance of US dollar-denominated, investment- grade-rated corporate debt publically issued in the US domestic market. A closed-end fund is a publicly traded investment company that raises a fixed amount of capital through an initial public offering (IPO) and is then structured, listed and traded like a stock on a stock exchange. An open-end fund is a type of mutual fund with no restriction on the amount of shares issued; it will continue to issue shares to meet investor demand and will buy back shares when investors wish to sell. Net asset value is the per-share value of open-end and closed-end funds and exchange-traded funds (ETFs). Mutual funds’ NAV is computed once a day based on the closing market prices of the securities in the fund’s portfolio’ shares of ETFs and closed-end funds trade at market value, which can be a dollar value above (trading at a premium) or below (trading at a discount) NAV. Financial leverage refers to the use of debt to acquire additional assets. Shares of closed-end funds frequently trade at a discount to their net asset value in the secondary market and the net asset value of closed-end fund shares may decrease. In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer’s ability to make payments of principal and/ or interest. Leverage created from borrowing or certain types of transactions or instruments may impair liquidity, cause positions to be liquidated at an unfavorable time, lose more than the amount invested, or increase volatility. There is no assurance a trust will achieve its investment objective. An investment in these unit investment trusts are subject to market risk, which is the possibility that the market values of securities owned by the trust will decline and that the value of trust units may therefore be less than what you paid for them. Accordingly, you can lose money investing in these trusts. The trust should be considered as part of a long-term investment strategy and you should consider your ability to pursue it by investing in successive trusts, if available. You will realize tax consequences associated with investing from one series to the next. 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NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2016 Invesco Ltd. All rights reserved. What do rising rates mean for closed-end funds? by Invesco Blog