An Introduction to Stock Trading Part 5 - Metrics

The Next Topic I am going to look at is Metrics - basically a few ways to look at a company and try and decide if they are going to be a good investment. It is worth pointing out that no metric can predict the future so they are mostly concerned with looking at the past but it is always important to do your own research so that you are happy with how you think the future is going to go. Never invest your money unless you are happy with where it is going.

Follow these links for earlier posts on Terms, Dividends, Corporate Actions and Types of Accounts

Earnings Per Share

The most basic measure of a companies performance is the earnings per share, this is simply the profit earned divided by the numbers of shares in circulation so for a company with 1,000,000 shares and £1,000,000 in profit then the EPS would be £1

Price Earnings or PE Ratio

PE Ratio is calculated as Market Price of the Share divided by the annual earnings per share (You can also predict a future PE by looking at the forecast earnings) this basically shows how much each pound of profit costs to the shareholders so for example if the above companies shares were trading at £10 per share then the company would have a PE of 10/1 The FTSE 100 average P/E is around 17 (Historically) Simplified a company with a higher P/E is considered by the market to be "Growing" where as a Lower P/E would show that the market thinks that the company has limited growth prospects.


Liability Ratio

The Liability Ratio is a measure of how well a company can survive in hard times, it is calculated by dividing Assets by Liabilities. For Example if a company has £1,000,000 of Debts and Liabilities but has £3,000,000 of Assets on it's books then it will have a Liability ratio of 3/1 and so the company will be seen as having a good viability over the short term, The acceptable Ratio is different for different industries (With perceived riskier industries needing a higher ratio) The Average ratio is between 1.5 and 3.

Return on Capital Employed (ROCE)

The ROCE is a measure of how effective a company is at utilising its capital. it is calculated as Earnings/Capital Employed so if a company has a profit of £1,000,000 for the year and has employed £500,000 then it has a ROCE of 2/1 (So it can earn £2 for every £1 it uses.)

An Introduction to Stock Trading Part 4 - Types of Accounts

Part four of the Beginners Guide will look at the different types of account that can be used to hold your shares.

Follow these links for earlier posts on Terms, Dividends and Corporate Actions

One of the main differences in the types of accounts is to do with Tax treatment and as such they will change by tax jurisdiction, Therefore the information I am listing here is related to the UK Tax area only.

The first two accounts Traditional and Nominee can be grouped together as Non-Tax Efficient accounts, neither of these accounts offer any tax relief on your savings. 

Traditional Broker Account (Paper Certificate)

Before the proliferation of the internet and the digital Revolution most shares were held physically in paper form either by yourself or by your broker.

With this type of broker account you request for your broker to make a deal they will then purchase the shares and the companies register of stockholders would be updated and a new paper certificate would be dispatched to you to show your ownership, after this point all correspondence will be directly from the company to the shareholder with the broker only being involved when you wish to sell.

Traditional Brokerage is now likely to hold the shares in CREST (The UK's security settlement system) which allows direct ownership but with the advantages of same day clearing and faster confirmation of the deals.

Nominee Account
These days most shares of small holding share owners are owned through brokers electronically in what is known as a Nominee Account. The advantages of the Nominee Account is that the shares are traded and cleared a lot sooner, as you do not hold the shares directly then you are known as the beneficial owner where as the broker is the nominee owner. Technically the Broker remains the owner of the shares so all decisions that are owed to you as the owner are passed to you through the broker rather than coming from the company directly.


Forms of tax efficient accounts include

ISA - Individual Savings Account

The Individual Savings Account (ISA) is probably the most important of tax efficient savings accounts and I have never heard any advice different to filling your ISA before thinking about using any other account. Shares saved in an ISA are free from paying Capital Gains Tax (If you are over the CGT threshold) and Income Tax (Only payable for higher rate tax payers.)

The ISA comes in two types, Cash or Stocks and Shares, each year the government sets a limit to hhow much can be invested in ISA accounts per person. The amount for 2014 is set to £11,520 of which half (£5,760) can be stored in a Cash ISA.

You can combine a Cash ISA with a Stocks and Shares ISA so you could have £5,760 in each or any proportion as long as you do not exceed the total limit or have more than 50% as cash. The other thing to remember with an ISA is that the limit is money paid in regardless of what is withdrawn so if you pay in £6,000 and then withdraw it you will be unable to repay it all in as it would be over the total ISA Limit.

An ISA is a flexible account as subject to the account providers terms and conditions there is no limit to when you can withdraw the money and it is entirely tax free.

SIPP - Self Invested Personal Pension

A second type of tax free savings account is the SIPP, The SIPP as the name suggests is essentially a pension plan that is managed by you rather than by a fund manager. As it is a pension plan the money paid in is not available for withdrawing until you are at least 55 years of age, at 55 you have the option of withdrawing up to 25% of the balance tax free as a lump sum with the option of using the remainder to purchase an annuity to provide a retirement income or to start drawing down the SIPP as an income. All income that comes from a SIPP is taxable at the usual income tax rates.

Although you pay income tax on the money withdrawn from a SIPP the main tax advantage is that the money placed in is pre-tax, so if you are a standard rate tax payer (20%) you will get £1,000 for ever £800 you put in and if you are a higher rate tax payer you can also claim a further 20% relief on your tax return.

So as an example if a higher rate tax payer wanted to invest £1,000 in a SIPP he would pay £800 to his broker who would request the additional £200 tax relief from HMRC giving him £1,000 to invest. When he fills out his self-assessment (providing that he has paid more than £200 of higher rate tax) he can claim an additional £200 of his tax liability.


SIP - Share Incentive Scheme


The SIP is a specific shares scheme operated by a company for their employees. Only share schemes that are approved by HMRC are SIPs and valid for tax relief. A SIP can include Free Shares, Partnership Shares, Matching Shares and Dividend Shares.

Free Shares: A company can give up to £3,000 a year worth of free shares per employee, The shares can be given free of tax, if the shares are removed less than 3 years after being awarded then Income Tax and NI is payable at the current market rate. If the shares are removed between 3 and 5 years of the award date then the shares are taxed at the lower of the value of when they were awarded and when they were sold. If they have been held over 5 years then there is no tax payable.

Partnership Shares: These shares are bought by the employee with pre-tax pay (Also known as salary sacrifice) There is an annual limit of £1,500 each year that can be used to purchase partnership shares. The tax implications are the same as for free shares so holding them for over 5 years will result in no tax to pay.

Matching Shares: These shares can be awarded by the company for each partnership share that is bought up to a rate of 2 matching shares for each partnership share. Matched Shares can only be awarded if the Employee remains employed by the company for three years after the award date. They will also be liable to tax if removed from the scheme before 5 years after the award date.

Dividend Share: These shares are the reinvested company dividends, like the matched shares they can not be removed from the scheme less than 3 years after the award date unless you leave the company, unlike the other shares in the SIP there is no Income Tax or NI paid on these shares regardless of how long they have been held.

An Introduction to Stock Trading Part 3 - Corporate Actions

For the third part of my Beginners Guide to the Stock Market I am going to speak about Corporate Actions.

Part 1 - A few Terms and Part 2 - Dividends can be found on these links.

 

A corporate action is an action taken by a publicly listed company that effects the share holding in some way, The most common type of Corporate Action is the Dividend as I spoke about earlier but in this section I am going to look at a few of the more common corporate actions that come up rarely but that you will see if you hold shares for any period of time - especially through a turbulent financial time.

Please note that all of these explanations are  generic and you should seek advice before making any decisions on your portfolio.

Rights Issue:

A rights issue is where a company looks to raise more capital from its shareholders and it does it buy issuing to those shareholders a "Right" to purchase more shares - normally at a reduced cost. These rights can be taken up by the shareholder in which case the %age of the company he owns is maintained, he may refuse his rights in which case the shares are sold on the market and the profit from the sale is given to the shareholder or the shareholder can sell some of the rights and use the proceeds to purchase the remainder of the shares (Called Swallowing Your tail.)

as an example if we consider a company where we hold 100 shares worth £1 each in a company. during a rights issue the company gives a rights ratio of 1:1 and a discount of 25% then their rights would be for 100 shares at 75p each. If he took the full rights then he would have 200 shares at an average cost of 88p if he sold the rights then they would be worth 25p each (Effectively the difference between the special purchase price - 75p - and the normal market value -£1) so he could sell all of his rights for £25 or "Swallow the tail" by selling 75 of the rights to purchase 25 of the new shares to give him 125 shares at an average cost of 80p but with a smaller % of the company.

Return of Value:

A return of value typically occurs when a company is able to release a lot money either through dispersal of assets, a planned for project that is no longer needed or simply to return reserves that had been built up.

The return of value could be in Cash or Shares depending in what way the company receives what it is holding. The actual return of value will normally follow the same process as a dividend payment and will normally be received the same way that you receive your dividends. If you receive shares as part of the return then there will often (but not always) be a trade facility offered to dispose of them at a reduced rate - depending on your broker and the size of the deal.

When there is a return of value to the shareholders the price of the share will normally increase by the amount to be returned when it is announced, in fact it is normally priced in before that as the market senses that something may happen, and the share price will drop by the amount of the return on the ex-div date.

Consolidation/Stock Splits:

A stock consolidation reduces the amount of shares in a company and a stock split increases them, essentially they are two sides of the same coin.

Stock Splits are done to increase the amount of shares in the market and typically take place after a share value increases rapidly, the share split is designed to make the market in the shares more liquid as it enables people to diverge part of their holdings and more buyers may be present for 10 shares at £10 than for 1 Share at £100. although a Split is often thought to encourage further price rises by making shares more trade able there is no net gain by the shareholder unless the share price continues to go up.

A consolidation goes the other way and takes  several shares and replaces them with one share of the combined cost. so if you had 10 shares at £1 each they may replace them for 1 share at £10. this is often as result of a very poor performing share so there is often a stigma to consolidating but it can also occur after corporate events for example if a company sells off a large asset it may lose half its value in which case by doing a stock consolidation they can maintain the share price.

for example, if you have 100 shares at £1 each and the company announces that you will get a return of value equal to 50p per share your shares will reduce in value by 50p to offset this the company may also complete a consolidation and therefore they will return to you 100 x 50p (£50) and at the same time complete a 2:1 consolidation so after the return of value you would have £50 and 50 shares at £1 there is no net difference to the shareholder (If there is money to be made it would be made before the action is announced)

Share Buy Back:

A buy back is an alternative to a dividend payment,The company uses its profits to purchase its own shares which it can then take out of distribution or hold for a time that it needs to reissue them.

A share buy back should return some value to shareholders as it will restrict the amount of shares available and should therefore push the share price higher, it is mostly used when the company believes that its shares are trading on a considerable discount.

An Introduction to Stock Trading Part 2 - Dividends

Following on from yesterday's guide to Stock Market today I am going to look closer at Dividends.

Dividend:

The two main ways to make money on the stock market are through trading and dividends. Trading is making money through the actual buying and selling of shares (The Buy Low Sell High philosophy) or through dividends.

Dividends are the payment paid by a company to its shareholders, it is paid as a fixed amount per share the more shares you have the more the payment. There are a few dates you need to keep in mind when thinking about divdends which are:

Dates: 

The Results Date/Declaration Date: The results date is the day that the company announces its earnings and normally with in the many pages of results is the amount of the dividend. after a publicly traded company announces a dividend it is now a liability on its books and the company legally owes the payment to the shareholders.

Ex-Dividend Date: The Ex Dividend Date is the date at which dividends will no longer be received by the new owner in the case of a sale. A share sold before the Ex-Div Date will pay the dividend to the new owner where as a share sold on the Ex-Div date will pay the dividend to the old owner. for this reason a share price will normally go up on the results date by the amount of the dividend and will go down by the rate of the dividend on the Ex-Div date.

Record Date: The Record date is the date at which all shareholders must be recorded in order to receive the Dividend payment. In most modern exchanges the registration is automatic so this date is not as important.

Payment Date: the final date in the process is the Payment Date, This is the date that you will actually receive your payment. If you hold your shares in paper form then this is the day the cheque will be mailed, if you receive your payments electronically then you should actually receive them on this date.

Dividend Ratios:

Dividends feature several key metrics that should be looked at when deciding on a dividend focused investment, these include Dividend Yield, Dividend Cover and Dividend Growth.

Dividend Yield: The Dividend Yield is the Annual Dividend as a Percentage of Share Price, Essentially this is used to calculate how good an investment one share is against the other, If a share was 100p with a yield of 3% then you would receive a payment of 3p per share. If a share was £100 with the same yield then you would receive £3 per share. So if you were investing £500 then the two investments would be identical in value despite the difference in Share Prices.

Dividend Cover: The dividend cover is the amount of times that a company could cover the dividend with profits. The average dividend cover is 2 meaning that the companies earnings per share (Company profit / number of shares) is twice the dividend. Some industries operate with a lower dividend cover than others and it is generally a reflection of the maturity of the company and the need for contingency funds. If a company has a dividend cover of less than 1 then it means that the Dividend is more than the profit made and so the dividend is being covered by reserve funds. In this case the Dividend will be unsustainable unless trading conditions change.

Dividend Growth: The dividend growth is the rate at which the dividend is grown each year, this growth is important for people who are using their dividends to live off as the dividends need to grow at a faster rate than inflation in order to provide the same (or greater) level of spending power.

Dividend Taxes:

Dividend income is taxed as income in the UK but is taxed at lower rates of 10%, 35% and 40.5% depending on if you are a Basic, Higher or Additional Rate Tax Payer. However as the money paid as dividends has already had tax paid on it as corporation tax then there is considered a 10% tax paid before the dividend is received so the amount to be paid is therefore 0% for Basic Rate (20%) tax payers, 25% for Higher Rate (40%) and 30.5% for Additional Rates (45%). Dividend Tax that is payable needs to be completed on a self assessment form. If you hold your Shares in an ISA or SIP then there are no taxes due on the dividend income.

As always I would welcome any feedback.

An Introduction to Stock Trading Part 1

As I have previously stated I am very interested in the Stock Market at the moment so I have decided to compile an introduction to the Stock Market in the hopes that it may help someone who is in the position I was in last year.

I hope someone may find it useful, if there is anything you think I should include then please let me know so I can research it.

Thanks.

The first part is just a few definitions of terms, phrases and ratios

Stock/Share

I guess the first thing to define is what is a Stock? There are a few different types of stocks but for the basis of this guide I will only look at Ordinary Shares, which are the most regularly traded. A stock is basically a part of a company, how much of the company depends on how many Stocks are in circulation. A Limited Company owned by an individual still has a Stock but there is only 1 which covers 100% of the company if there were two directors then each share would cover 50% and so on. With the larger PLC (Publicly Limited Company) the volumes of shares is massive. Lloyds Banking Group as an example have 71,368,000,000 shares in circulation so a single share gives control of 0.0000000014% of the company. When the company holds meetings and decisions need to be made then every shareholder is entitled to a vote equal to the percentage of the company owned.

Ticker (EPIC) Symbol   

The ticker symbol of a stock is the abbreviation code by which it is traded, It is called a ticker symbol as a historical throw back to when the prices were released on a giant ticker tape. The symbol comprises two elements the first one being the name of the company and the second being the exchange that it is registered on. The first part of the symbol can include letters and numbers and is usually up to 4 characters. The market identifier is added to the end of the Ticker after a "." a company can (But doesn't have to) use the same code on different exchanges.

i.e. BP PLC has the following ticker symbols.
BP.L                 London Stock Exchange
BP                    NYSE
BPE.F              Frankfurt Stock Exchange
Obviously in this situation using BP alone would not be a unique identifier. It is good to know the ticker symbol of Stocks that you are interested in as it will remove the need to search through lists (It is also useful to always add the ".L" onto the share when looking for UK shares as otherwise many websites will assume you are after US securities.


Market Capitalization

The Market Cap of a company is taken by taking the share price and multiplying it by the number of shares, in essence this is the cost to purchase the company (Assuming everyone was willing to sell) so for Lloyds Banking Group with a share price today of  83.16p the Market Cap would be 83.16p X 71.368M shares which means that Lloyds as a company are currently worth £59,349,000,000. The market Cap is the default measure of a companies worth (At least its worth according to the stock market) and is a key metric of listed companies and it is market capitalization that is used to work out the constituents of share indexes such as the FTSE 100 (The 100 largest companies on the London Stock Exchange)

Google Supporting Equality at the Sochi Olympics

 

The above was the Google Logo this morning on the day of the opening ceremony of the Sochi Olympics, with all of the coverage on Russia's appalling homophobic policies it is good that some companies are willing to make a stand for what they think is right, I think the logo itself being the rainbow flag shows their support for the LGBT community in Russia but adding the quote from the Olympic Charter will hopefully make the IOC look more carefully at their own charter when they think about where they host their tournaments.

Hopefully Fifa will put some pressure on Quatar and Russia ahead of more global showpieces being held in areas where equality is a word rather than a way of life.

Scottish Independance Makes Business Nervous

With the big vote coming up in September on Scotland's status in the UK there have been several people speaking out on the matter recently, ignoring the clearly biased views spouted by the likes of Alex Salmond (Wants to be King of Scotland) and Alistair Darling (wants to ensure Labour don't lose the seats in Westminster) a few interesting points have come out in the last few days.

Firstly Mark Carney governor of the Bank of England spoke out about what independence would mean from a technical monetary position. before Bob Dudley, CEO of BP spoke out about the uncertainty that comes from being unsure what the Union would look like at the end of the year, although he still stated that BP were going to invest £10Bn in Scotland.

Basically these neutral viewpoints are going to be the most interesting as we head through into what I think may well become a really nasty campaign full of scare tactics and accusations where assessing what Scottish independence means may become difficult.

Personally I support Scottish Independence as I am very interested in what will happen next (I would imagine that not much would change to be honest.) My only worry is that if there is a Yes vote then we will be stitched up when it comes to negotiating the settlement with Scotland taking all of the North Sea Oil Revenue and taking on none of the National Debt. But that is more my fear in the ability of our politicians to negotiate than a fear of independence itself.