Technical analysis

Today I want to look at technical analysis of precious metals and other commodities.

 

Orange picture of graph with text about technical analysis

Technical analysis of crude oil, June 21, 2017

This is a weekly chart of crude oil:

Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 1. Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

Description:

The chart has been in a pennant until a few weeks ago. Now all the resistance in the chart is gone.

 

The bullish scenario:

In this scenario prices neglect gravity and head up from here without sensing any downward pressure.

While this scenario is not impossible, I don’t consider it likely.

I would give such a scenario a probability of 1 per cent.

 

The bearish scenario:

In this scenario prices go down because there is no resistance left in the chart.

At this juncture this is the likely scenario.

I would give such a scenario a probability of 99 per cent.

 

Conclusion:

It seems likely that we are going to fill up our cars cheaply this summer.

 

Technical analysis of gold, June 19, 2017

This is a weekly chart of gold:

Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 2. Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

Description:

The chart is in a pennant, currently on its way down, and once it breaks out of the resistance or the support, the move will be violent.

The bullish scenario:

In this scenario prices head up from here and break out of the resistance that is weighing on the upside.

Its not an unlikely scenario, but I would only give it a probability of 20 per cent.

The bearish scenario:

In this scenario prices go down from here. This is the more likely scenario given how prices have moved lately.

I would give such a scenario a probability of 80 per cent.

Conclusion:

In the short-term prices are likely to continue down, but in the medium-term it looks as though they are moving up. The reason why I say this is because prices have been knocking on the upper resistance zone at least twice recently. It would surprise me if they did not succeed to go through at some point.

 

 

Technical analysis of gold, June 12, 2017

This is what a weekly chart of gold looks like:

Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 2. Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

Prices sit just at the descending trend line and depending upon where they move from here will determine their movement for a long time.

 

The bullish scenario

In this scenario prices are slowly edging their way through the descending trend line.

If the resistance is gone prices have no immediate thing stopping them from much higher.

In favor of this is the fact that we are above both the 50-week and the 100-week moving averages.

Given the lower high made in February, I’d still give such a scenario a probability of 40 per cent.

 

The bearish scenario

In this scenario prices are headed lower from here.

The arguments for lower prices are the same as above.

I would give such a scenario a probability of 60 per cent.

Technical analysis of crude oil, June 09, 2017

This is a weekly chart of crude oil:

Daily chart of the crude oil index (XOIL.X). 50-day moving average is in blue and 100-day is in turquoise. Ascending and descending straight trend line are in white.

Figure 2. Daily chart of the crude oil index (XOIL.X). 50-day moving average is in blue and 100-day is in turquoise. Ascending and descending straight trend line are in white. Chart: FreeStockCharts.com

Summary:

Prices have now come down again and are now pushing against the ascending trend in the Figure 1.

 

The bearish scenario:

I will begin with the bearish scenario. This is where prices fall down through the ascending trend line and then continue down. At this point I would give such a scenario a probability of 65 per cent.

 

The bearish/bullish scenario:

In this scenario prices first go down but then rebound once they hit the trend line below. This is not implausible and I give such a scenario a probability of 30 per cent.

 

The bullish scenario

This is where prices shoot straight up from here. Given recent trends I don’t consider it very likely and I would give it a probability of 5 per cent.

 

 

 

Technical analysis of gold, June 05, 2017

This is what a weekly chart of gold looks like:

Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 3. Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

What we are seeing is that prices are coming up towards the descending trend line.

The bullish scenario

In this scenario prices are going through the declining trend line and then continue up beyond.

Given that the 100-week moving average is slightly ascending, I would give such a scenario a probability of 70 per cent.

 

The bearish scenario

In this scenario prices are going down from here.

While a distinct possibility, I only give such a scenario a probability of 30 per cent.

 

 

Technical analysis of gold, May 29, 2017

This is what a weekly gold chart looks like:

Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 4. Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

The bullish scenario

Prices are now coming up against the declining trend line and in the bullish scenario they go through the trend line and continue up afterwards.

Because of the rising 100-week moving average I do consider this a probable scenario that I would give a probability of 30 per cent.

The bearish scenario

In the bearish scenario prices go up to the declining trend line, but then they stumble and fall.

Given the lower high in February and the potential of a head and shoulders-pattern in the chart (Figure 2), I give this a higher probability of 70 per cent.

If the Head and shoulders-scenario plays out, then we are potentially looking at prices around $1,080.

Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Potential Head and shoulders-pattern is in white

Figure 5. Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Potential Head and shoulders-pattern is in white. Chart: FreeStockCharts.com

 

 

 

Technical analysis of crude oil, May 26, 2017

This is a weekly chart of crude oil:

Daily chart of the crude oil index (XOIL.X). 50-day moving average is in blue and 100-day is in turquoise. Ascending and descending straight trend line are in white

Figure 6. Daily chart of the crude oil index (XOIL.X). 50-day moving average is in blue and 100-day is in turquoise. Ascending and descending straight trend line are in white. Chart: FreeStockCharts.com

Prices are now just between the descending and the ascending trend lines.

Where they go from here is not clear, but I would give it a slightly higher probability of going lower rather than higher (60:40).

 

 

 

 

Technical analysis of the gold bugs index, May 25, 2017

This is weekly chart of the HUI:

Weekly chart of the HUI Index from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 7. Weekly chart of the HUI Index from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

Prices are stuck between the 100-week and the 50-week moving average.

Chances are about 50:50 that they go up or down.

The bullish scenario

In the bullish scenario prices are lifted by the 100-week moving average and go higher through the descending trend line.

I would give such a scenario a probability of 40 per cent.

The bearish scenario

In the bearish scenario prices are being pressed down by the declining 50-week moving average.

Given the lower high in February I would give such a scenario a probability of 60 per cent.

Technical analysis of platinum, May 24, 2017

This is a weekly chart of platinum:

Weekly chart of platinum (XPLT) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white.

Figure 8. Weekly chart of platinum (XPLT) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

The bullish scenario

In the bullish scenario prices are going through both the 100-week and the 50-week moving average.

Because I don’t think that this is likely I give it a low probability of 20 per cent.

The bearish scenario

In this scenario prices are being pushed down by the descending 100-week moving average and then they are being pushed down through the vertical trend line.

I give this a probability of 30 per cent.

The bearish/bullish scenario

This resembles the one above with the only difference that prices are bouncing off the vertical (or slightly ascending) trend line.

I give this a probability of 50 per cent.

 

Technical analysis of silver, May 23, 2017

This is a weekly silver chart:

Weekly chart of Gold (XSLV) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white.

Figure 9. Weekly chart of silver (XSLV) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

The chart is stuck between the ascending and the descending trend lines.

Where it will go from here is anybody’s guess.

It can go up and it can go down. Nobody knows for sure.

 

Technical analysis of gold, May 22, 2017

This is what a weekly chart of gold looks like:

Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white.

Figure 9. Weekly chart of Gold (XGLD) from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

What we see in the chart is that we are now pushing up against the 50-week moving average.

Prices seem to be getting squeezed between the 100-week and 50-week moving average.

The bullish scenario

In this scenario prices go through the 50-week moving average and continue up through the descending trend line.

Because of the lower high in February I give such a scenario a low probability of 20 per cent.

 

The bullish/bearish scenario

In this scenario prices are first going up until they reach the descending trend line and after that they go down.

I give this a slightly higher probability than the one above: 40 per cent.

 

The bearish scenario

In the bearish scenario prices are simply falling down from where they currently are.

Given the current nature of the chart I give such a scenario a low probability of 10 per cent.

 

The bearish/bullish scenario

In this scenario prices are first going down and then rebounding at the ascending trend line.

If we ignore the reasons why the chart would fall in the first place, I would give such a scenario a probability of 30 per cent.

 

 

Technical analysis of Randgold Resources (ticker: GOLD), May 21, 2017

This is weekly chart of Randgold:

Weekly chart of Randgold Resources (GOLD) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white.

Figure 10. Weekly chart of Randgold Resources (GOLD) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

The bullish scenario

In the bullish scenario prices are being pushed up by the ascending 100-week moving average.

Because prices are now above the 50-week moving average it is not at all implausible.

I would give such a scenario a probability of 0 per cent.

 

The bearish scenario

In this scenario prices are being pushed down by the declining 50-week moving average.

I would give such a scenario a probability of 30 per cent.

 

Technical analysis of Wheaton Precious Metals Corp (ticker: WPM), May 20, 2017

(note: the company was formerly known as Silver Wheaton.)

This is a weekly chart of Wheaton Precious Metals Corp:

Weekly chart of Wheaton Precious Metals Corp (WPM) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Horizontal lines describing the potential Head and shoulders pattern.

Figure 1. Weekly chart of Wheaton Precious Metals Corp (WPM) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Horizontal lines describing the potential Head and shoulders pattern. Chart: FreeStockCharts.com

The bullish scenario

In this scenario prices are following the ascending trend line upwards.

In favor of this is the rising 100-week moving average, but that’s about it.

I would give such a scenario a low probability of 20 per cent.

 

The bearish scenario

There is possibly a head and shoulders pattern forming in the chart.

What this means is that the downside of the chart is the ten points that the “head” is higher than the right “shoulder”.

This means that prices may drop all the way back to ten.

I would give such a scenario a probability of 80 per cent.

 

 

Technical analysis of crude oil, May 19, 2017

This is a weekly chart of crude oil:

Daily chart of the crude oil index (XOIL.X). 50-day moving average is in blue and 100-day is in turquoise. Ascending and descending straight trend line are in white.

Figure 1. Daily chart of the crude oil index (XOIL.X). 50-day moving average is in blue and 100-day is in turquoise. Ascending and descending straight trend line are in white. Chart: FreeStockCharts.com

It is obvious from the chart that we have two opposing trends working.

Eventually one of them will win, but I do not know which.

I would however put a slightly higher probability on a bearish scenario, but it would not surprise me if the outcome instead was bullish.

 

Technical analysis of the gold bugs index, May 18, 2017

This is a chart of the gold bugs index:

Weekly chart of the HUI Index from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 1. Weekly chart of the HUI Index from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

The bullish scenario

In this scenario prices go up and through the declining 50-week moving average.

Given the nature of the chart I give this scenario a low probability of 20 per cent.

The bearish scenario

In this scenario prices are going down and continue through the ascending trend line.

Given the lower high achieved in February I give this scenario a probability of 30 per cent.

The bearish/bullish scenario

In this scenario prices first go down and then bounce up once they have hit the ascending trend line.

I give this scenario a probability of 50 per cent.

 

 

 

Technical analysis of gold, May 15, 2017

This is a weekly chart of gold:

Weekly chart of gold (XGLD) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white.

Figure 1. Weekly chart of gold (XGLD) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

The bullish scenario

In the bullish scenario prices obviously go up from here. They not only go up but through the 50-week moving average as well as the descending trend line.

Given the downward pressure exerted by the upper trend line I give such a scenario a low probability of 20 per cent.

 

The bearish scenario

In this scenario prices are going down through the 100-week moving average and continue down.

Given the lower high in February I give this scenario a high probability: 80 per cent.

 

 

Technical analysis of IAMGOLD Corp., May 14, 2017

This is a weekly chart of IAMGOLD:

Weekly chart of IAMGOLD Corp from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white

Figure 1. Weekly chart of IAMGOLD Corp from the end of 2015 until now. 50-week moving average in blue and 100-week moving average in turquoise. Ascending and descending trend lines are in white. Chart: FreeStockCharts.com

The bullish scenario

It looks as thogh prices are being lifted by the ascending trend line and that they are continuing up at least until the descending trend line.

I would currently give such a scenario a high probability of 70 per cent.

 

The bearish scenario

Of course I can also argue for a bearish outcome where prices tumble from here.

In favor of this argument is the lower high that we reached in February.

I would give such a scenario a probability of 30 per cent.

 

 

Technical analysis of Yamana Gold Inc., May 13, 2017

This is a weekly chart of Yamana:

Weekly chart of Yamana Gold Inc (AUY) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Horizontal lines describing the potential Head and shoulders pattern.

Figure 1. Weekly chart of Yamana Gold Inc (AUY) from the end of 2014 until now. 50-week moving average in blue and 100-week moving average in turquoise. Horizontal lines describing the potential Head and shoulders pattern. Chart: FreeStockCharts.com

The bearish scenario

The chart looks heavy and I prefer to write about the bearish interpretation first.

We are beginning to see a head and shoulders pattern develop in the chart.

Where that will lead us is difficult to say for sure, but the text book reading of the Head and shoulders is the following:

The High point in the head = $6

High point of right shoulder = $3.60

Difference: $6 – $3.60 = $2.40

(more…)

A company wants to buy my site for $1.6m. I’m currently making between $8k and $11k a week with it. Should I take the deal?

Is this a good deal?

Blue picture of dollar with text about the offer

You have a website that is generating a good amount of cash.

You have been approached by a company that wants to buy your site. You have been offered $1.6m for it.

Now you are asking yourself if you should sell your precious business or if you should keep it and continue running it.

Because I don’t know anything about your situation I have to make a few assumptions.

First of all I’m going to assume that the $8K to $11K is pure profit and that all else is paid for.

Then I’m going to calculate a mean of the $8K and $11K to arrive at a figure per month. This turns out to be $9,500.

Then I’m going to multiply an average of $9,500 with the number of weeks in a year:

$9,500 x 52 = $494,000

So you are roughly making $500,000 a year.

From the point of view of an analyst looking into the offer this would represent a Payback period of 3.2 years.

From an investment perspective this would be considered good. The initial investment is rapidly being paid back. This means that the deal makes sense from the buyer’s perspective.

But you are asking if it’s also a good deal for you.

I would say go for it.

The thing about being an online entrepreneur is that there’s no shortage of ideas of how to make money.

Once you have made one company work it’s easy to make another one with just a slight change of the input parameters.

Even if you are signing a deal with the company not to participate in the exact same market again, you can easily find another niche where you can thrive.

Therefore I would accept the offer.

Fundamental analysis of small-cap stocks

Fundamental analysis of Fluor Corporation (FLR), June 19, 2017

Description:

Fluor Corporation is an american engineering and construction company based in Dallas, Texas.

Valuation:

Fluor is expensive at 22.5 times trailing earnings. Calculating a P/E over an average of the past three years’ earnings it comes in marginally better at 16.8. The Price to book is 2.3 which must be considered high.

Balance sheet:

The company has a Working capital of $1.8bn which looks healthy. Its Debt to equity ratio is 1.8 which is a little bit on the high side. The Return on equity is 9% which is not associated with a growth company.

Free cash flow and dividend:

Fluor corporation last year had a Free cash flow of $470m which equates to $3.34 per share. The Freen cash flow allows the company to pay a dividend of $0.84 per share. With a yield of only 1.9% it seems that the company could do more.

Conclusion:

Fluor Corporation is a well run company with solid earnings and a good Free cash flow. However, at 22.5 times trailing earnings it is too expensive for my taste.

 

Fundamental analysis of ETAM S.A., June 12, 2017

Brown picture of styleized E with text about ETAMGROUPE

Description:

ETAM is a French apparel company that specializes in lingerie. It is a family business based in Paris, France. A bid for the shares of the company was recently put forward by the majority shareholder families at €49.30

Valuation:

Until about a week ago the stock was cheap with a trailing P/E below 10, but because a bid for the company was recently put forward the P/E is now pushing towards 20.

Balance sheet:

The company has a healthy Working capital of €37.3m, but the Debt to equity ratio is a little bit high at 1.8.

Free cash flow and dividends:

ETAM has a Free cash flow of €8.6m which equates to €1.20 per share. This allows the company to pay out a dividend of €0.70 per share which is not very good considering that the current dividend yield is only 1.4%

Conclusion:

Would I buy the stock at current prices? The answer to that question is no, but the offer of selling the stock at €49.30 is too good to refuse!

 

Fundamental analysis of Stanley Black & Decker, June 10, 2017

Yellow picture of wrench with the text StanleyBlack & Decker

Description:

Stanley Black & Decker is a Fortune 500 manufacturer of industrial tools, household hardware and provider of security products. Its headquarters are located in New Britain, Connecticut.

Valuation:

At $140, the Price to earnings ratio is 21.5 (trailing earnings) which in my opinion is expensive. The Price to the average of the past three years’ earnings is hardly better at 24.6. The Book value of the company is negative because they have a lot of intangible assets (which should be subtracted from the Equity to arrive at the Book value).

 

Balance sheet:

With Current assets of $4.8bn and Current Liabilities of $2.8bn, the company has a Working capital of $2bn which is a lot of cash in the bank. They have a Debt to equity ratio of 1.5 which is not out of the ordinary.

 

Free cash flow and dividend:

Stanley Black & Decker has a Free cash flow of $1.14bn which allows it to pay out a dividend of $2.26 per share (or a 1.6 per cent yield). The company is part of the Dividend aristocrats, which is a list of the companies that has paid out uninterrupted and rising dividends for 25 straight years.

 

Conclusion:

Stanley Black & Decker is a well run company with solid earnings and a good free cash flow. However, the current price is too high for my taste.

 

 

 

Fundamental analysis of Leggett & Platt Inc., June 2, 2017

Valuation:

Leggett & Platt seems expensive at a trailing P/E of 19.1. Over the average past three years the P/E is even worse at 27.7.

Balance sheet:

With a Working capital of $620m seems well capitalized. However the company has a Debt to equity ratio of 1.7, a figure associated with high risk.

Free cash flow and dividend:

Leggett & Platt has a Free cash flow of $430m which equates to $3 per share. Of this the company pays out a dividend of $1.12 (2.5%) which seems reasonable.

Conclusion:

Leggett & Platt is a well run company with solid earnings and good cash flow. However, at these prices I would not buy new stock.

 

 

 

 

Fundamental analysis of Actia Group (ticker: PAR-ATI), May 29, 2017

Green picture of electronic circuit and with text about Actia Group

Description:

Actia Group is an international electronics group that is situated in Toulouse, France. They have operations in both the automotive and the telecommunications sectors.

Valuation:

Actia is cheap at a trailing P/E of 8.5. The P/E over the past three years’ earnings is good at 10.6. The Price to Book value is a little bit on the high side at 1.7.

Balance sheet:

The company has a lot of debt with a Debt to equity ratio of 1.9. Otherwise the balance sheet looks good with a Working capital of €88 million.

Free cash flow and dividend:

The company has a Free cash flow of €12 million with equates to 61 euro cents per share. Out of this they pay a low dividend of 10 euro cents which equates to a yield of 1.1%. The dividend history is not the best. The company only has 3 years of consecutive history of paying out uninterrupted and increasing dividends.

Conclusion:

The company is reasonably priced at current levels, but the dividend is low due to high R&D costs. Another problem with the company is debt with a high Debt to equity ratio. I would have bought the company if they paid a better dividend. Now it’s a HOLD.

 

 

 

 

 

Fundamental analysis of Hormel Foods Corp. (ticker: HRL), May 26, 2017

White picture with text Hormel Foods

Description:

Hormel Foods produces and commercializes various meat and food products.

 

Valuation:

The company is expensive at a trailing P/E of 21.5 and considering an average of the past three years’ earnings it looks even worse at 26.3. The Book value is negative due to the high Goodwill component of the Balance sheet which consequently gives a negative Price to Book value.

 

Balance sheet:

The Current assets to Current liabilities ratio looks good at 1.9 with a Net working capital of $975 million. The biggest problem for Hormel is its debt where the Debt to equity ratio is very high at 5.0.

 

Cash flow and dividend:

The Free cash flow last year came in at $735 million which equates to $1.36 per share. The Free cash flow allows the company to pay out a dividend 58 cents (1.7%). The dividend has been uninterrupted and increasing for more than 25 years which makes the part of the Dividend aristocrats.

 

Summary:

Hormel would be a good investment if it was about half the price, but now it is too expensive for me. I would not buy new stock at this point, but if you already own it by all means : HOLD.

Fundamental analysis of Guillemot Corp. (ticker: PAR – GUI), May 22, 2017

Picture of vinyl disc and text about Guillemont Corporation

Description:

Guillemot makes hardware for DJ’s and for the gaming industry. The company is based in Brittany – France and its has a Total revenue of €64,200,000.

Valuation:

The company seems reasonably valued at a P/E of 9.2. However, its earnings history makes the current P/E ratio a bit deceptive. Its result last year was positive, but the previous four years it made a loss. Altogether Guillemot’s earnings need to be taken with a pinch of salt.

The Price to book ratio looks alright at 1.4.

 

Cash flow and dividend:

The company has a negative free cash flow and consequently it does not pay any dividend (which considering its erratic earnings history is not strange).

 

Balance sheet:

The company has a Net working capital of €21.4 m which tells us that the company can pay its bills in the short-term. The Debt to equity ratio, on the other hand, is high at 1.2. The Return on equity is a feeble 11%.

 

Conclusion:

Guillemot is an interesting company with a lot of potential. However for somebody looking for value in the small-cap space its earnings seem to be a little bit too erratic.

 

Fundamenal analysis of S&W Seed Company (ticker: SANW), May 19, 2017

Black and green picture with text about S&W Seed Company

Description:

S&W Seed Company is an agricultural company that is specializing in the breeding, growing and commercialization of alfalfa seeds.

 

Valuation:

SANW is expensive at trailing a P/E of 172. The average earnings over the past three years is looking even worse at a negative 6 cents.

Consequently the P/E ratio over the average three years is negative.

The Price to Book value is 2.9 which is very high.

The earnings are to say the least erratic over the years. Last year they 2 cents per share and the year before the company had a loss of 25 cents per share.

The Shiller earnings since 2009 are a negative 4 cents.

 

Balance sheet:

Then we come to the balance sheet and here things looks a little better.

The Working capital is a solid $16,000,000 which equates to $1.08 per share.

The company has a Debt to equity ratio of 0.9 and a Current assets to Current liabilities ratio of 1.4.

 

Free cash flow and dividend:

The company has a good Free cash flow of $4,000,000, but they do not pay out any dividend which seems reasonable given their non-existent earnings.

 

Conclusion:

S&W Seed has great potential, but it is not an investment for me at current prices.

 

Fundamental analysis of PDL Biopharma Inc. (ticker: PDLI), May 15, 2017

Green picture of medicine with text about PDL BioPharma

Description:

PDL BioPharma Inc. has two major sources of income: They generate income from royalty agreements from bigger pharmaceutical companies and they sell generically manufactured products in the United States and in Europe.

Valuation:

The stock is very cheap at a trailing P/E of 5.7 and the P/E for the average 3 preceding years is 1.6 which looks very cheap. The price to book value is 0.5 which is also very good.

Balance sheet:

The Balance Sheet looks very good working capital and low debt levels. The only thing that is wrong with the company is the decreased earnings for 2016 compared to 2015. The lower earnings continued in Q1 of 2017 which indicates structural problems.

Free cash flow and dividend:

The company’s free cash flow is a solid $100 Million which equates to $0.62 per share. Of this they were only paying out 10 cents in dividends last year but their dividend history seems a bit erratic.

Conclusion:

The company is active in a niche which is highly dependent on clinical trials and permits from the NIH which makes it tricky. But if you are like me and you are looking for cheap stocks and low valuations PDL Biopharma certainly looks cheap at these prices.

Fundamental analysis of Quarto Group Inc. (ticker: LON:QRT), May 8, 2017

Green picture of book icon with text about Quarto Group Inc.

Valuation:

Quarto Group is lossmaking so a trailing P/E value does not make sense.

However, when looking at a P/E with the average past three years’ earnings it becomes 18.4 (when taking into account last year’s loss).

The Shiller P/E over 7 years comes in at 11.7 so the company does not look overvalued.

Balance sheet:

The company has a lot of goodwill which will be subtracted from the equity in order to get to Book value.

The equity valuations are therefore not looking good.

Debt to equity is 3.6 and and Price to Book value is 19.2.

Free cash flow and dividends:

Free cash flow is good at $40 million which allows for a good dividend of 10 cents.

Quarto has a history of paying out uninterrupted and increasing dividends for more than ten years.

Summary:

If you can live with the fluctuating earnings then Quarto Group Inc. is actually not expensive.

However the debt situation of the company makes it tricky. At current prices I would call it a HOLD.

Fundamental analysis of Cummins Inc. (ticker: CMI), May 4, 2017

Figure of natural gas turbine with text about Cummins Inc.

Last week I listened to an interesting interview with the famous gold investor Martin Armstrong on Eric Townsend’s Macrovoices.

In the interview Armstrong lays out a bullish case for stocks even if he recognizes that they are already overvalued.

The reason Armstrong gives is that bond yields are so low that stocks by default look attractive.

This especially is true for well ran companies with solid earnings, low debt and good dividend yields.

This brings me to today’s stock which is Cummins Inc.

Valuation:

The stock is expensive at a P/E ratio of 19.3 and taking the average over the past three years it only becomes marginally better at a P/E of 19.0.

The Price to Book ratio is 4.2 which is exceptionally high.

Free cash flow and Dividend:

The company earns a Free cash flow of $1.4 billion which allows them to pay out a reasonable dividend of $4.00 or 2.5%.

The dividend history looks good with consistent and increasing dividend payments for more than 15 years.

Balance sheet:

The Balance sheet looks good with a Net working capital of $3.8 billion and a Current assets to Current Liabilities ratio of 1.8.

The Debt to equity ratio is 1.1 which is on the high side in my opinion, but nothing out of the extraordinary.

Summary:

Cummins Inc. to me looks overvalued at current prices. It is however a well run company with solid earnings and cash flow. Had these been normal times I would not have bought such expensive shares, but Martin Armstrong may be on to something.

 

Friday, April 28, 2017

Light blue picture of cluster of grapes with text about Dillard's

Dillard’s is traded on the New York Stock Exchange under the ticker symbol DDS.

Valuation:

Dillard’s is a well ran business with solid earnings, solid cash flow and overall performance.

The trailing P/E ratio 11.2 and the P/E over the average three years is 8.4.

Free cash flow and dividend:

Free cash flow is healthy at $412,000,000 which corresponds to $12 per share.

The dividend is also at a paltry 26 cents per share which is too low considering the Free cash flow.

Balance sheet:

But DDS’ overall financials look more than reasonable.

For instance, the ratio between Current assets and Current liabilities is 1.9, but the Debt to equity ratio is a little bit high at 1.3.

Return on equity is 10%.

Negatives are that the company is involved in buying its own stock which only favor the ones who are selling the stock.

Summary:

Dillard’s seem reasonably priced with a good Free cash flow, but with a high Debt to equity ratio.

I would consider the stock as a BUY at these prices.

 

 

Monday, April 24, 2017

Today I will look at one of the best value Faroese companies around: P/F Bakkafrost A/S.

Orange figure of fish with text about Bakkafrost

The company is traded on the Norwegian Stock Exchange under the ticker BAKKA but they report their financials in Danish kroner.

Valuation:

Bakkafrost looks cheap at a P/E ratio of 7.9, but when looking at the average of the past three years’ earnings it comes in at 10.8 which does not look that impressive.

The Price to book ratio is 3.0 which is not cheap.

Balance sheet:

The Balance sheet on the other hand looks more than OK. The company has a Debt to equity ratio of 0.5 and a Working capital to debt ratio of 1.6.

Current assets to current liabilities is very good at 7.2.

Free cash flow and dividend:

The company has a Free cash flow of 163 Million DKK which equates 3.34 DKK a share.

This does not pay for the dividend at 8.70 DKK per share, but the dividend has been steady and increasing for the past 5 years.

Summary:

Even if the stock is not really cheap at 206 DKK, I would still consider it a BUY today.

 

 

 

Thursday, April 20, 2017

Today I will take a look at one of the best run French companies: Inter Parfums SA (ticker (Paris): ITP)

Blue figure of perfume bottle with text about Inter Parfums

Description:

Inter Parfums is a cosmetics and perfume company based in Paris.

The company is very well run with solid earnings and cash flow.

Valuation:

However, for the stability you will have to pay. The trailing P/E ratio is 30.0 and the P/E ratio over the past trailing years’ is 32.6.

The Price to book value is a hefty 4.1.

Balance sheet:

The balance sheet looks very good: The company has a Working capital of €280 million and a Debt to equity ratio of 0.4 which is considered to be low risk.

The ratio between Current assets and Current liabilities is also good at 3.5.

Cash flow and dividend:

The company has a Free cash flow of €42 million which equates to €1.28 per share.

Of this they pay out a dividend of €0.50 which amounts to a yield of 1.7% – a reflection of the high price.

Summary:

In summary I would not buy new stock at these prices. However, if you already own it I would hold on to the stock and keeping on reinvesting the dividend.

 

Monday, March 20, 2017

Today I would like to look at fundamental analysis of The Cato Corporation (ticker: CATO).

a32e38

Valuation

The company is an extremely well run apparel business based in North Carolina.

The trailing P/E value is 9.0 and if you look at the preceding three years’ earnings the P/E comes in at 10.1.

The Price to Book is a healthy 1.5.

Balance sheet

The company has a healthy looking Balance sheet with a Working capital of $280 million and Net working capital of $242 million.

The Debt to Equity ratio is 0.56 which is considered as low risk.

Cash flow and dividend

The Free cash flow is $67 million and the company pays out a dividend of $1.20 per share.

The company only has three years’ history of paying out uninterrupted and increasing dividends, but this is misleading because the dividends have been paid for more than 15 years.

The current dividend yield is 5.5% which is good.

My recommendation:

At these prices The Cato Corporation is a BUY.

 

 

Monday, March 13, 2017

Today I would like to look at fundamental analysis of one the best ran British small-cap stocks, Treatt Plc.

Blue picture of perfume icon with text about Treatt Plc.

Valuation

As always I prefer first to look at the valuation numbers and here it becomes clear that the stock is expensive.

You have to pay a hefty 28.8 times the trailing earnings for the stock.

When you look at the average three preceding years, the stock is even more expensive at 32.7 times trailing earnings.

Already here I would hesitate, but it gets worse. At these market prices, you are paying 5.2 times Book Value which obviously is not cheap.

Balance Sheet

The Balance Sheet looks far better. The Debt to Equity ratio is 0.9 and the Working Capital to Debt is 1.1.

The ratio between Current Assets and Current Liabilities is 3.3 which is very good.

Treatt Plc. has a Net Working Capital of £21,000,000 which equates to about 40p per share.

Dividends

The dividend history looks good with more than 15 years of non-interrupted and increasing dividends.

The current dividend yield is only 1.3 percent which obviously is a reflection of the high price.

Conclusion:

If you already own Treatt Plc. by all means keep the stock, but if you do not I wouldn’t buy it at these prices.

The Balance Sheet looks very good, but I would not buy the assets at this price.

The company has a good dividend history, but the feeble yield is a reflection of the price.

 

Thursday, February 23, 2017

Blue picture with brown car icon with text about Tesla Motors.

The reason for this is that I’ve recently been watching a Youtube channel called Now You Know that show a lot of news about Tesla Motors.

So I thought that I should look into the hype and see for myself if there was anything to it.

What I did was that I went to Tesla’s website and I downloaded their financial reports.

The numbers are shocking.

Tesla has been in business for almost ten years and in none of those they have made any money.

Granted, the loss last year was less than the year before, but still the second largest loss out of these ten years.

Looking at the balance sheet it’s very much the same story.

Its total debt is a staggering 16.8 billion dollars and the free cash flow is a negative 1.4 billion.

No wonder that the stock is losing more than 5 percent as I write this.

Who in their right mind would want to invest in something like that?

It’s clear that if you buy Tesla stock you hope that the earnings will materialize in the future.

At $259 those hopes are very expensive.

Elon Musk may be an excellent visionary, but his abilities as a CEO of Tesla Motors are not as good.

If you would like to learn more about fundamental analysis you can do that here.

How to use Microsoft Excel in finance – Part 3

This time we will look a bit more in depth on how to use Microsoft Excel for financial calculations.

Green Excel icon with text about using Microsoft Excel in finance

What we will look at today is Financial statements and how to use them in order to understand the financial health of a company.

In particular we will look at:

  • Financial statements
    • Balance sheet
    • Income statement
  • The basic difference between accounting (or book) value and market value.
  • The difference between accounting income and cash flow.
  • How to determine a firm’s cash flow from its financial statements.
    • Calculate cash flow.
  • The difference between average and marginal tax rates.
    • Calculate taxes

Finance not accounting

The first thing to grasp is that we will look at the numbers and look at them through the eyes of people in finance.

They use the numbers differently than the people in accounting and we will show you how.

Balance sheet

In the last article we talked about this formula:

Assets = Liabilities + Equity

Everyone in finance is using this equation and not just in finance but also in accounting.

What the Balance sheet does is that it reflects the equation.

The Balance sheet is a snapshot of the Firm’s account balances at the last day of the reporting period.

Hypothetical Balance Sheet of ABC Corporation (Current assets, Non-current assets and Total assets).

Figure 1. Hypothetical Balance Sheet of ABC Corporation (Current assets, Non-current assets and Total assets).

Assets

The assets are divided into Current assets and Non-current assets where the Current portion is assets that can be turned into cash within 12 months.

Then per definition Cash is a Current asset. Then we Accounts receivable which is accounts that will be cash soon. Inventory is another Current asset. The whole point of inventory is so that you can sell it and get cash.

The Current assets are important not only in finance, but also in accounting, auditing and banking. It’s very important to see a business’ Current assets, because if they don’t have very many current assets perhaps they cannot pay their bills.

The Non-current portion are fixed assets that cannot be easily transformed into cash. These are your buildings, your trucks or patents or the long-term assets that actually define your business.

This is what you’ve invested in because you think you can make a profit from this.

In a financial statement you will see different periods. That is because you want to compare one year’s numbers to another.

 

Liabilities

We will also talk about the other side of the equation, which are the liabilities. These are the funds that the company have at its disposal.

The company either goes out and get debt (current), it borrows money long-term (bonds) or it issues equity to get its funds which means the cash it is going to use to buy its assets.

Current liabilities are liabilities that need to be reimbursed within a year – much like the current assets which are assets that can be converted into cash within a year.

Current liabilities are the bills the company need to pay within one year.

As you can see, within the current liabilities there are two items Accounts payable and Notes payable.

Accounts payable is when the company goes out and buys products that it has to pay for. Notes payable is when the company borrows money that it has to reimburse within a year.

The combined current liabilities and non-current liabilities represent debt on the balance sheet.

Hypothetical Balance Sheet of ABC Corporation (Current liabilities, Non-current liabilities, Total liabilities and Shareholders' equity).

Figure 2. Hypothetical Balance Sheet of ABC Corporation (Current liabilities, Non-current liabilities, Total liabilities and Shareholders’ equity).

Shareholders’ equity

In cell A19 you can see that we’ve written Common stock and paid-in surplus. What that means is that if the company issues common stock and they are being priced at $22 but were supposed only to be worth $20, the paid-in surplus is the $2 that the stockholders pay in order to own the company.

Retained earnings belong to the shareholders and they are to be paid back to the shareholders in the form of dividends, but sometimes they are not.

If they are not paid out to the shareholders they can be used within the company in the form of investment.

The way to account for such a situation is to label the item Retained earnings.

Adding it all up

Finally we add it all up. First we calculate total liabilities which is the sum between current and non-current liabilities.

Then we calculate total liabilities plus shareholders’ equity which is just what it sounds like.

Why is it called the Balance sheet?

That’s because there’s an equal sign in the formula Asset = Liabilities + Equity which means that the two sides have to balance each other.

So what I do in cell B24 (Figure 2) is that I add the total assets from Figure 1 in cell B18 and in cell C24 (Figure 2) I add the Total liabilities and Shareholders’ equity from cell B22:

Comparison between Total assets for 2016 (B24) and Total liabilities and Shareholders' equity for 2016 (C24).

Figure 3. Comparison between Total assets for 2016 (B24) and Total liabilities and Shareholders’ equity for 2016 (C24).

The result that we get in D24 is then TRUE.

 

Working capital

Remember that Current assets are assets that the firm easily can convert into cash and that the Current liabilities are the bills that the company needs to pay within 12 months.

If your current liabilities are greater than your current assets it means you’re in trouble and you need to find cash somehow.

The Net working capital is the term that is used and it is defined as Current assets – Current liabilities.

The Net working capital is defined as the difference between the Current assets and the Current liabilities.

Figure 4. The Net working capital is defined as the difference between the Current assets and the Current liabilities.

The Net working capital is the short-term capital that the firm has to work with.

We will use the Net working capital when we do our cash flow calculations and we will also use it in the next chapter when we do analysis of financial statements.

In accounting you will see that the term Net working capital is used but in finance the term Capital is used more broadly for all assets.

If we now have our Current assets and Current liabilities on different sheets like this:

Screenshot of Microsoft Excel showing Assets, Liabilities and Working capital on different sheets.

Figure 5. Screenshot of Microsoft Excel showing Assets, Liabilities and Working capital on different sheets.

If we now want to calculate the Net working capital we do it like this:

In the sheet Working capital we type an equal sign in cell D16.

Screenshot of Microsoft Excel showing how to calculate a Net working capital: Step 1.

Figure 6.Screenshot of Microsoft Excel showing how to calculate a Net working capital: Step 1.

We then click on the sheet Assets in Figure 5. and we click on Current assets (cell B13):

Screenshot of Excel showing how to activate cell B13 in the sheet called Assets.

Figure 7. Screenshot of Excel showing how to calculate a Net working capital: Step 2.

If we look in the formula bar in Figure 7 we see that we have now activated cell B13 in the sheet called Assets. The exclamation sign means that we are using a different sheet for our data.

We then type a “-“-sign (1) and click on the “liabilities”-sheet (2) in Figure 5:

Then we click in cell B16 and hit Enter and we are immediately brought back to the Working capital sheet.

Screenshot of Microsoft Excel showing how to calculate the Net working capital from different working sheets in the same Excel document.

Figure 8. Screenshot of Microsoft Excel showing how to calculate the Net working capital from different working sheets in the same Excel document.

What’s important to remember here is not to click on Working capital sheet but rather hit Enter (if you don’t hit Enter your formula will be ruined).

If we then go back to the Working capital sheet and hit the F2 key, this will appear:

Screenshot of Microsoft Excel showing how to calculate the Net working capital in cell D16.

Figure 9. Screenshot of Microsoft Excel showing how to calculate the Net working capital in cell D16.

Of course, different businesses have different values for their Net working capital, but in general, the number should be positive.

Liquidity

We will then turn our attention to Liquidity:

Different concepts of liquidity and how it can be used.

Figure 10. Different concepts of liquidity and how it can be used.

Liquidity is important because if you run out of it you’re in trouble.

If your working capital is getting too small then maybe you have to sell assets to get cash for the company.

Liquidity is defined as:

How quickly an asset can be converted into cash.

Furthermore, liquidity has two dimensions:

  1. Ease of conversion into cash.
  2. Loss of value because you have to sell your asset quickly.

There are highly liquid assets which can be sold quickly without loss of value. (This can be inventory or a short-term investment).

How liquid is cash? That is the most liquid.

How liquid is accounts receivable? You can quite easily convert accounts receivable into cash. In fact you can sell those assets to bank and get cash in return.

The we have illiquid assets which are assets that cannot be sold quickly without significant price reduction. Examples of this are machinery and buildings.

You can almost sell anything if you reduce the price enough.

On the Balance sheet the items are usually listed in decreasing liquidity so that the most liquid assets come first.

Another aspect of liquidity is that businesses that have it can go out and get a loan easily.

A firm needs a positive working capital in order to pay its bills, but there is another aspect to it:

The reason why a lot of companies are keeping a lot of cash on their balance sheets is so that they can go out and buy other businesses quickly.

The last point is that you probably don’t want to have too much cash on your balance sheet because it doesn’t earn any return.

Building a balance sheet

We will then turn our attention to building a balance sheet:

Screenshot of Microsoft Excel showing how to build a balance sheet.

Figure 11. Screenshot of Microsoft Excel showing how to build a balance sheet.

The first thing that we want to look at is assets. What I do is that I type en equal sign in cell B10 and then I write SUM( and I highlight cells B7 and B8:

Screenshot of Microsoft Excel showing how to calculate Total assets by adding Current assets and Fixed assets.

Figure 12. Screenshot of Microsoft Excel showing how to calculate Total assets by adding Current assets and Fixed assets.

Then we do the same thing for the liabilities in cell E7 and E8:

Screenshot of Microsoft Excel showing how to calculate Total liabilities by adding Current liabilities and Long-term debt.

Figure 13. Screenshot of Microsoft Excel showing how to calculate Total liabilities by adding Current liabilities and Long-term debt.

The result in E10 will of course be $550.

How are we then going to calculate the equity? If you remember the fundamental accounting equation:

Assets = Liabilities + Equity

In other words:

Equity = Assets – Liabilities

So what we do is that we take the assets and we subtract the liabilities:

Screenshot of Microsoft Excel showing how to calculate Shareholders' equity by subtracting Total liabilities from Total assets

Figure 14. Screenshot of Microsoft Excel showing how to calculate Shareholders’ equity by subtracting Total liabilities from Total assets.

Then finally we can check that liabilities and equity equal assets, like so:

Screenshot of Microsoft Excel showing how to calculate Total liabilities and Shareholders' equity by adding cells E10 and E11 together

Figure 15. Screenshot of Microsoft Excel showing how to calculate Total liabilities and Shareholders’ equity by adding cells E10 and E11 together.

And the result in cell E12 is of course $1650.

Debt vs. equity

In finance we have Assets which are the use of the funds and on the other side of the equation we have Debt and Equity. Debt and Equity represent the source of funds:

Fundamental accounting equation where the Assets represent the use of funds and Debt and Equity the source of funds

Figure 16. Fundamental accounting equation where the Assets represent the use of funds and Debt and Equity the source of funds.

If we look at the Source of funds we will see that there are two different items: Debt and Equity. What is the difference between the two?

The debt is a Fixed claim and is something that you must pay back to the lender at some point in the future + interest.

The Equity on the other hand is Residual claim which means that you as a company does not have to pay the holder back

If I go out and buy a stock of ABC Corp. in the stock market for $50, the company does not have to pay me back if the stock loses value.

If the company goes bankrupt and there isn’t enough money around to pay off the creditors I get nothing. Residual means “left over”.

Then we have dividends which are only paid out once there is something left over.

Why then would anybody like to do equity if it’s always residual?

It’s because of the upside. If you invest in a well run business with equity that is steadily growing then you can make a lot of money.

Interest expenses (cash out) are tax deductible. This means that when you are paying your taxes you will pay a little bit less if you have interest payments.

Let’s say that you are paying $2500 in interest then if you deduct the interest payments you will less than that (let’s say $2300).

On the other hand dividends (cash out) are not tax deductible which means that there is a slight advantage of using debt.

The creditors are also paid first during bankruptcy while if you have equity you will get whatever is left over.

Debt

We will now turn our attention to debt:

Description of the expressions "Capital structure" and "Financial leverage"

Figure 17. Description of the expressions “Capital structure” and “Financial leverage”.

The question of whether to use debt or equity to raise funds is called Capital structure.

The term Financial leverage is used when the firm has debt. If you are using debt wisely you can reap the benefits of having your debt tax deductible and put the capital to productive use.

The more debt you have, the higher your leverage.

Leverage can magnify both gains and losses.

Market value vs. Book value

This will be the last topic that we will cover about the Balance sheet:

Description of the Market value and the Book value of an asset.

Figure 18. Description of the Market value and the Book value of an asset.

Market value

The Market value is the amount that you would get if you sold your equity stake.

For financial assets like stocks and debt you can go out and see what the value is every day.

But for a lot of equity this is not really possible so we need to estimate the market value.

Otherwise you do not know for sure until you sell your asset.

Book value

For fixed assets like machines and trucks finding a market value becomes much more difficult.

That is why accountants have invented the Book Value.

When I buy the business outright, the machines, the buildings and the inventory, that receipt is telling me what it is and will be the sum that I’m going to record.

That is also called the Historical cost principle and it is required by the Generally Accepted Accounting Principles (GAAP).

Then the Book value of the company often does not take into account the company’s most valuable assets such as:

  • Talented employees and managers
  • Customer lists
  • Reputation

These are all intangible assets, but it can be tangible assets also where the value of the assets can change radically from the price that you paid.

The Market value of an asset is almost always different from the Book value.

The goal of the financial management is to maximize the market value of the stock. At least in theory this is a good thing.

That means that the financial manager is more interested in the market value than he or she is of the book value.

We are given these numbers so we don’t have to research them:

Screenshot of Microsoft Excel showing Book value vs. Market value for a number of Balance sheet items.

Figure 19.Screenshot of Microsoft Excel showing Book value vs. Market value for a number of Balance sheet items.

Now we will calculate the Book value of the assets and we begin by adding cell B5 to the Book value in cell B16:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Book value of the New working capital to cell B16.

Figure 20. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Book value of the New working capital to cell B16.

We then add the Book value of the Fixed assets to cell B17:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Book value of the Fixed assets to cell B17

Figure 21. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Book value of the Fixed assets to cell B17.

Then we do the same thing for the Market value. We begin by adding the Net working capital to cell C16:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Market value of the Net Working Capital to cell C16

Figure 22. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Market value of the Net Working Capital to cell C16.

We then continue the Market value of the Fixed assets (cell B4):

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Market value of the Fixed Assets to cell C17.

Figure 23. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are adding the Market value of the Fixed Assets to cell C17.

Finally we highlight cells B18 and C18 and use the keyboard shortcut Alt  + =.

What that does is that it calculates an auto sum of the numbers above it:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are using the autosum option (Alt + =) in cells B18 and B19.

Figure 24. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are using the auto sum option (Alt + =) in cells B18 and B19.

We can then see that we have different numbers for Book and Market Value.

Finally we do the same thing for liabilities.

First we assume that the Book and Market value for the Long-term debt is the same:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are using the Long-term debt from cell B7 in B25 and C25.

Figure 25. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of different assets. Here we are using the Long-term debt from cell B7 in B25 and C25.

So what is then Shareholders’ equity?

Remember the fundamental accounting equation in Figure 16:

Assets = Debt + Equity

That means if we fill in Total assets from cells B19 and C19 into B27 and C27:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of Shareholders' equity and Total liabilities. Here we are using Total assets from cells B18 and C18 for Total liabilities and Shareholders' equity in cells B27 and C27.

Figure 26. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of Shareholders’ equity and Total liabilities. Here we are using Total assets from cells B18 and C18 for Total liabilities and Shareholders’ equity in cells B27 and C27.

we can then calculate Shareholders’ equity by subtraction:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of Shareholders equity and Total liabilities. Here we are calculating the Shareholders' equity in cell B26 by subtracting B25 from B27.

Figure 27. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of Shareholders equity and Total liabilities. Here we are calculating the Shareholders’ equity in cell B26 by subtracting B25 from B27.

Then we do the same thing for the Market value in cell C26.

The final result is like this:

Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of Shareholders' equity and Total liabilities. Here we are showing the final result.

Figure 28. Screenshot of Microsoft Excel where we are calculating the Book value and the Market value of Shareholders’ equity and Total liabilities. Here we are showing the final result.

Income statement

In this section we will talk about the Income statement.

The Income statement is different from the Balance sheet in that it shows revenues, expenses and net income for the whole period.

On the other hand, what the Balance sheet showed us was valid just for a particular day.

The first thing that we are going to look at is the Revenue:

 Picture showing Total revenue, Total sales and Net sales.

Figure 29. Picture showing Total revenue, Total sales and Net sales.

Total Revenue is the accounting term used for the Total sales of the business during the period.

Then we have Net sales which is the Amount earned by the business from delivering products or services.

You get this from taking the Total revenue and then subtracting any expenses.

Another thing that is important to recognize is that the company cannot record revenue before the product is delivered to the customer.

In accounting that is called accrual accounting.

The definition of accrual accounting is this:

Generally Accepted Accounting Principles (GAAP) definition of Accrual.

Figure 30. Generally Accepted Accounting Principles (GAAP) definition of Accrual.

As you can see there is both an Expense and Revenue meaning of the word.

If the business receives a bill and it isn’t due until 30 days later, they have to record the expense at the earlier date.

This is then an example of a hypothetical Income statement:

As you can see the statement is valid for the whole period ending on December 31, 2016.

For publicly traded stocks the reporting periods are either annual or by quarter.

In Figure 31 you will find a made up Income statement:

Screenshot of Microsoft Excel showing a hypothetical Income statement.

Figure 31. Screenshot of Microsoft Excel showing a hypothetical Income statement.

An Income statement is profit or loss for the whole period ( in this case the period is a whole year.)

We have our Total revenue and Cost of goods sold.

If you sell a widget for $100 and you paid $50 for it, you will record $100 as revenue and $50 for cost of goods sold.

If you look in cell C6 you will find an item called Depreciation and this is where accrual accounting comes in.

This is where the cash may be spent at at a different period from where it is received. We will look into when to book an expense like that.

It could come as cash, or it could come later as accounts receivables as we saw in the balance sheet.

Then we have Earnings before interest and tax which we get by subtracting Cost of goods sold and Depreciation from the Total revenue.

We calculate this by adding a formula. We first take Total revenue in cell C4 and subtract the sum between the Cost of goods sold in cell C5 and Depreciation in cell C6:

Screenshot of Microsoft Excel showing how to calculate Earnings before interest and tax by subtracting the sum of C5 (Cost of goods sold (COGS)) and C6 (Depreciation) from C4 (Total revenue).

Figure 32. Screenshot of Microsoft Excel showing how to calculate Earnings before interest and tax by subtracting the sum of C5 (Cost of goods sold (COGS)) and C6 (Depreciation) from C4 (Total revenue).

The result in cell C7 is then of course $1,928,000. We then do the same thing when we calculate the Taxable income by subtracting Interest paid (C8) from Earnings before interest and tax (C7):

Screenshot of Microsoft Excel showing how to calculate Taxable income by subtracting Interest paid (C8) from Earnings before interest and tax (C7)

Figure 33. Screenshot of Microsoft Excel showing how to calculate Taxable income by subtracting Interest paid (C8) from Earnings before interest and tax (C7).

The result in cell C9 is of course $1,856,000. Finally we are doing the same thing when we are calculating the Net income in cell C11 by subtracting taxes in cell C10 from Taxable income in cell C10:

Screenshot of Microsoft Excel showing how to calculate Net income by subtracting Taxes (C10) from Taxable income (C9).

Figure 34. Screenshot of Microsoft Excel showing how to calculate Net income by subtracting Taxes (C10) from Taxable income (C9).

The final Net income in cell C11 is then $1,536,00. The Net income (or the Earnings) can go in one of two places. Because technically they belong to the shareholders they can either be paid out in dividends or they can be plowed back into the business to buy more assets.

Generally if the company keeps a lot of retained earnings, it’s because they have good ideas of to make the company grow.

If we go back to the Balance sheet (Figure 8) and take a look at the item that is called Retained earnings, we now understand where that item comes from.

So in order to calculate how much money ABC Corp is keeping to plow back into the company we need to take the Dividend (cell C13) and subtract from the Net income (cell C11):

Screenshot of Microsoft Excel showing how to calculate Retained earnings (cell C14) by subtracting Dividends (cell C13) from Net income (cell C11).

Figure 35. Screenshot of Microsoft Excel showing how to calculate Retained earnings (cell C14) by subtracting Dividends (cell C13) from Net income (cell C11).

We will also consider the total number of shares outstanding. This means that at this particular date, the 31 December 2016, there were 210,000,000 shares outstanding.

Then we can calculate Earnings per share by dividing Net income (cell C11) x 1000 (because our numbers are divided by 1000 to begin with) by Shares outstanding (cell C15).

The formula looks like this:

Screenshot of Microsoft Excel showing how to calculate Earnings per share (cell C16) by dividing Net income (cell C11) times 1000 and the total number of shares outstanding (cell C15).

Figure 36. Screenshot of Microsoft Excel showing how to calculate Earnings per share (cell C16) by dividing Net income (cell C11) times 1000 and the total number of shares outstanding (cell C15).

The result in cell C16 will then be $7.31.

After that we continue with Dividend per share where we divide the Total dividend paid out in cell C13 (x 1000) with the total number of shares outstanding (cell C15):

Screenshot of Microsoft Excel showing how to calculate Dividend per share (cell C17) by dividing Dividends (cell C13) times 1000 and the total number of shares outstanding (cell C15).

Figure 37. Screenshot of Microsoft Excel showing how to calculate Dividend per share (cell C17) by dividing Dividends (cell C13) times 1000 and the total number of shares outstanding (cell C15).

The result in cell C17 will then be $0.31 which means that in this case the company keeps a lot of the earnings.

Depreciation

Then we come into the subject of depreciation:

Green picture with text Depreciation is a non-cash expense that shows up on the income statement

Figure 38. Explanation of the word Depreciation: Depreciation is a non-cash expense that shows up on the income statement.

In the following example we are using trucks for FedEx for $10 million with a Salvage value of 500,000 and an estimated time in use of 7 years:

The salvage value is what you would get out of your investment in a fire sale:

Screenshot of Microsoft Excel showing Linear depreciation of a $10,000,000 investment, $500,00 slavage value and 7 years of use.

Figure 39. Screenshot of Microsoft Excel showing Linear depreciation of a $10,000,000 investment, $500,00 salvage value and 7 years of use.

What this means is that if the cash goes out the first year, but that the Depreciation event is accounted for every year.

That means that there is no cash associated with it because it all went out the first year.

To give you an example of what I mean we first need to discuss the Matching principle:

Definition of the Matching principle in accounting.

Figure 40. Definition of the Matching principle in accounting.

This is part of the concept of accrual accounting that we discussed earlier in this chapter. What it means is basically that we need to add revenue and expenses in the right period so that they finally add up.

If we then look at Figure 39 again we see that we have a linear depreciation for our purchase of the assets over 7 years. What that means is that we assume that the trucks are going to last for 7 years.

But if we have the trucks they are going to generate revenue during that whole period and this we have to account for.

We do thisby matching the revenue that we are going to get from the trucks with the depreciation.

If we put this information into Excel it will look like this:

Screenshot of Microsoft Excel showing how to account for depreciation to match the related revenue for the same period.

Figure 41. Screenshot of Microsoft Excel showing how to account for depreciation to match the related revenue for the same period.

This is then the proper way of accounting for depreciation.

Another example of depreciation comes when we calculate Net capital spending or NCS:

Screenshot of Microsoft Excel showing how to calculate a Net capital spending or NCS.

Figure 42. Screenshot of Microsoft Excel showing how to calculate a Net capital spending or NCS.

What we are going to do is to calculate a Net cash flow from our accounting numbers.

The first thing that we need to look at is the begin number. The begin number we find in the Balance sheet item of Net fixed assets of the 31 December 2016 (cell B8).

Then we need to find the end number which is the Net fixed assets on the 31 December 2017 (cell B9).

That means that we have more cash at the end of the period than in the beginning (which is a good thing).

Then we need to look at the depreciation and because these items have already taken into account the depreciation we need to add it back.

The calculation therefore becomes B9 – B8 + B10. In Excel it looks like this:

Screenshot of Microsoft Excel showing the formula for calculating Net capital spending in cell B12.

Figure 43 Screenshot of Microsoft Excel showing the formula for calculating Net capital spending in cell B12.

The result in cell B12 is then of course $265,000.

Cash flow from accounting information

We previously discussed the concept of accrual accounting.

There is a fundamental problem with it and that is that it doesn’t consider cash flow.

That is what financial managers are interested in, cash.

We therefore have to take the financial numbers of the balance sheet and the income statement and convert them into cash:

Screenshot of Microsoft Excel showing a hypothetical balance sheet from which we are going to calculate cash flow.

Figure 44 Screenshot of Microsoft Excel showing a hypothetical balance sheet from which we are going to calculate cash flow.

On the balance sheet accrual accounting is for instance affecting Net fixed assets. Similarly, on the Income statement, Sales are recorded when they are earned and expenses are recorded when they are paid out:

Screenshot of Microsoft Excel showing a hypothetical Income statement from which we are going to calculate cash flow.

Figure 45. Screenshot of Microsoft Excel showing a hypothetical Income statement from which we are going to calculate cash flow.

The next figure is again the fundamental accounting equation:

The fundamental accounting equation where Assets equal Debt plus Equity.

Figure 46. The fundamental accounting equation where Assets equal Debt plus Equity.

In finance we think of the equation like this:

When FedEx buys trucks or Coca-Cola buys buildings they are acquiring assets which in other words is use of cash or funds. The reason why they buy these assets is because they think that they are going to make a profit from them.

Where are we then going to get the cash from? The cash is coming from either Debt or Equity which are the source of funds.

This equation, where we have Use of cash and Source of cash, will be our starting point when we calculate cash flow.

So the first question to answer is “What is cash flow?”

Figure explaining the concept of Cash flow.

Figure 47. Figure explaining the concept of Cash flow.

In finance people care about cash in and cash out.

Cash flow is not the same thing as Net earnings.

We will therefore have to derive cash flow information from the Balance sheet and the Income statement.

We will look at how cash is generated from utilizing assets and how it’s paid to those that finance the purchase.

Figure explaining how Cash flow from assets equals Cash flow to creditors and Cash flow to stockholders.

Figure 47. Figure explaining how Cash flow from assets equals Cash flow to creditors and Cash flow to stockholders.

What this means is that Cash flow from assets can either go to the Bondholders or the Stockholders.

In the next figure all the calculations we are going to do are summarized:

Summary of all the Cash flows that we are going to calculate.

Figure 48. Summary of all the Cash flows that we are going to calculate.

If we begin with the second box we see that it says Cash flow from assets and the way to calculate it is by taking the Operational cash flow and subtracting Net capital spending and Changes in net working capital.

In order to calculate the Operational cash flow we need to take the EBIT (Earnings Before Interest and Taxes) and add back the Depreciation minus Taxes.

To calculate the Net capital spending we need to take the end value of the Net fixed assets then subtract the value of the Net fixed assets at the beginning of the period and finally add back the Depreciation.

 

This article is part of a series. You can read Part 1 here and Part 2 here. This article is highly influenced by the excellent work of Michael Girvin (Excelisfun) on Youtube.

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What do you buy when you buy shares in a publicly traded company?

Today I would like to dive into the question of what you are actually buying when you buy shares in a publicly traded company.

Green picture of rising stock index with text about buying shares

Equity

If you are anything like me you’ve been thinking: “What’s the point of buying shares in the first place? Why would anybody want to do that?”

So why on earth would you want to buy shares in a publicly traded company?

Is it solely because the company pays a dividend or is there any other reason why you would want to invest your hard earned cash into something so intangible as a share?

In order to answer the question we first need to understand the capital structure of a company.

As always we come back to the fundamental accounting equation which looks like this:

The Fundamental Accounting Equation where Assets equal Liabilities plus Equity.

Figure 1. The Fundamental Accounting Equation where Assets equal Liabilities plus Equity.

What this means is that when you have a publicly traded company you want your assets to be worth more than your debt so that the Equity portion is positive.

When the company is selling stock it is the Equity portion of the company divided by the number of shares outstanding that it is selling.

As always we can use Microsoft Excel to illustrate what we mean.

Let’s say that our company has a $1,000,000 in assets and $750,000 in liabilities. How much equity does the company have?

Screenshot of Microsoft Excel showing how to calculate the Equity portion by subtracting Liabilities (cell B2) from Assets (cell B1).

Figure 2. Screenshot of Microsoft Excel showing how to calculate the Equity portion by subtracting Liabilities (cell B2) from Assets (cell B1).

Then we can calculate how much Equity (or Book value) the company has per share by simply dividing Equity (cell B3) with number of shares (cell B4):

Screenshot of Microsoft Excel showing how to calculate the Equity per share by divideing Equity (B3) with Number of shares (B4).

Figure 3. Screenshot of Microsoft Excel showing how to calculate the Equity per share by divideing Equity (B3) with Number of shares (B4).

The result in cell B5 is then of course $22.73. If the company has no Intangible assets the Book value is equal to the Equity.

Earnings

One consequence of buying shares of the Equity portion of the company is that the profits belong to the shareholders.

They do so since the Earnings are not part of the Liabilities (obviously), but part of the Equity portion of the company.

Negative equity

What happens then if the company has negative equity?

It is obviously a red flag and the analyst needs to look deeper into the financials to find an explanation.

Theoretically, if the company goes bust the shareholders owe money to different creditors.

Now, that is not going to happen because there are clear laws protecting shareholders from lawsuits, but it bears thinking about when buying into such a company.

In most cases negative equity is the result of preceding losses being carried forward.

Conclusion:

The fundamental accounting equation is as follows:

Assets = Liabilities + Equity

Why would you want to buy shares in a company? The reason is of course Equity which is the part of the business that is the “surplus”.

 

 

 

 

 

 

 

 

What is the best way for a 18-year-old to invest $2,000?

Today I would like to look at the question of how to invest $2,000 if you are 18 years old.

You’re young and you have $2,000 to spare but you don’t know how to invest it. How do you make the best out of your investment?

Is is to squander it all expensive mining shares because you think that metal prices will be higher in two years?

Or is it better to play it safe and invest in solid businesses with steady cash flows where you are getting a decent return and safety of the money you’ve put in?

If you only have limited funds then in my opinion the best way to invest is to buy an index fund.

An index fund is the cheapest way to participate in the market.

If you look at an average mutual fund they are generally expensive.

You often need to pay more than 1.0% a year in charges for an actively managed fund and even 1.5% in some cases.

On the other hand an index fund you can get for as low as 0.15% a year which in my opinion is reasonable.

Adding up

Over the years this lower percentage difference adds up. We can now calculate how much with Microsoft Excel.

First of all, we use this formula for our calculations:

Formula for how to calculate the Future value (FV) from a Present value (PV) with a Rate (R) and Number of years (X).

Figure 1. Formula for how to calculate the Future value (FV) from a Present value (PV) with a Rate (R) and Number of years (X).

In Microsoft Excel it then looks like this:

Screenshot of Microsoft Excel showing how to calculate a Future Value (FV) from a Present Value (PV), a rate, number of years and Present value (PV)

Figure 2. Screenshot of Microsoft Excel showing how to calculate a Future Value (FV) from a Present Value (PV), a rate, number of years and Present value (PV).

 

What we are doing here is that we are calculating the Effective rate that we will receive if we assume a return of 6% annually. We do this by subtracting cell C4 from cell C3 and the result is shown in cell C5.

We then plug in the numbers that we have into the formula and we get $14,496.50 out.

On the other hand, when we are calculating with a cost of 0.15%, setup is as follows:

Screenshot of Microsoft Excel showing how to calculate a Future Value (FV) from a Present Value (PV), a rate, number of years and Present value (PV).

Figure 3. Screenshot of Microsoft Excel showing how to calculate a Future Value (FV) from a Present Value (PV), a rate, number of years and Present value (PV).

The result in cell C14 is then $25,829.67. If we then calculate the difference between cells C14 and cell C7 we will get $11,333.17 in cell C16.

That is how much more money you will have when you are 65 years old at a cost of 0.15% compared to a cost of 1.5% with a starting capital of $2,000.

Conclusion:

In today’s post we’ve been looking at the advantages of buying an index fund compared to speculation/squandering of your hard earned cash.

 

Technical analysis for beginners

Welcome to another blog post by me, LJ Nissen. In this guide we are going to be talking about technical analysis for beginners.

(This is part 1 of a series of articles. You can find part 2 here. If you want to learn more about technical analysis of individual precious metal charts, you can do that here.)

when the world ends

When I first started out trading a few years ago there weren’t too many resources available for rookie traders.

Sure, there were tips on which stocks to trade and how to do it with technical analysis, but not from a point of view where the whole situation was considered.

As a result I made enumerable mistakes where I lost almost all my money – doing what I otherwise really wanted to do.

The situation felt awkward.

After many years working in a very interesting field – scientific research – I had finally found my passion, but now I couldn’t do it because I didn’t have the resources.

It felt frustrating so in this article I wanted to change that.

Here I want to help you find your way around the technical terms used when trading stock.

I would like to give you a bottoms-up guide of the whole process.

A process that will span everything from your personal finances and online brokers to methods of trading that are good for beginners.

So let’s dive in!

 

Where you are at

If you don’t mind, I’m going to start with a few assumptions that I make about you.

The reason for me doing so is that it helps me as author of this guide to help you with technical analysis.

The assumptions are probably not completely correct, but close enough for you to have an interest in what I write:

 

  1. I’m going to assume that you still have your day job. That is a good thing, because it limits your trading to a level where you can consider it a hobby and not a full time job. It also pays your bills – at least food and rent -so that you don’t have to pay those from your trading account.This is positive from a trading perspective.
  2. My second assumption is that you’ve already dipped your toes into the stock market. Maybe you have made a little bit of money investing or trading and now you are eager to learn more. The money you have made may not be too much, but enough to whet your appetite. And now you want more of the same, but you don’t know where to find the information needed to continue.
  3. My third assumption will be that you don’t yet have the skills in technical analysis needed to become a successful trader. Of course, they are important if you want to become a trader, but how do you get them if you haven’t had anybody teaching you? Don’t worry! I will go through those in this article.

 

I’m also going to assume that you at least have a basic understanding of how the internet works.

Even if these assumptions are off by far you will get value out of this article anyway. So please continue reading!

 

Part 1 – The basics

One big advantage that you have when you are betting on the race track over somebody trading is that you always bet a fixed amount.

You go up the counter and put a 20 dollar bill to bet on a specific horse in a specific race and then you watch the horses run.

What will happen if your horse does not win?

You will only have lost your 20 dollars.

When you are trading you do not have that advantage. If a trade goes against you, you can lose more money than anticipated.

That is why trading the stock market can be a very dangerous game if you have people that are financially dependent on you.

So what you need is a system where you know in advance how big your gains and losses will be.

What the systems does is that it takes the emotion out of your trades so that you can focus on executing them.

There are several systems that you can use.

What I will propose in this post is a system that works for me, but it may be that you have come up with a better one.

The point being that you need to limit your losses and maximize your gains and the only way to do that is by being systematic about your trades.

That is the only way to make money consistently.

My first advice if you are only starting out is to start small.

My recommendation would be to start with a minimal account of 10000 USD.

In that way you will have a good balance between making gains and limiting losses.

The amount is small enough so that you can live with the losses that you will inevitably make while learning.

At the same time the amount is big enough so that you can feel the gains when you make them.

That is the main reason why I don’t like to trade with demo accounts.

After all what’s the point in trading if you don’t reap the rewards?

The problem if you are using a too small amount is that you will not be able to reap the rewards of a good trade when you make it.

Similarly if you are using a too big amount to start with you will feel stressed every time a trade goes against you.

This is the mindset that you need to learn:

 

Not all of your trades will be beneficial and some of your trades will go against you.

 

Of course, the opposite is also true in that you can also expect some gains, but this should not be a cause for being cocky.

Another thing that is crucial when trading is to keep a record of each trade.

That can be a hand written journal in a file or in electronic form. It really doesn’t matter.

That way you can go back and review what had happened to a particular trade, when you got out of the trade or if you were stopped out.

In this way trading is a lot like doing experiments in the lab (my former profession).

The most important thing in research is the lab journal and the same goes for trading.

In the journal you should always note things like date and time, points of entry and exit and how much money you had put into that particular trade.

I cannot stress the importance of the journal strongly enough. Please keep one for your own sake.

That way you can go back to your trades, review them and see what worked and what did not work and why.

 

Now, companies usually report their earnings four times a year and the price swings happening after those results have been published can be violent.

Those price swings are not coming from the results themselves but from the expectations of the results.

For example, if the market expects company ABC to have consistently good earnings, but ABC misses slightly on earnings growth, the sell-off that can follow may be violent.

Under those circumstances you don’t want to hold your stock and it is better to get out.

 

Part 2 – The specifics

 

If there is one thing that I have learnt in life it is that we all need systems in order to function.

It can be a system of movements that you are performing every day when you are in your car or it can be a system when dealing with your daily chores.

It doesn’t matter what it is. We all need systems to make life easier.

This is especially true when you are trading.

Well, for one you need a system that will limit yourself to the downside as well as to the upside, but the bottom line is that you need those rules in order to function.

What does not work is to live life without the constraints of rules. Then everything from cleanliness in the house to a healthy food intake will start to fall apart.

So what rules can be applied to trading?

In essence, we need a system where we can:

 

  • Limit our losses, and
  • Maximize our gains.

It is as simple as that.

Trying this out, the best thing that I’ve come up was developed by Quint Tatro of Tatro Capital.

Experimenting with this back and forth, the method is what I now call the “3-step” method.

What you do is that you set aside a small percentage of your account for each trade.

That will be a small amount in the order of magnitude of 0.5% of your total account.

It is very important that you do not exceed this amount under any circumstances.

Remember that your money is the life blood of this business.

By using technical analysis you will then be able to identify where to get in and – most importantly – where the particular trade is no longer viable.

That point will be your stop.

Now, whatever happens always respect your stops.

That point cannot be stressed enough.

You don’t want to find yourself in a situation where you lose copious amounts of money and only seeing the losses getting bigger and bigger by the hour and minute.

Now the advantage of doing this is that you can then calculate how much you would lose if the trade goes against you and you reach your stop.

That way you know exactly how much you are betting. In this way, trading gets similar to the race track.

So let’s get into some numbers.

What I prefer is to use a spreadsheet for this purpose, but you can do it any way you want.

The calculations will look something like this:

Three step stock trading

Figure 1. Spreadsheet of entry and exit points when using the 3-step method of trading stocks.

In Figure 1 you can see how we plan our trade.

We will get in at a particular price, in this case 9 USD.

Now if the trade does not go in our favor we will be stopped out 8.5 USD.

What we will then do is to calculate the differential between our entry point and our stop and add that value to our entry point.

In this case it would be:

9.0 USD – 8.5 USD = 0.5 USD.

If we add this to our entry point we will have what I call 1x.

Then when we set up our trade we can define at which point we will get out.

What you will then do is to get out at three instances: 1x, 2x and 3x.

We take one third off at each exit point.

Now we have set up a system that:

 

  1. Will have made sure that you have defined the amounts involved before acting on the trade.
  2. Allows you to take the emotion out.

 

These are the two main characteristics that we want from a trading system: The ability to know how much money there is at stake and to be able to sleep at night.

The method may seem awkward at first but when you get used to it, it becomes second nature.

Please take a few moments to familiarize yourself with the steps before implementing them.

Part 3: The technicals

 

Now we have come to the part where I will introduce you to the technical patterns involved in trading.

Of course the charts themselves are not a prediction of how the market will behave, they will merely lay out what is probable based on experience.

The moving average

My favorite technical indicator is the moving average.

What the moving average does is that it takes the average opening and closing values and plot them in a curve that will be displayed in the chart.

When looking at charts I usually display three moving averages which are good for different purposes.

I’m using the 10-period, the 20-period and the 50-period moving averages.

In Figure 2 there is an example of what I mean.

 

GLD weekly chart

Figure 2. Weekly chart of the exchange traded fund GLD in August of 2015. The 10-, 20- and 50-period moving average are shown in yellow, red and blue, respectively.

When I look at a weekly chart, the intermediate term movements will be determined by the direction of the 50-week moving average.

Similarly, the 10-week moving average will tell you more about the direction in the short term.

Now, the 10-week moving average is for all intents and purposes similar to the 50-day moving average.

If your stock is trading above the 50-day moving average it is a bullish sign near term.

If, on the other hand it is trading below the 50-day moving average it is bearish.

The 10- and 20-period moving averages are useful for looking at the movements that are extremely near term and personally I don’t find them to be particularly useful.

Resistance and support

One thing that must be grasped with chart movements is the concept of resistance and support.

This goes back to the mass psychology of the markets and tells you when the last trader is changing his or her position.

A resistance zone will appear when there are enough traders willing to sell stock at a particular level.

Similarly, a support zone appears when traders are willing to buy at a particular level.

Let me illustrate what I mean with a chart.

In the chart, a support zone is found at the 100 USD level and similarly a resistance zone is found around 200.

 

BOIL weekly chart

Figure 3. Chart of the ETF BOIL illustrating the concept of resistance and support zones.

 

When a support or resistance zone is then finally broken, the chart will move out of the zone without hindrance and the moves can be violent.

Again, mass psychology can explain what happens.

There is no one willing to buy the ETF beyond the 230 level and once it drops below support at the 100 USD level it will quickly move down to a new support level around 40 USD.

 

The pennant

 

One of the more effective chart patterns is a reflection of the above, the pennant.

In the pattern, a resistance zone and a support zone is gradually merged together reducing the volatility in the trading of the stock.

What it means is that buyers and sellers are gradually moving closer to one another and when one of those finally gives way the move will be particularly violent in either direction.

150819_dxy0

Figure 4. Daily chart of the dollar index, DXY0, illustrating the concept of a pennant.

 

Resistance and support zones are here represented with converging straight lines.

 

Head and shoulders

 

Head and shoulders patterns appear when discrete moves out of resistance/support zones can be observed.

The chart may first have broken out of resistance only to find itself with a new level of resistance higher than the first where it is then trading for a given amount of time.

If it cannot hold this level and falls back to the first level it will find that the old level of resistance is now support and the chart will move sideways for some time.

What then happens is that this support zone is gradually giving way and when it is up the chart action will be particularly violent.

The fall can then be semi-quantified in that the move from the first resistance zone to the second (left shoulder to head) will also apply to the right shoulder.

In Figure 5 there is an illustration of the chart action.

 

PHK daily chart

Figure 5. Head and shoulders chart action. The zone of resistance of the left shoulder is represented to the left, the head in the middle and the right shoulder to the right. The distance, d, between the left/right shoulder and the head can be applied to quantify the size of the move.

 

Conclusion:

 

In this article I’ve been talking about the need to start small if you are an aspiring trader and want to start out with technical analysis.

If you are a beginner I suggest you to use somewhere between 8000 and 10000 USD in your trading account.

That amount is big enough so that you limit your losses when they occur and at the same time lets you dip your toes into the gains that can really be made.

What I’ve also been talking about in this article is the need for a system that takes the emotion out of your trades.

The best system that I have come up with is what I call the 3-step method of trading stocks.

What it does is that when a particular trade is identified a small percentage – usually 0.5 % – of your total trading account is committed.

The first thing that you then do is that you identify your stop which will be the point where you will have to admit failure and move on.

Not to do this is a very dangerous game so always respect your stops!

You will then measure the distance between the stop and the entry point in the chart to identify the 1x, 2x and 3x points which will be your exit points.

I have also talked briefly about different chart patterns. What they mean, their limitations and how you can use them to your advantage.

 

If you’ve read this whole text and want more of the same please sign up for my newsletter!

That way you will get information first hand on when I release new products and content.

It is very easily done. You can do it here.

 

Published August 20’th 2015.

Valuation of gold stocks

In today’s post I want to look at valuation of gold stocks.

Green picture with text about valuation of gold stocks

The last few days I’ve been trying to wrap my head around how to value gold stocks.

It’s not as easy as just valuing a normal manufacturing company with Debt to equity, Price to earnings or by Price to book value because of the resources in the ground.

This makes it inevitable to normalize all the values according to either production or reserves.

The first thing that we will look at is how to calculate the cash cost per ounce produced.

Calculating the cash cost per ounce.

The cash cost is calculated by subtracting Operational cash flow from Total revenue:

Cash cost = Total revenue – Operational cash flow

To get to grips with what this means we can visualize the subtraction like this:

Total cash cost is calculated by deducting Operational cash flow from Total revenue.

Figure 1.Total cash cost is calculated by deducting Operational cash flow from Total revenue.

Which is equivalent to this:

Net cash is calculated by deducting Cost of sales from Total revenue.

Figure 2.Net cash is calculated by deducting Cost of sales from Total revenue.

Then to calculate the Cash cost per ounce we divide with the total production for the year:

Total cash cost per ounce = Total cash cost / Total production

 

Estimated operational cash flow

The next thing that we will look at is an estimate of how much money can come into the company through sales of the metal.

If we estimate that the company produces X ounces of metal in the year, the average cost of production is Y $ per ounce and that the average price of the metal is Z $ per ounce then the estimated operational cash flow of the company is:

Formula for calculating Estimated Operational Cash Flow (EOCF) in $. FMP is the Forecast Metal Price in $ per ounce, CPO is Cost Per Ounce Produced and EOP is the Estimated Ounces Produced in # of ounces.

Figure 3. Formula for calculating Estimated Operational Cash Flow (EOCF) in $. FMP is the Forecast Metal Price in $ per ounce, CPO is Cost Per Ounce Produced and EOP is the Estimated Ounces Produced in # of ounces.

Estimated operational cash flow (OCF) = X (ounces produced) * ( Y ($ per ounce) – Z ($ per ounce))

This number we will use in subsequent valuation calculations.

Price to Cash flow ratio

We can then use the Operational cash flow and calculate a Price to Cash flow ratio where a lower number indicates a cheaper stock.

If, for instance, the Price to Cash flow ratio is 5 then investors are paying $5 for each additional dollar of Cash flow.

Typically this number ranges from 3 x to 30 x and the lower the number the cheaper the stock.

Market cap to Forecast production ratio

We can also use the the Market cap to figure out a valuation to forecast production ratio.

Here again the lower this number gets, the lower the stock is valued in the market.

Typically this number ranges from about $1000 per ounce to $25,000 per ounce.

The lower the Market cap is per ounce of forecast production the cheaper the stock.

 

Market cap to reserves ratio

What we look at here is the Valuation (or the Market cap) and divide with the total number of ounces that the company has in reserves.

This number typically ranges from $100 to $1000 depending on the location of the resource.

Again this is a valuation metric where a lower number is cheaper.

 

Price to Earnings ratio

This is the classic valuation ratio where the price of the stock is divided by the earnings.

For gold stocks this number is usually higher than for ordinary stocks and a number of 50 is not unusual.

The lower the number the cheaper the stock.

The question then of course becomes:

How can it be that the Gold stocks are so expensive that investors are gladly paying 50 times earnings to get it?

The reason is that investors are paying for the gold reserves and the gold production that the company have.

The equity valuation is just a part of the value.

 

Examples

So that you better understand what I mean when I talk about the value of different gold stocks, I will now give some examples:

The first is of a hypothetical gold mine ABC Gold Inc. that has the following Cash flow and Income statement:

Screenshot of Microsoft Excel showing how to calculate Total cash cost by subtracting Operating cash flow from Total revenue.

Figure 4. Screenshot of Microsoft Excel showing how to calculate Total cash cost by subtracting Operating cash flow from Total revenue.

We then hit Enter and we get the result that we want in cell B6 ($1360,000,000).

Then we continue to calculate the Cash cost per ounce by dividing B6 with B5:

Screenshot of Microsoft Excel showing how to calculate Cash cost per ounce by dividing Total cash cost by Total gold production.

Figure 5. Screenshot of Microsoft Excel showing how to calculate Cash cost per ounce by dividing Total cash cost by Total gold production.

Here again we hit Enter and we get the Cash cost per ounce in cell B7:

Screenshot of Microsoft Excel showing how to final values of Total cash cost in cell B6 and Cash cost per ounce in cell B7.

Figure 6. Screenshot of Microsoft Excel showing how to final values of Total cash cost in cell B6 and Cash cost per ounce in cell B7.

So what do we do with these numbers?

Well the first thing we can do is to calculate the Estimated operational cash flow at a given gold price:

Let’s say that we estimate that the average gold price will be $1350 per ounce in 2017, the Total cash cost per ounce was $817 in 2016 and that the company forecasts a production of 1,725,000 ounces in 2017, then the Estimated operational cash flow per ounce will be:

Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow per ounce taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce

Figure 7. Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow per ounce taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce.

We then see that the Estimated cash flow per ounce is $533 and to get to the Estimated operational cash flow we multiply B12 with B10:

Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow by multiplying the Estimated cash flow per ounce with the Forecast production (B10).

Figure 8. Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow by multiplying the Estimated cash flow per ounce with the Forecast production (B10).

The result is of course as in Figure 9:

Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce.

Figure 9. Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce.

 

Conclusion:

In today’s post we have been looking at the valuation of gold stocks as a function of their production and reserves in the ground.

 

 

 

The principles of wealth building

Here are the ten rules of wealth building that we have discovered throughout the years. Don’t consider these principles absolute rules, but more of a guidance to how to think about your wealth in order to accumulate it. The principles are:

 

Green thinking person icon

  1. Be motivated. The first principle has to with your personal situation. What led you to the thought of accumulating wealth in the first place? Was it a period of being low on cash or was it that you inherited a large sum of money? Whatever it may be it is important to know the reasons why you are accumulating your wealth. Each time you feel that you are slipping in motivation go back to these reasons and stay on the course.Icon showing giving
  2. Give more than you take. The famous investor Benjamin Graham (whom we often cite at these pages) once said: “Each day should be a day of something foolish, something creative and of something generous.” Nobody wants to build wealth in a vacuum – the same way as nobody wants to build a company or do a project in a vacuum. It’s always a good idea to be humble, remember where you come from and give a large portion of what you have acquired back.
  3. Live with integrity. To build wealth requires a certain amount of integrity – integrity to say no to bad behavior. You don’t want to be a rich man or woman on the back of somebody else. If what you are doing does not feel right then it probably isn’t right either.Icon showing people shaking hands
  4. Be courageous. To build wealth is about being courageous in times of doubt. When everyone fears that the world will fall apart that is when it is best to participate. This is especially true when the market has been down for a considerable time and you can pick securities much cheaper than usual.Picture showing a medal for courageous action.
  5. Be disciplined. To live with a budget perhaps feels a little bit awkward at first, but once you have gotten into the habit there is nothing more rewarding. The point here is to live within your means – not more nor less. Each month make a Google spreadsheet where you list all the money that comes in and all the money that goes out. Once you have done this for a couple of months you will begin to see other parts of your life will become more organized too.Picture showing a disciplined worker
  6. Avoid lavish consumption. If you want to build wealth you cannot live a lavish lifestyle simultaneously. It just doesn’t work. Remember that it is by living within your means and by having small expenses that you will begin to see your wealth accumulate.Picture showing a dollar coin
  7. Nurture your environment. It is important that you have a supportive environment around you, one that you can trust. If you don’t have a supportive community around you, you need to build on those relations. Why is this important? Well, we’ve all found ourselves tough spots occasionally. The best way to get out of them is to ask for help. You cannot do that unless you have good people around you.picture showing how people are connected
  8. Apply leverage.Financial leverage is often frowned upon in the investment community, but there is nothing inherently bad about it. Banks do it all the time. The idea being that you can borrow money at a certain rate and put that money to use in a different environment with a different rate. You can then make the difference in rates into a profit. Do not try to build your wealth in a vacuum, it will not work. Rather try to leverage the knowledge of others by staying true to your own values.picture showing leverage
  9. Treat your investments as a business. When you are accumulating wealth – be it by analyzing financial statement, bonds or just looking at your bank statement – you need to treat the whole process as a business. “Due diligence” are words that get thrown around often in the investment world and there is a reason for that. Only by knowing what you own you will be able to make decisions based on business reality.Picture showing ascending graph
  10. Manage your wealth. If you don’t have any clear idea of how to manage your money get somebody to do it for you. The job of a good wealth manager is to protect you from your own worst ideas when it comes to money. Please don’t fall into the trap of trying to know everything yourself.

Conclusion:

Today we have been talking about the ten principles of wealth building and how they relate to your personal fortune. They are more of a guidance on how to think about money and not absolute rules. As always the first step is the most difficult.

If you’ve read this whole text, you may want to consider joining our mailing list. You can do that here.

Why is the Shiller P/E flawed?

Today I would like to take a stab at the question “why is the Shiller P/E flawed?”

red recycling arrows with blue background and the text: why is the Shiller P/E flawed?

What is CAPE and why is the Shiller P/E flawed?

The cyclically adjusted P/E-ratio is calculated by taking the average over the past ten years’ inflation adjusted earnings.

This may sound as a good way of looking at the value of a company, but this way of looking at deep value is actually not the best way to go about. I will explain why it is not in this post.

First of all when you are calculating the Shiller P/E you are averaging over the previous ten years.

What that means is that one years’ calculation contains almost the same information as next year.

To illustrate what I mean consider this figure:

Schematic illustration of selecting two different ten year periods with just one year differing.

Figure 1. Schematic illustration of selecting two different ten year periods with just one year differing.

The first selection contains the same years as the second selection. Only one year changes.

So, in effect, you only have data points each tenth year and not each year as it is presented.

Looking backwards

The Shiller P/E is only a way of looking in the rear view mirror and not ahead.

As we all know a trailing P/E does not give you any information about coming earnings.

It does, however, give you an idea of past earnings.

If you want to make real money in the market you will have to guess future earnings which a Shiller P/E does not do.

Then ten years is a long time. We all know that.

During this time small-cap companies often change and sometimes even dramatically.

Their business model may change so to calculate an average over ten years makes no sense.

Moreover, the accounting methodology over the past ten years has changed which makes the Shiller P/E even more flawed.

What do you suggest instead?

Instead I propose to look at the inflation adjusted earnings of the past three years and using that as a guess for next year.

I believe this is a better metric because it gives the investor a clearer idea of what to expect for next year’s earnings.