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Financial tools that investors should apply to investment decisions

Financial tools that investors should apply to investment decisions | FINANCE | Scoop.it

The purpose of this article is to highlight the main financial tools that investors should apply when making investment decisions.

 

The most important ratio that investors should look at is the Price Earnings (P/E) Ratio.

 

A useful ratio for the evaluation of investment companies is the net asset value per share.

 

EARNINGS PER SHARE (EPS): A good management team should be able to register a solid annual increase in EPS of say 15% per annum.

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Spotting Profitability With ROCE

Spotting Profitability With ROCE | FINANCE | Scoop.it

Think of return on capital employed (ROCE) as the Clark Kent of financial ratios. Most investors don’t take a second look at a company’s ROCE, but savvy investors know that, like Kent’s alter ego, ROCE has a lot of muscle. In fact, ROCE can help investors see through growth forecasts, and it can often serve as a reliable measure of corporate performance. In this article we'll reveal the true nature of ROCE and how to calculate and analyze it. Read on to find out how this often overlooked ratio can be a superhero when it comes to calculating the efficiency and profitability of a company's capital investments.

 

Defining ROCE
Put simply, ROCE reflects a company’s ability to earn a return on all of the capital that the company employs. ROCE is calculated by determining what percentage of a company's utilized capital it made in pre-tax profits, before borrowing costs. To calculate ROCE, you determine what percentage of a company's invested capital it made in pre-tax profit before borrowing costs. The ratio looks like this:

= Profit Before Interest and Taxation / Capital Employed

 

The numerator, or the return, includes the profit before tax, exceptional items, interest and dividends payable. These items are located on the income statement. The denominator, the capital employed, is the sum of all ordinary and preferred-share capital reserves, all debt and finance lease obligations, as well as minority interests and provisions. These items are all found on the balance sheet. The denominator shows how much capital is being employed in the operation of the business. (For further reading, see Reading The Balance Sheet and Understanding The Income Statement.)

 

What Does ROCE Say?
For starters, ROCE is a useful measurement for comparing the relative profitability of companies. But ROCE is also an efficiency measure of sorts; ROCE doesn’t just gauge profitability as profit margin ratios do, it measures profitability after factoring in the amount of capital used. To understand the significance of factoring in employed capital, let’s look at an example. Say Company A makes a profit of $100 on sales of $1,000, and Company B makes $150 on $1,000 of sales. In terms of pure profitability, B, having a 15% profit margin, is far ahead of A, which has a 10% margin. However, let’s say A employs $500 of capital and B $1,000. A has an ROCE of 20% [100/500] while B has an ROCE of only 15% [150/1,000]. The ROCE measurements show us that Company A makes better use of its capital. In other words, it is able to squeeze more earnings out of every dollar of capital it employs. A high ROCE indicates that a larger chunk of profits can be invested back into the company for the benefit of shareholders. The reinvested capital is employed again at a higher rate of return, which helps to produce higher earnings-per-share growth. A high ROCE is, therefore, a sign of a successful growth company. (See, The Bottom Line On Margins.)

 

ROCE in Relation to the Cost of Borrowing
A company’s ROCE should always be compared to the current cost of borrowing. If an investor puts $100 into a bank for a year at 5% interest, the $5 received in interest represents a reasonable return on the capital. To justify putting the $100 into a business instead, the investor must expect a return that is significantly higher than 5%. To deliver a higher return, a public company must raise more money in a cost effective way, which puts it into a good position to see its share price increase; ROCE measures a company's ability to do this. There are no firm benchmarks, but as a very general rule of thumb, ROCE should be at least double the interest rates. An ROCE any lower than this suggests that a company is making poor use of its capital resources.

 

Some Guidelines for Analyzing ROCE
Consistency is a key factor of performance. In other words, investors should resist investing on the basis of only one year’s ROCE. Take a look at how ROCE behaves over several years and follow the trend closely. A company that, year after year, earns a higher return on every dollar invested in the business is bound to have a higher market valuation than a company that burns up capital to generate profits. Be on the lookout for sudden changes; a decline in ROCE could signal the loss of competitive advantage. (For more insight, see Competitive Advantage Counts.)

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Because ROCE measures profitability in relation to invested capital, ROCE is important for capital-intensive companies, or firms that require large upfront investments to start producing goods. Examples of capital-intensive companies are those in telecommunications, power utilities and heavy industries. ROCE has emerged as the undisputed measure of profitability for oil and gas companies, which also operate in a capital-intensive industry. In fact, there is often a strong correlation between ROCE and an oil company's share price performance.

 

Things to be Aware Of
While ROCE is a good measure of profitability, it may not provide an accurate reflection of performance for companies that have large cash reserves, which could be funds raised from a recent equity issue. Cash reserves are counted as part of capital employed even though these reserves may not yet be employed. As such, this inclusion of the cash reserves can actually overstate capital and reduce ROCE.

Consider a firm that has turned a profit of $15 on $100 capital employed, or 15% ROCE. Of the $100 capital employed, let’s say $40 was cash it recently raised and has yet to invest into operations. If we ignore this latent cash in hand, the capital is actually around $60. The company’s ROCE, then, is a much more impressive 25%. Furthermore, there are times when ROCE may understate the amount of capital employed. Conservatism dictates that intangible assets - such as trademarks, brands and research and development - are not counted as part of capital employed. Intangibles are too hard to value with reliability, so they are left out. Nevertheless, they still represent capital employed.

Conclusion
Like all performance metrics, ROCE has its difficulties, but it is a powerful tool that deserves attention. Think of it as a tool for spotting companies that can squeeze a high a return out of the capital they put into their businesses. ROCE is especially important for capital-intensive companies. Top performers are the firms that deliver above-average returns over a period of several years and ROCE can help you to spot them.

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#MONEY - Credit Card Arbitrage: Free Money Or Dangerous Gamble?

#MONEY - Credit Card Arbitrage: Free Money Or Dangerous Gamble? | FINANCE | Scoop.it

"Credit card arbitrage involves borrowing money from credit card companies, then investing that money in an instrument offering a higher interest rate than what you're paying.

 

Here's how it works: you get an offer from a credit card company through the mail promising a 0% or low interest rate to transfer your balance from an existing card. You fill out the paperwork and make out one of the pre-printed checks the company sends with the offer payable to you. You do a little homework to find a high-yield savings account, CD or another instrument offering a higher interest rate. Invest the money, make at least the minimum payments each month on time and, when the initial lower "teaser" rate expires, withdraw the money, pay the balance owed on the card, and keep the difference as profit" http://buff.ly/155jut3


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How The 1% Really Makes Money

How The 1% Really Makes Money | FINANCE | Scoop.it
While the rest of the country depends on a routine paycheck, the super wealthy take home cash from investments.

Via Reginald Shipman, The New Media Moguls
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6 Tough Money Choices For Millennials -- And How To Make Them

6 Tough Money Choices For Millennials -- And How To Make Them | FINANCE | Scoop.it

Chicken or fish? Pepsi or Coke? Chocolate or vanilla? There are many “this or that” choices that, to the indecisive, present an impossible dilemma. For matters of food and leisure, it’s possible to find a compromise: you get chicken and I’ll get fish and we’ll share; I’ll get Coke this time and Pepsi next; the vanilla-chocolate-twist cone sounds great, thank you very much.

But when “this or that” debates pervade your financial life? It’s a whole new ballgame. And for a Millennial who may be new to managing his or her money, choosing between one financial option (like, putting money in a savings account for emergencies) versus another (like, investing that money instead in the stock market) can cause quite the headache.

“In 99.9% of the population, we don’t have unlimited money and it all comes down to making these choices,” says David Weliver, founder of financial advice website Money Under 30. “And every little choice affects another one.”

According to Weliver and other experts on Millennials and their money, there are certain “this or that” financial decisions that Millennials have a particularly hard time making. Here are what they say are the trickiest choices — and how to go about reaching a decision that’s right.


Via Tonya Scholz, The New Media Moguls
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15 Best Job Search Websites

15 Best Job Search Websites | FINANCE | Scoop.it
Are you on the hunt for a new job? We've recently covered what jobs skills are most in demand right now, including marketing analysts, healthcare professionals, and every skill that involves computers.

Via Steven Hughes, The New Media Moguls
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The Importance of Liquidity: Liquidity Is King — Not Elvis!

The Importance of Liquidity: Liquidity Is King — Not Elvis! | FINANCE | Scoop.it

Do you have a metal chain in your house? Take a look at it. You will notice all the links are of equal size. The U.S. economy can, in a way, be represented by the links in a chain. But, the difference is that the economic links are not of equal size. In addition, some links are weaker than others.

 

The biggest link in our national economic chain is the consumer or more explicitly, consumption expenditures. This link now represents 70% of our Gross Domestic Product (GDP) and dwarfs all the other economic links combined. This link is also the weakest link in our chain and is the one of most concern. 

 

The question, then, is how do you grow your business in an environment that will be highly competitive and turbulent. The most logical answer is to increase prices of the goods and services your company offers. Logical– yes, but it is not realistic. If anything, with the economic environment described above, the market will be dictating downward pressure on prices– not upside. This leaves one other alternative: going after market share.

 

We have had the mistaken belief in this country that the business future belongs to the big and the mighty. This is nonsense. The future belongs to the swift. The swift are those men and women whose businesses have liquidity (low debt levels) and are generating sufficient levels of free cash flow to take advantage of opportunities that will be presenting themselves. Free cash flow is the wherewithal, the stuff, that successful business people can use to innovate new products and services, which along with effective marketing and customer relations can be used to grab market share from your competitors.

 

Additionally, those businesses that have liquidity and cash flow can also secure market share by lowering prices while still maintaining profitability. This line of survival thinking falls under the category of guerrilla marketing. Let’s face it—- it is a jungle out there, and the swift and nimble are the ones who will prosper in this environment.

 

People tend to make situations more complex than they are are. This evolves from a tendency in human nature to drift from the simple to the complex. But, in business it does not have to be this way. If you can focus on building-up the free cash flow in your business (and it wouldn’t hurt your personal life either), you will both increase its value and have a competitive edge in the marketplace. It is that simple.

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Lessons from the Top: What We Can All Learn from CEOs

Lessons from the Top: What We Can All Learn from CEOs | FINANCE | Scoop.it

"Many of us tend to look at certain types of financial or life advice—especially the kind that requires a little money—and disregard it because it doesn't feel like it applies to us. That's not always the case. We can all take a lesson or two from a wealthy CEO's playbook, whether it's about delegation, negotiation, or proper use of money." http://buff.ly/14E93GL


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5 Personal Finance Sites That Will Help Get You In Shape

5 Personal Finance Sites That Will Help Get You In Shape | FINANCE | Scoop.it

In these tough economic times, not being financial literate can cost thousands of dollars and a lifetime of savings.


Via Patty Ball, The New Media Moguls
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How to Make a Business Plan for Your Life

How to Make a Business Plan for Your Life | FINANCE | Scoop.it
Eight steps to realize your life's potential.

Via Lonnie Juarez, The New Media Moguls
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Lonnie Juarez's curator insight, September 4, 2013 4:27 PM

Do you have a business plan for your life? This is a good article that gives you a step by step process to follow to develop you on personal plan.

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Investing 101 for First-Time Investors

Investing 101 for First-Time Investors | FINANCE | Scoop.it

"It’s a natural response from millennials when told they should start investing while their young. Most of today’s 20-somethings, still scarred from the stock market collapse in September 2008, are down-right scared to put any of their hard-earned money into what seems to many as a risky financial move. Compounded by the fact that many millennials witnessed their parents lose considerable wealth in the market crash, it’s no wonder that more than half of millennials reported that they were less-than-confident about putting their money in the stock market.

 

Yet simple math shows that investing as a twenty-something is the best strategy to help build wealth over the long-term. Even the most conservative estimates of historical returns on the stock market show that compounding returns and investing early can mean a cushy retirement later." http://buff.ly/19qmqzp


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How This Woman Left Her Job to Become Her Own Boss

How This Woman Left Her Job to Become Her Own Boss | FINANCE | Scoop.it

"Seven months ago I transitioned out of a corporate job in market research to work for myself full-time.

 

By the time I left my day job to become a personal finance coach, I had nine clients, $22,000 in savings to cover my living expenses and $5,000 in a business account."

 

Continue Reading: http://buff.ly/1adjGCD


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