Share Screening Systems - Essay Example

Share Screening Systems (a) Discuss the strengths weakness of the specific share screening system suggested and such methods in general. Share screening systems: There is no perfect share screening system as such, the investor has to look for a system, which suits his investment goal. However generally while choosing a share the following criterions are looked into: Earning per share: (EPS) is calculated by dividing company’s net income after taxes with average no. of common share outstanding – The EPS should have a steady growth. Price/earnings ratio: (PE) ratio is calculated by dividing the company’s share price with the earning per share. Companies with high P/E ratio indicate of companies of higher growth. Price to Book Value: This ratio is calculated by dividing share price with share price obtained by company’s assets less liabilities per share. The low Price to Book Value is indicative of value stocks. Return on Equity ratio: (ROE) is calculated by company’s net income divided by shareholders’ equity. This indicates how the company utilizes the shareholders’ money. Price to cash flow ratio: Company’s share price divided by the cash flow (derived by adding earning to depreciation, amortization and other non cash expenses) per share is called Price to Cash flow ratio. This ratio is helpful for analyzing companies with significant non-cash expenses. Price to sales ratio: this is calculated by dividing share price with annual sales per share. This analysis is helpful for companies with little or no profit. Net dividend yield %: This is calculated by dividing dividends per share with earning per share. This indicates the percentage of profit the company is distributing among the PEG ratio: This is calculated by dividing the company’s P/E ratio with its expected earning growth rate. This is useful foe evaluating growth stocks. Net gearing or debt equity ratio: This is calculated by (Total liabilities less cash in hand an bank) divided by shareholders’ fund. It should be as lower as possible. Market cap or size: Market cap is the per share price multiplied by the no. of shares outstanding. Now let us look into the criterion selected by David: 1. Price : Book Value – Less than one: this is a good approach, the Price Book value should be low for good investment 2. Net gearing – Low, which is a good criteria. 3. Broker’s opinion – generally favorable, this can be one consideration, which should be taken to buttress the own judgment after self-analysis. 4. Net debt:equity ratio – less than 100%, which is not a good sign. The debt equity ratio should be as low as possible. 5. Share price – higher than previous three month; this is not a good criteria for selecting a share. Just because it is higher than previous three months does not ensure it will remain so. It may be suitable for short-term investment. 6. PE ratio – Should be high. From the table it is seen that most of the shares have a high PE ratio, which is a good sign. 7. Net dividend yield %- The dividend yield varies from companies to companies and depends on factors like type of companies, type of business, age of company etc. So it does not have a thumb rule to assess a company. (Word count – 525) (a) Analyze the features and suitability of the suggested equity portfolio. To answer this question we will first study companies one by one and then go to analyze the overall portfolio. 1. Communsis: Price: Book ratio at 0.75 is healthy sign, Net gearing at 99% is not a very good sign, 3 months price change (5%) is very placid, PE ratio (12.2) is very healthy sign, Net dividend yield (7.6) is very healthy sign. Brokers’ Rec. (strong buy) adds strength. 2. Delta: Price: Book ratio at 0.7 is healthy sign, Net gearing at –42% is not a very good sign which shows that the company is relying on high debt, 3 months price change (14%) is good, PE ratio (14.4) is very healthy sign, Net dividend yield (2.6) is alarming. Brokers’ Rec. (overweight) seems to be correct for long run investment it is risky. 3. Minerva: Price: Book ratio at 0.99 is not good sign, Net gearing at 33% is a very good sign, 3 months price change (19%) is ok, PE ratio (280.2) is very interesting sign, Net dividend yield (0) is ok. Brokers’ Rec. (Neutral), it should be a good buy. 4. Vodafone: Price: Book ratio at 0.75 is healthy sign, Net gearing at 47% is a very good sign, 3 months price change (6%) gives stability, PE ratio (12.1) is very healthy sign, Net dividend yield (5.0) is ok. Brokers’ Rec. (overweight), it’s a good buy for long-term investment. 5. Fibernet: Price: Book ratio at 0.87 is not a very good sign, Net gearing at 98% is not a very good sign, 3 months price change (72%) very volatile, I agree with Brokers’ Rec. (over weight). 6. Air music & Media: Price: Book ratio at 0.46 is very healthy sign, Net gearing at 60% is a very good sign, 3 months price change (16%) good, Brokers’ Rec. (neutral) can be over ruled. 7. Cello group: Price: Book ratio at 0.97 is not a healthy sign, Net gearing at 45% is very good sign, 3 months price change (3%) makes it unattractive, PE ratio (13.1) is very healthy sign, I agree with the Brokers’ Rec. (overweight) 8. CSS Stellar: Price: Book ratio at 0.42 is healthy sign, Net gearing at 36% is very good sign, 3 months price change (9%) gives stability, PE ratio (31.5) is very healthy sign, I don’t agree with Brokers’ Rec. (overweight) 9. Gemfield Resources: Price: Book ratio at 0.84 is healthy sign, Net gearing at 5% is gives strength, 3 months price change (13%) good return, PE ratio (20.4) is very healthy sign. I agree with Brokers’ Rec.(strong buy) adds strength 10. Spectrum Interactive: Price: Book ratio at 0.93 is not a healthy sign, Net gearing at 81% is ok, 3 months price change (38%) makes it volatile, PE ratio (6.9) is not attractive, Net dividend yield (6.7) is not attractive. Brokers’ Rec. (neutral) I will not recommend for long-term investment. 11. Surface Transforms: Price: Book ratio at 0.97 is not healthy sign, Net gearing at -81% is very risky, 3 months price change (4%) makes it placid, Brokers’ Rec. (Neutral). I don’t find any attraction in this stock. Total portfolio: Beta calculation: Overall Beta = 0.2X0.11 +0 .3X0.11 + 1.4X0.11 + 1.2X 0.11 + 0.5X0.11 + 0.2X0.11 + 0.2X0.11 + 0.2X0.11 = 0.462 As the beta value is available for 8 out of 11 stocks, we can assume that the risk factor is less. (Word Count: 561) (c) Briefly discuss the validity of the original adviser’s criticism of the Dow-Jones Index and the money-weighted rate of return. To discuss the validity of the original adviser’s criticisms of Dow-Jones Index and the money-weighted rate of return to measure performance, we will look into the formula used for Dow-Jones Index, Money-weighted return and Time-weighted return. Stock Indices are benchmarks used to measure the performance of a group of Stocks. There are various types of Indices available for this purpose. Dow Jones Index is the most famous of all. This is highly respected for its history and simplicity. The Dow Jones index is computed by using a price-weighted indexing system. The editors of Wall Street Journal select 30 widely traded blue chip stocks, adds the prices of all the stocks and divided them with the no. of stocks. But it has some disadvantages. There is a big question mark of Dow’s representative value for the total market as it is done only with 30 stocks. Secondly it uses weighted-price instead of Market capitalization. It is generally agreed that the market performance is better measured by market capitalization-weighted indices than price-weighted indexes. Money-weighted rate of return is used whenever there is incidence of inflow and outflow of fund. The formula used for calculating MWR: MV (End) =MV (Start) (1+R)+CASHT(1+R)(1-T) Where MV (Start) = Market Value of the fund at the start MV (End) = Market Value of the fund at the end CASHT = Cash introduced or withdrawn at time T T = Proportion of period elapsed at time to the year R = Money Weighted Return The timing and the size of positive or negative inflow of fund have significance bearing on MWR. Time-weighted rate of return smoothes out the distortion effect of cash flow by placing equal weight on the total returns for a single period or time. Here return is calculated at each point of cash inflow or outgo for the period since the last inflow or outgo. It is the product of a no. of individual returns. Generally Time weighted returns are lower than Money weighted returns. Normally time weighted rate of returns are preferred in measurement of a Portfolio Manger’s performance. However there is a school of thought where they emphasis of the importance of Money-Weighted Rate. They say that by not considering MWR concept and ignoring the timing effect of the cash flow will cause misinterpretation and wrong feedback into the investment process. Normally the investment Managers prefer the Time-weighted Ratio, because the timing of fund flow is the prerogative of the client and the fund manager does not have nay control over it. Whereas the MWR is called the clients return. In that sense the criticism of the original adviser is as per line. However many are now turning focus and consideration for MWR is growing. (Word count: 452) (d) with particular reference to the circumstances of the case, assess the arguments for and against cashing in the ISAs and using the proceeds to fund SIPP. SIPP stands for Slef-Invetsed Personal Pension. This is an arrangement within the pension Scheme in UK, where the investor has the freedom of choosing his portfolio within the premises of the scheme. It also allows the investor in acquiring commercial property. This scheme is ideal for the purpose of providing annuity, cash withdrawal in retirement of the member. It is also proper investment for avoiding inheritance tax. The investment in SIPP can be in solely insure schemes or in allowable investment asset classes or in a hybrid of the above two. ISA stands for Individual Savings Account. This is a tax saving scheme. The investors are exempted from Income Tax and CGT on the income arising from the investments held in this scheme. No tax is levied on capital gains arising on the investment. Withdrawal is allowed at any time. It has three separate elements: Cash Investment, Stocks and shares, Life Insurance It gives additional tax benefit of 10% on the investments mad eon UK equity component and Life Insurance element invested until 5April 2004. ISA is advantageous to small investors who can invest as low as £3000 in cash investment, the fund being available for withdrawal and get the benefit of tax saving. The suggestion for cashing the ISAs and using the proceeds to fund a SIPP seems to be a good decision. Let me give the reasons: 1. David wants to make provision for his children and future grandchildren and wants to avoid inheritance liabilities: SIPPs are good for inheritance tax planning. The draw down fund can be paid to the family at the expiration of the investor. A tax of 35% is Levi able but only to the capital retained in the segments designated to provide an income, the balance untouched segment calls for no tax. 2. In SIPP David will have more control in investment of the funds. As he has time now and wants to utilize his time in financial affairs it is ideal for him to control the funds invested in SIPP. 3. He can opt for a Hybrid type of SIPP, where he will keep some assets in insured investment products and some to use direct investment controlled by him. The insured products will give him security whereas Direct Investment will allow him to play for better return. 4. As his ISA investments emphasize on International funds, he is not getting the tax benefits available for investments of ISA components in life insurance and for UK based equity. Disadvantage: 1. The liquidity advantage of ISA, which allows an investor to withdraw from the account any time, without loss of tax relief, will not be available with SIPP. 2. The risk factor is high in SIPP, if he keeps the share component of his investment more. As he considers himself as averagely risk averse it will have an impact on him. But considering the other benefits, this disadvantage can be controlled by wise investment (word count – 490) (e) Discuss the other aspect of financial planning which David and Lorraine Campesi should consider. To discuss the other aspects of financial planning David and Lorraine should consider we should go for a full analysis of the facts and their Goals: The facts are: 1. David and Lorraine both are retired and do not expect regular income from their jobs. 2. He wishes to keep provision for inheritance to his children and grandchildren, but does not wish to burden with inheritance tax. 3. He has sufficient personal pension at £274,000. 4. He has deposits with ISA £1,00,000, which he wants to switch to SIPP. 5. David has received £140,000 as salary and £200,000 as capital gain. 6. He invested £100,000 in his daughter’s business 7. He has invested in property at Portugal £150,000 8. He has property at UK worth £550,000 9. They are averagely risk avers persons 10. No evidence available for any life insurance cover. His financial planning should meet: 1. His expenses for traveling. 2. His regular expenses 3. As he is only 58 years of age, the investments should continue to grow and should outperform inflation rate. 4. Leave inheritance for his children and grandchildren Their financial plan should include: 1. Income from pension schemes for £274,000 2. He has ready cash for investment £90000, the balance he has after investing £100000 in his daughters business and £150000 for the holiday property in Portugal from the salary £140000 and capital gain of £200000 he received. 3. He will switch his ISA amount to SIPP, which will give him some control on the fund deployed. However the investment in SIPP should be of hybrid type. A good percentage can be invested in insurances. 4. His investment in the portfolio of 11 stocks he has short listed, should be for long time investment with moderate income and sound growth. A serious rethinking on some of the stocks are needed to ensure his goal of steady low risk growth, regular return. 5. They consider themselves average risk averse; hence their investment should be of low risk type. He wants to control his finances himself but have plans for traveling, which will not give him enough time for trading in shares; hence long-term investment is suggested. (Word Count: 361) References Cicutti. 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Stefan Illmer, Ph.D., Wolfgang Marty, Decomposing the Money-Weighted Rate of Return http://ch.csam.com/dss/fundsamdi2/gir_msc_dmwrr_eng.pdf Time –weighted Returns http://www.andreassteiner.net/performanceanalysis/?Return_Calculation:Returns_with_Contributions:Time-Weighted_Returns Wikipedia self investment Pension Plan, http://en.wikipedia.org/wiki/Self-invested_personal_pension Wright Paul, General Editor, Investment and savings handbook 2003-04, Zurich Financial Services Ltd. Wohlner, Roger, Evaluating Potential Stock Investments, Stock Strategies http://www.investorguide.com/igu-article-828-stock-strategies-evaluating-potential-stock-investments.html Wohlner, Roger, Measuring a Stock’s Risk, Stock Basics http://www.investorguide.com/igu-article-823-stock-basics-measuring-a-stocks-risk.html Read More