Monday, February 25, 2013

Negative Interest Rates

First of all, sorry for being one day late. I was in Sydney for Soundwave yesterday and did not have access to a computer. Secondly, today's post will not be about P/B ratios. I'll write about them next Sunday :P

So about a week ago I was having a lovely conversation with a friend, we got along quite well and our conversation seemed to flow seamlessly from one topic to another. So for some reason we ended up talking a bit about Japan, about their economy and mentioned something about negative interest rates. It is something that I’ve heard about but never really did any research on. So after the conversation I’ve decided to so some homework and study a bit about interest rates.

Basically interest rate is the rate that is paid by borrowers to borrow money from a lender. So if I lend you 100 dollars and say you have to pay me back 110 in 6 months, the interest rate would be 10/100 x 100 or 10%. Interest rate targets are set by central banks or reserve banks to try (I emphasized ‘try’) and deal with things like investments, be it in businesses or shares, inflation and unemployment.

Generally, interest rates are reduced to encourage investments and consumption. This makes sense because if interest rates are low, it becomes a disincentive to hold cash. If you have cash that is making you 2%, why not put it in a company that could earn you 5% in dividends and potentially more in capital gains. Low interest rates also give people access to cheap money. So it means I can borrow more money because interest rates are low, I only have to make a small amount from that money to cover my cost. As you can imagine, this theoretically can stimulate the economy a bit and when there is more money around, things start to become more expensive, i.e. inflation. Then the central banks will increase the interest rate targets to try and catch up with inflation, encourage people to save more cash and make it more expensive to borrow money.

There are two main types of interest rates; real and nominal interest rates.

Nominal interest rate is the amount of interest payable so like before, if you make a deposit of 100 dollars and get 110 at the end of the year, the nominal interest rate would be 10/100 x 100 or 10%.

Real interest rate tells us the purchasing power of the interest because it takes into account inflation. So if you make 10% interest from your deposit but prices of food went up by 10% in that same year, your purchasing power did not actually increase and your real interest rate would be 0%.

So back to Japan and negative interest rates. From the very little reading that I’ve done, negative nominal interest rates are a very very rare occasion. Whereas negative real interest rates are a lot more common. You can imagine if the interest rate is close to zero say 1% and inflation for the year is 2% a -1% real interest rate is quite easy to imagine, you don’t actually lose money by putting your money in your bank, you lose buying power (which is sorta the same thing at the end of the day).

However can you imagine actually having negative nominal interest rates? Meaning if you deposit money in a bank, you’ll get less out when you withdraw it. Something like this happened before in Sweden back in 2007 when Sweden’s central bank, Riksbank, reduced its interest rate to -0.25%, requiring banks to pay that amount on the money that they have deposited in the central bank.

Something like this has also happened in Japan for a short while when investors who bought short-term Japanese Government bills made negative yields. (Keep in mind we’re talking about central banks and government bonds, we’re not talking about consumer banks, I cant imagine what’ll happen if consumer interest rates ever become negative.)

I think it is fascinating and a bit scary that things can get so bad that you’d rather lose money by holding cash than put money into other investment vehicles like properties and shares to avoid the risk of losing more.

Thanks for reading, feel free to drop me an email or leave a comment if you anything to add, correct or clarify about the post.

Sunday, February 17, 2013

P/E Ratios

Hey there,

Today I’m going to be focusing on this part of the key measures

So first of all, I have to say I am not sure what the aspect earnings model is. So if anyone would like to shed some light on that, please please please post a comment or send me an email. Otherwise I’ll spend a bit more time doing some research and trying to find out what it means.

P/E Ratio or price to earnings ratio is quite simple to understand I think. Basically it is the company’s current share price compared to the company’s earnings per share. So in other words it is:

Market Value per Share/Earnings per share (EPS)

Say company XYZ’s current market value is 20 dollars and the earnings per share is 2 dollars the P/E ratio would be 20/2 or 10. The math is very simple but what you make of it is a different story I guess.

Some people look at the P/E ratio as a marker of value and some look at it as a marker of future growth. So a low P/E ratio 0-10 can mean that the company is undervalued or the company’s earnings are thought to be in decline. A P/E ratio of 10-17 is usually considered fair value and a company with a higher P/E ratio say 17-25 can be considered to be overpriced or have a lot of potential for growth.

It is always important to compare company’s P/E ratios within their relevant sectors. For example, mining companies that are still exploring may have a very high P/E ratio and when they find something their P/E ratio might go even higher. Does this mean that the company is overvalued? I’m not sure. But I know it can also mean that the company has found something, is working on extracting it and will eventually (hopefully) earn some money from it. In this case, the high P/E ratio can be normal and is more reflective of the company’s future earning potential.

On the other hand, if we were talking about a bluechip supermarket company, some people might view the P/E ratio as an indicator of its current value. If the earnings per share is 2 dollars and the current market value of the share is 50, that gives you a P/E ratio of 25 which can be considered high. If one day the supermarket is found to be selling chicken infected with salmonella, an overreaction from the market could push the share price down to 20 dollars, bringing the P/E ratio down to 10. Now if the company is unlikely to go bankrupt from this event, and you think that they will eventually go back to normal you can say that the company is currently undervalued and can buy some shares in them.

Another way to look at this P/E ratio is the long term average. Say a company is earning 2 dollars per share and it’s long term average P/E ratio is 15. If it is trading at P/E of 10 ($20) for whatever reason, and you anticipate the prices to rebound to its long term average of 15, it will be a good idea to buy because a P/E of 15 would mean that the market value of the share will be 30 dollars.

I think the most important thing of all is to not judge a stock/company purely based on the P/E ratio. Always remember to look at everything else. Look at the company’s website, etc. So is P/E ratio something that you always look at before buying into a company?

I hope this post has been helpful. Next week, P/B ratio.

Friday, February 8, 2013

First project of 2013

Hey there, 

It has been a long time.

Since my last post, I've finished medical school, accepted a job offer in Canberra Hospital and received my first pay check, all of which went into my credit card because I had been living 3 weeks without any cash before that. I've more or less moved into a new house in Forrest, which is supposed to be a fancy suburb in Canberra. So things has changed quite a bit for me. 

I've decided that since things are starting to settle down and I wont have any more exams for the next two years, I should dedicate more time into investing and saving. As a result, I am going to do some revision on financial statements, balance sheets and key indicators. 

Below are examples of how they look like. 

Key Indicators of Greencross Limited extracted from ComSec

 Financial Statements of Greencross Limited extracted from ComSec

Balance Sheet of Greencross Limited extracted form ComSec

Every Sunday starting from 17/2/2013 I will write a post about an indicator until every key indicator and heading in the financial statement and balance sheet is covered. 

Thank you for reading!