Tag Archives: Finance

Dividend Stocks, Investing

Pros and Cons of Discounted Cash Flow Valuation

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Pros and Cons of Discounted Cash Flow Valuation

Most investors care about one thing when it comes to choosing a company to put their investment: cash. The cash flow of a company is important for investors because it is the basis for the possible amount of money they are going to receive. For that reason, an appropriate approach has to be followed to devise a sensible investment decision. 

Discounted Cash Flow Valuation is a mathematical technique in gauging the appeal of an investment on a company based on its potential cash flows in the future. This evaluation method helps to determine the value of a company today which must be derived from the capability of a company to continuously generate cash stream in the coming years. Analysts exert efforts to construct projections on the financial performance of a company with the aim of weighing up its value. Aside from the individual investments, discounted cash flow valuation scrutinizes the projects that the investors or the company can maneuver. 

The present value of projected future cash flows requires a discount rate for discounted cash flows valuation. The company’s estimated present value is needed in order to thoroughly assess a possible investment. The potential investment could be taken into account once the present value computed using the discounted cash flows analysis is proven to be greater than the cost of the investment today.

The discounted cash flow valuation is advantageous for investors from the fact that the present value of a company can be used for them to estimate the future cash flows that an investment or a project can bring. Investors must consider not only the investment but also the ending value of pieces of equipment and other assets for them to accurately appraise the potential cash flows in performing the discounted cash flow valuation. 

But before you depend on this valuation method, we are going to discuss the advantages and disadvantages of using discounted cash flow valuation. This is for you to determine if this method is appropriate for the company and to assess the extent to which you can rely on this valuation method.

Discounted Cash Flow Advantages:

  • A Practical Instrument to Back Up Value Prices Issued by Analysts

There are a lot of aspects that influence discounted cash flow analysis such as profit margins and future sales growth. The valuation method takes account of the discount rate affected by the risk-free rate of interest. Discounted cash flow analysis regards the company’s cost of capital and potential risks to its share prices as essential steps from this valuation method. For you to estimate the company’s share price precisely, these factors cannot be overlooked because these will give ideas about the different elements that influence a company’s value. 

  • Dependability and Precision

According to corporate finance textbook authors Peter DeMarzo and Jonathan Berk, “the most accurate and reliable” valuation method for constructing a sensible investment decision is by using discounted cash flow analysis to decrease investments to net present value. Although some results on computing using this process are doubtful, there is no existing valuation technique that can be as reliable as the discounted cash flow analysis in assessing the investment which provides the greatest value for the company. 

  • Focuses on a Single Figure

One of the benefits of applying the discounted cash flow model is that it uses a particular value to represent an investment. This valuation method aids to rationally decide upon different investments. If the discounted cash flow model concluded a negative result, the company can have a possibility to incur losses due to the investment; if it leads to a positive outcome, the investment has the capability to bring successful cash inflow and can be considered by the company. The analyst shall forecast the cash flows from the investment, discount it to the present value, combine them all, and systematically weigh them up. The most lucrative choice is the one that has the greatest present value.

  • Reliability on Free Cash Flows

For investors, discounted cash flow analysis is the only valuation method that depends on free cash flows. Free cash flows are the cash of a company gained from its operation, decreased by the cost of expenditures on assets that is why it is a reliable measurement of money allotted to the investors. It is also a good basis of valuation because it disregards the independent accounting policies and manipulation of financial statements related to reported earnings. Free cash flow is essential for the discounted cash flow valuation since it helps to determine the companies that have high open costs that have a probability to impact earnings today but has the capability to escalate earnings eventually. In addition to that, free cash flow exposes the capacity of a company to satisfy its obligations, stabilize its growth, and distribute dividends. 

  • Validation Purposes

The discounted cash flow method is commonly used to easily assess whether the current share price is reasonable or not. As an alternative to approximating the intrinsic value, the current stock price is applied upon the discounted cash flow valuation model. By working in reverse, the valuation model will reveal if the company stock price is overvalued or undervalued. 

  • Business Strategy Construction

Other valuation techniques have limited data that restrain them from being exploited by devising business strategies. Investors can maximize the use of the discounted cash flow model by considering it as one of the bases for significant alterations to the business strategy.

Discounted Cash Flow Disadvantages:

  • Complexity 

The risk in employing the discounted cash flow model is deciding what cash flows to be discounted while the investment is complicated and substantial, or the unfamiliarity of the investors about the future cash flows. This valuation method is important for investors since it is based on cash flows offered for the new shareholders. A weak value is constantly implied when the method is based on the distributed dividends to a small group of shareholders.

  • If Widely Employed 

If the discounted cash flow is used excessively and outside its coverage, it may lead to unreliable presumptions. Continuously fluctuating amounts relevant to the valuation method may nullify the analysis once an investment or a project has commenced.

  • If Relevant Data are Inaccessible

As minority shareholders, they lack information about a company’s cash flows and projects needed to form assumptions for the discounted cash flow valuation since they don’t have any control from it. Therefore, this valuation method will not be beneficial for these investors. 

  • Susceptible to Appraisal Mistakes

The discounted cash flow valuation is a powerful instrument from the fact that it covers a broad range that covers the data for estimation. The model is prone to different kinds of errors. If estimated figures are fallacious, the net present value might be erroneous as well. Therefore, the model is impractical to use since it may cause an investor to form poor investing assessments and decisions. The valuation method is achieved by constructing forecasts. The cash flow of a company is required to be forecasted by an analyst. But that process cannot be attained only by just guessing because the data will be unreliable. The cash flow projection must still be based on significant pieces of evidence. In addition to that, the discount rate on the discounting formula must be estimated. The specific total cash changes periodically have to be presumed in order to get the discounted rate. 

If the discounted cash flow valuation is too complicated for the investors to understand and to maximize as a basis for their investment decisions, the method will not be significant. Hence, alternative techniques have to be utilized. But if you try to study the method with the help of qualified valuation accountants, you can thoroughly scrutinize companies for long-term investing. 

 

Economy, Market News, S&P 500

Economic Policy: Recent Fed Rates Cuts and Their Significance

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Economic Policy: Recent Fed Rates Cuts and Their Significance

The Federal Reserve (Fed) has the responsibility of implementing monetary policy on behalf of the US government by setting interest rates. When interest rates are low, capital is available, which stimulates economic growth. However, if unchecked, low-interest rates may lead to high inflation. High-interest rates create a situation of low money supply, which may cause a recession or even depression.

The Fed is required to maintain acceptable levels of unemployment between four to five percent while restricting inflation to figures around two percent. The Fed achieves this mandate by raising or lowering the fed overnight lending rates (the fed funds rates). At the end of October 2019, the fed decreased the fed funds rate to a target of between 1.5 to 1.75 percent. This is the third cut since July this year.

Why Did the Fed Cut Interest Rates?                    

By lowering the fed funds rate, the Fed aims at stimulating economic growth. The department of commerce has released data for the third quarter that shows GDP growth at a rate of 1.9 percent. Although the figures are better than the market expectation of 1.6 percent, it is a decline from the 2.0 percent growth in the previous quarter. The US growth is on a decline, in the third quarter of 2018, GDP growth was at 3.4 percent. The 1.9 percent growth rate is the slowest in 2019.

The October interest rates cut was more of a precautionary move. A majority of fed committee members believe that the US economy is reasonably strong. The current unemployment rate is the lowest in recent times. Consumer spending performed better than expected. The rates cut is a result of reduced investments and exports due to weakening global growth. The Fed’s decision to cut interest rates is to protect the US economy from the trade-war effects and global slowdown.

Importance of the Fed Funds Rate

The Central Bank of America monitors the performance of the US economy due to its significance to the global markets. Currently, the US is operating on a budget deficit meaning the economy is a net importer. Many countries across the globe depend on exports to the US for stability. Should the US economy underperform, many economies will be hurt. A recession in the US will adversely affect Canada, Mexico, Europe, and many other nations like it did in 2008-2009.

Significant volumes of investment instruments in the financial markets are US dollar-denominated. For this reason, the Fed has to worry about the economy, and by extension, the US dollar. The US dollar is of great importance in international investments and the flow of capital across borders.

Three Funds Rate Cuts: The Performance Connection in Bonds

Historically, three successive interest rates cuts have had positive effects on the performance of the bond market. Between 1995, 1996, and in 1997, there were three consecutive rate cuts and a pause. The S&P 500 returned 24 percent and 19 percent in those years. Where there had been an economic slowdown followed by three rate cuts and a stop, the economy always responds by accelerating. The October funds rate cut was the third in a row. Fortunately, the Fed has no intention of cutting the rates further soon. Going by precedence, the bond market is in line for better returns.

Conclusion

Data from the US economy is not giving a clear picture of the status of the economy. While there has been a decline in GDP growth, unemployment and inflation rates are within their targets. The rate cut will help address declining GDP growth and shield the US economy against the impact of the current trade wars. Bond investors should expect improved yields if history repeats itself.

Dividend Stocks, Investing, Options

What’s The Difference Between Cash Dividends And Stock Dividends?

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What Are The Differences Between Cash Dividends And Stock Dividends?

A dividend is the distributed profit by a corporation to its shareholders. This is how corporations give back to their investors as they contributed capital to its successful performance, and maintain a good rapport between them. Periodically, a corporation pays dividends with an amount that depends on each shareholder’s investment to the company. The decision in allocating a portion of retained earnings is developed by the Board of Trustees. The management shall agree to a decision if there must be an appropriated budget for the dividend payment or what kind of dividends shall be distributed.

Most corporations usually issue two types of dividends: cash dividends and stock dividends. Therefore, investors must familiarize themselves with these types of dividends because they will surely encounter both in the future. In this article, we are going to specify the distinctions on every aspect of these dividends in order to bring awareness of why corporations pay a particular dividend. Consequently, this will eventually help you utilize the knowledge to your advantage towards a successful investment experience.

What are Cash Dividends and Stock Dividends?

A cash dividend is a regular payment in the form of money taken from the retained earnings of the company. Normally, cash dividends are distributed quarterly after prioritizing the payment for the company’s outstanding debts. 

A stock dividend, which is also called as scrip dividend, is an allocation of a company’s additional shares originating from unissued shares. This type of dividend is being distributed instead of paying cash dividends to the shareholders if the company’s liquidity is low. Companies distribute stock dividends in order to repay their shareholders without spending cash. Therefore, companies are able to retain their assets and appropriate them for expansion purposes. 

Stock Market Calculations

The amount of cash dividend to be given on a shareholder is different from another shareholder depending on their number of shares since it is issued on a per-share basis. For example, if the Board of Directors declared $20 per share, an investor that owns 10,000 shares will receive $200,000 worth of cash dividend. Even if the cash dividend is stated at a specific percentage, the result will always be the same. Let’s say 10% is issued as a dividend on a $200 par value per share. The investor on the preceding example will still get the same amount of $200,000. 

The amount of cash dividend that investors will periodically acquire depends on how many times the company will issue annually. Using the previous example, the company pays cash dividends quarterly. Therefore, shareholders will receive $5 per share every 3 months. 

With the allocation of stock dividends, the retained earnings are being capitalized while shareholder’s equity stays unchanged before and after its declaration and distribution. The allotment of the stock dividend only expands the number of shares but does not affect the benefits nor the ownership of its shareholders. For instance, a corporation that has 300,000 shares declares a 20% stock dividend. As a result, a shareholder that possesses 3,000 shares from that corporation will gain 600 more shares. The shareholder that owns 10% from the shareholder’s equity will maintain its portion from it after earning a 20% stock dividend and the market price of the stock remains the same. 

A small stock dividend considers the distribution of additional shares of less than 25% chargeable to retained earnings at the market value. While the additional share of 25% is considered as a large stock dividend that must be charged at the par value. 

Advantages of Cash and Stock Dividend Acquisitions

Obtaining cash dividends will benefit investors whose goal is to earn cash regularly. Cash dividend-paying companies are obliged to pay cash to their shareholders regardless of the companies’ financial status. Therefore, investors must carefully pick the cash-dividend paying companies to invest in for them to ensure a permanent source of passive income. 

Through cash dividend, investors are also given the freedom not only to spend it for personal use, but they can also buy more shares from the same company and buy shares to another company concurrently. Shareholders who are willing to reinvest their cash dividend must undergo on a dividend reinvestment plan. Buying more shares is a wise way to earn more money in the future if you believe that the company and economy have the potential to grow. 

The advantage of gaining stock dividends instead of the cash dividend is that investors will not incur tax from its acquisition. However, receiving a stock dividend with a cash dividend option included is subject to tax. Investors can sell their stock dividends in exchange for cash. Due to the sale of the stock dividend, it will not be exempted from tax anymore.

Disadvantages of Cash and Stock Dividend Acquisitions

The liabilities of a company increase because it is paying out cash dividends to its shareholders. The companies that distribute cash dividends may either have enough cash flow to support its growth or just feel obliged to give back to its shareholders in order to gain their trust. If a company still pays out cash dividends while still having losses and outstanding debt, that’s already a sign of its financial instability. Instead of distributing cash dividends, companies could have allocated their cash for expansion purposes which may result in market price appreciation. Aside from that, the cash dividends earned by shareholders are subject to tax based on the amount received. 

Stock dividends don’t have any value for investors who are expecting cash from the company they capitalized on. For that reason, they are pressured to sell it even for an amount lower than the dividend’s market price. In addition to that, shareholders will incur costs and taxes from selling their stock dividends. 

Reasons Companies Issue Dividends

Cash dividends are issued by companies because they already obtained ample earnings. It is predicted that giving back to their shareholders will not affect long-term financial strength. These cash-dividend paying companies pay out cash because they might have a good financial position but has a limited capability to venture on expansion to spend their cash up.  Companies tend to issue stock dividends to their shareholders when it is not yet the right time to exhaust assets just to repay shareholders. These stock-dividend paying companies are just taking safety measures because they don’t want to inflict any harm to their liquidity.

 

Stock Markets

Corporate Earnings Preview: Stock Markets Q3 2019

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Ask Traders Commentary – Corporate Concerns Persist:

Current Market View: Corporate earnings performances during the third quarter period will depend heavily on trade war effects and the economic trends that began during the second quarter.

For the second consecutive quarter, EPS growth in the S&P 500 dropped and the word “tariff” was used in the Q2 conference calls of 142 different companies in the S&P 500.  As a result, expectations for earnings growth have steadily deteriorated amongst analysts.

However, this leaves open the potential for upside surprises. In Q2, roughly 3/4 of all companies in the S&P 500, and this trend could continue during the next reporting periods.

Our Predictions for Q3 2019:   The S&P 500 finished the Q2 reporting period trading at 2,940 and market valuations have since risen by just 1.63%.  Despite the continued concerns over global growth, a steady EPS performance for the S&P 500 in Q3 should help the index vault key psychological levels at 3,000 for the majority of the coming quarterly period.

For more financial news and stock market trading tips, visit AskTraders.com

Earnings Season Preview
Gold, Precious Metals

Silver: This Under-Achiever Is Ready To Shine

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Silver: This Under-Achiever Is Ready To Shine

For most of 2019, the emerging trends in the precious metals space have been undeniably strong.  Many analysist (possibly a majority of the financial analyst community) seemed to think that these types of events were impossible, given the fact that the S&P 500 was on a clear course to continue posting record highs.  

However, when this type of enthusiasm in equities reaches an extreme, it’s often a good idea to start looking at the precious metals space as a protective buffer against the growing potential for downside volatility.  This was the basis for many of my bullish commentaries (and actual trades) during these periods and recent price moves have largely confirmed the accuracy of those forecasts.

If we take a long-term view of the SILVER/USD chart history (weekly), we can see that the initial surge in price activity became apparent during the May-June trading period.  The first major signal that the paradigm had shifted developed once prices forcefully broke through the Ichimoku Cloud structure. Prior to this event, the most significant price lows formed toward the end of May (just below $14.30) and SILVER/USD soon rallied by more than 37.5% to reach new highs of $19.65 in roughly five weeks.

Silver Price Chart
Silver Price Chart

For some investors (particularly those focusing on cryptocurrencies), these rallies might not seem all that significant.  However, we must consider the fact that SILVER/USD had been caught in a dramatic long-term downtrend that had produced very little upside price movement since July 2016.

If we look at this same catalyst event on the SILVER/USD daily charts, we can see that Kumo support lies within close proximity to the current market valuation.  This is another highly encouraging element for anyone bullish on assets tracking the value of silver. As long as markets can hold these levels (and not break downward through the Kumo), the implication is that SILVER/USD will be in a position to move above the September highs of $19.65.

Silver Price Chart
Silver Price Chart

Of course, all of that will depend on price performances seen in the shorter-term charts.  Interestingly, we are starting to see similar events unfold on the SILVER/USD hourly charts (and this largely supports the broader thesis).  

Silver Price Chart
Silver Price Chart

Traders that are familiar with the practice of Fractal Analysis might view these recent developments as particularly exciting, given the ways they suggest an extension of the prior bull move that generated the May-June price breakout in SILVER/USD.

Silver Price Chart
Silver Price Chart

What’s notable here is that the short-term Ichimoku Cloud break (on the hourly charts) shares many of the same features that were present during the May-June catalyst event.  On the hourly charts, there is a bit more distance present between price and the Kumo, so this actually suggests we could still see some further downside without eroding the bullish bias for SILVER/USD.

Silver Price Chart
Silver Price Chart

Furthermore, this recent break of cloud resistance on the SILVER/USD monthly charts was accompanied by an overbought surge in the Connors RSI indicator reading.  When I use the Connors RSI indicator, I will generally look for bullish/bearish divergences rather than instances of price extremity. The reason for this is that the indicator tends to send many more signals when compared to the traditional RSI reading.  

In this case, the Connors RSI projected upside price moves (based on the divergence) and this is another factor that points to an eventual re-test of the September highs.  For more information on how I interpret these specific indicator readings, I encourage readers to review my Connors RSI Trading Tutorial for a detailed explanation of how I conduct my price analysis. 

S&P 500, Stock Markets

Economic Data Reports Send U.S. Stocks To Sustained Highs

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Economic Data Reports Send U.S. Stocks To Sustained Highs

Even with recent declines seen during the summer of 2019, the S&P 500 has managed to post a series of long-term higher highs that have defined an uptrend for the benchmark.

S&P 500
S&P 500

Recent jobs reports in the U.S. have been critical in terms of the implications they hold for the future monetary policy actions at the Federal Reserve.  Stock market valuations will continue to be influenced by interest rate policy changes that are made during the remainder of this year.

Consensus estimates suggest the U.S. economy added an average of roughly 150K jobs for each month of this year (down slightly from the 160K recorded in prior averages).  The national unemployment rate in the U.S. is expected to hold at lower levels, which is a key indicator of economic strength.

On balance, the U.S. is still posting some very strong economic numbers and any positive surprises in the next few jobs reports will likely push the average consensus in analyst surveys closer to the long-term averages.  Current expectations for future rate hikes this calendar year remain questionable. However, all of these data figures will help to clarify some of these issues in the months ahead.

It will also be important to continue watching for developments in the U.S. ISM Services report, which has largely supported the bullish angle over the last year. With the readings that were posted for the last few months. This recent decline from the previous month’s readings may appear ominous but we are still coming off of figures that represent a 12-year high. 

As a result, some declines were reasonably expected in the analyst surveys. Markets have still managed to trade higher after these prior releases on the argument that this long-term strength does bode well for the upcoming nonfarm payrolls figures coming out in the months ahead.

The services sector represents 70% of the US economy and these reports cover businesses like retailers, hospitals, and restaurants. Numbers above 50 signal expansion in the economy, and readings above 55 are considered “exceptional.” We are firmly above those levels, and this helps tip the odds in favor of a bullish data surprise for payrolls reports that follow.

The ISM indexes for new orders have recently seen gains of 64.8 (from 62.7 previously, marking another long-term high). All told, 16 of 17 of the industries that are tracked in the report are showing strong evidence of expansion. This is highly encouraging for the underlying trend in the U.S. economy, as it shows companies are actually having difficulties with skilled labor shortages.

Supply costs have also been seen rising in the recent reports and this brings us back to the potential market disruptions that could be caused by the implementation of a trade war.  As labor costs also move higher, we are looking at a scenario that is essentially ripe for upside inflationary pressure in the U.S. economy.