7. Fundamental (Micro) “Cash Flow Statement”

     Cash Flow Statement (CFs) is very important in terms of predicting a future cash. The question is why don’t we just look at assets of the company? Are they the same thing? Some parts they are the same, but some are different. If I need to explain their differences, I would say cash is a subset of asset. Asset has many classes ranged from the lowest to highest liquidity. The highest liquidity is cash (might not be true in the present because credit card or online payment might be faster J). The reason that we want to know the cash balance of a company is if a company has no cash on hand at any time, a company may go bankrupt. It’s true that if any company has no cash, it could possibly borrow or OD from a financial institution. However, in the case that a company has no cash at some points, it means a company has a hard time maintaining the cash balance. As a result, that company might not have a capability to borrow more from any place.

     Another way you can think how important the cash is. You think of yourself having everything; house, car, etc. but you don’t have cash. Soon, you will have a hard time living your life and you might need to sell your assets to get some cash. So, people want your cash not your house or car (if they can choose). This analogy is the same as the borrower and lender. If you don’t have enough money to pay for your lenders, they can drag you down to the hole of bankruptcy.

     So, let’s look at how the cash flow statement is constructed. Cash flow statement consists of three activities.

      1. Operating

      This activity is related to day-to-day operation (e.g., collecting cash from customer, interest or dividend return).

      2.   Investing

  Investing activity is buying/selling some assets that generated revenue for a company for a long time, such as building or machine.

      3.   Financing

  The transaction involves in this category is about lending or borrowing money, such as issuing stock or bond.

The following is the sample of cash flow statement.

Source:http://www.unleashingideas.org/global-entrepreneurship-library/sites/grl/files/biz_resources_book-4.pdf

Algorithm: Stock screeners

    Today, I want to write the topic that I think it's interesting for me which is apart from what I usually write (fundamental knowledge in investment). I think most of you might have heard about the word "algorithm". In case of investment, due to the technology era, most of the trade depends on how fast you can utilize the computer and algorithm. In my opinion, the meaning of algorithm is what patterns of trade you  put on the computer's system in order that the computer will execute the trade accordingly. There are many strategies, but what I'm interested in to write today is what are the basic stock-screening criteria.
     I got this stock-screening criteria from one of my text books. "Essentials of investment" by Bodie Kane, and Marcus, as well as the advice from my professor of this class. Let's take a look at them......

You can get all information from yahoo finance and stockcharts.com
http://finance.yahoo.com/
http://stockcharts.com/

1. Low P/BV (close to 1)
    P=Price, BV=Book Value
     Price is the market price of the stock. Book value is the Asset minus Liabilities (pls, recall from Balance Sheet topic). Both of them could be both for each stock or total value. I mean if you calculate using price for each stock you need to divide your Equity by the number of total stocks. If price is closed to book value, it is good because it still has room to grow. We call it "value stock".


2. Low P/E (less than 10)
    P=Price per share, E=EPS=Earning Per Share
     The logic is similar to P/BV that if it is low, it's not expensive yet.


3. Surprised Earning Announcement
     There is a research showing that a few months after a company announces the surprised earning, company's stock price will always go up. So, we can interpret that if any companies announce surprised earning today, we should buy them and expect their prices to go up in a few month.

4. Small market Cap
      market cap = price X numbers of share
      The logic behind this criteria is that small stocks could generate you substantial amount of profit, because they are valuable but no one know about them much. Since few analysts pay attention to them, few people know about them. So, the small cap I mean is about less than 500M.

5.Beta
      Beta shows you the change of the stock price compares to the market (index). For example, if stock A has -1 beta, when the index change 3 percent, stock A will change 3 percent also but in the opposite direction. We don't want high beta because it will be too volatile.

6. Uptrend
     You can check this criteria from the graph. It needs to show you the bottom and peak need to be higher like the following picture.

7.Dividend

     Stocks should pay dividend.

If you don't have any idea yet what kind of stock you want to buy, these 7 screeners should be a good start!!

Income Statement

     Another tool to assess an interested company that you want to invest is "Income Statement". Income Statement will show you the profit and loss of a company. Unlike balance sheet that shows you the value of an asset since a company starts, Income Statement shows you a profit and loss of a specific range, such as a month or a year.
     If you read the topic "Fundamental (Micro) Balance Sheet" you should remember the part called "Equity". At last, Equity will be the section that ties Income Statement and Balance Sheet together. Profit/Loss will increase/decrease the equity which can be interpreted as a wealth of a company's stock holder.....let's see how "Income Statement" looks like!

Single Step

Source:http://www.vertex42.com/ExcelTemplates/income-statement.html

     The example above is the Single-Step income statement which is the simplest form of income statement. Just revenue minus cost, that's all!
     Next, some companies use Multi-Step income statement.

Multi-Step

Source: http://www.econ.ucsb.edu/~harmon/abc-multi.pdf

     You might get confused at this point why it is so different, but actually it is the same principle that revenue minus cost!

     Everything from the beginning to the red cross (X) is the company's main operation transaction which is easy to understand. We call it "Income from continuing operations". I will explain the highlighted topics that do not appear in the single-step income statement.

1. Discontinue operations: A segment or major business line that a company plans to sell/abandon.

2. Extraordinary item: Some unusual transactions or infrequent, such as natural disaster and new law effects.

3. Cumulative effect of accounting change: Such as inventory method FIFO, LIFO.

      We will stop about Income Statement here. I just want you to get some senses out of it, don't need you to be an expert! Next, we will explore some more about "Cash Flow Statement".

What's the problem if Mechanics stop lubricating the engine?

    Now is around 5 years since we faced the 2008 crisis. Everyone has tried to push the economy back up to the pre-crisis level, especially US Federal Reserve (FED), which now the world puts the spot light on, because America is the biggest country in terms of GDP (Gross Domestic Product).....I'd like to elaborate more why right now America is the hottest country in terms of investment.
     When a country faces a crisis, it means the economic engine becomes unsmooth and, sometimes, might even get stuck. The reason is because people delay their spending due to the fact that they want to save the money in case they are laid off. So, when the economic engine is working roughly, we need a mechanic to lubricate the engine. The mechanic here is the government (fiscal policy) and central bank (monetary policy).
     Typically, a government and a central bank will collaborate on improving the economy. However, government has overspent for the past several years; therefore, a government did not have enough power to lubricate the economy's engine, thus all responsibilities falling to central bank.
     During the 2008 crisis, central banks of every country put all their effort to keep the economy from falling down, but FED had the largest power; consequently, we need to consider FED because what the FED do will affect the whole world.

Ben Bernanke (Federal Reserve Chairman)

     So, what is the lubricant in my meaning? It is....."Money". The economy engine is driven by "money".
     There are many ways a central bank can inject the money into the economy, but the main tool is adjusting interest rate down. Let's see how it works......

When interest rate is down > people is tempting to borrow more because of the lower cost, such as housing loan > Then, people use that money to hire contractors to build their house > Then, constructors pay their workers a salary > Then, workers go to shopping at department store > .... This cycle will be iteratively going on and on, and economy then come back on track.

Food for thought!! Imagine that the first group of people in the cycle above did not borrow the money. What would happen?...... There would be no cycle!.....economy would get stuck!!!

     Okay, we com back to the point that why FED is on the spotlight now. Now, there is an issue that FED will put less lubricant on the economy. In other words, FED will decrease the amount of money FED injects in the economy, because FED believes that, now, economy is strong enough to stand on its own feet. Investors around the world are afraid that the economy will go down owing to this operation. In terms of investment, investors are more risk averse, and start to draw their money back from risky assets (e.g. stock) ......Last month (August), if you notice, stock markets around the world started to face a correction. The currency's value in emerging countries tumbled around 10% because the money flew out of the country. So, you might not be able to expect much at the end of this year.

Fundamental(Micro) "Balance Sheet"

     Previously, I mentioned that micro fundamental is to look deeply in the specific company via financial report. The followings are the 4 types of financial reports.

     1. Balance Sheet
     2. Income Statement = Profit and Loss = P&L
     3. Cash Flow
     4. Statement of change in equity

1. Balance Sheet

     Where does the name "balance" come from? What does it actually mean?.... In the accounting principle, it divides the balance sheet into 2 sides; left and right; and they need to be "balanced". If the left side has $100 value, the right side needs to have 100$ as well ( I will give you the example shortly). The next question is what do the left and right sides mean? The left side is the assets the company has/own. The right side is how company gets those assets by either from borrowing or from using their own (owner) money to get the assets. In the accounting term, we call borrowing "debt" and using owner money "equity".
     Example: There is a company named "Farmer Inc." which is founded by Mr.Lee. Farmer Inc. has two kinds of asset; a shovel and a horse. Assume that Mr.Lee uses his own money to buy the shovel, but he borrows money from a bank to buy the horse because it is expensive. Let's say the shovel price is $50 and horse's is $1,000. The following is the balance sheet of the Farmer Inc.

     In sum, a balance sheet will show you what assets a company owns at what value and how they acquire those assets (debt or equity).

    
     Actually, It's pretty easy if you understand the concept. Your next step is just to know the categorization and terminology.

• Categorization

              Both assets and debt are further categorized to short term and long term. The cross line between short and long term is 1 year. For example, if you have an assets that you are going to use it more than one year, it will be long term assets (e.g., building and car). And, if you borrow the money and need to return it in one year, it will be short term debt.

• Terminology

              There are a lot of jargons in accounting. You can study them by picking the balance sheet of some companies and googling words that you don't understand. If you are still confused, just email me:)

Next article we will talk about "Income Statement".

    

Mechanism

     After you decide to invest in the stock market, certainly, you might need some mechanisms to help you succeed. Here, I will divide the mechanism into two groups: fundamental and technical mechanism. In addition, I will split "fundamental" into Micro and Macro.

1. Fundamental

     The reason that we call "fundamental" because when you pick the stock, you want  a good stock. "Good" can be vey broad but, here, I will concentrate on "performance". How can we evaluate the company's performance? Basically or fundamentally, we will look at company's performance report and compare it with company's past performance, other similar types of companies' performance, and other different types of companies' performance.
     The report I mentioned is "financial report". Someone might not want to read further after hearing about financial report which is somewhat complicated for them. I agree that financial report is, sometimes, very detailed and hard to understand. But, we don't need to read every page! We just need to know where to start and go from that. Trust me it will be more fun if you know where to start. After you know the fundamental track, then, you can have your own style built on that track. You might have a question that how can we make a difference if the information everyone has is the same. I can tell you that even though people read a financial report which has the same information every page, they might come up with different conclusion. For instance, have you ever seen all broker houses recommend the same thing for the same stock? I've never seen that. It might have, but I think it is very rare. The same stock at the same period, broker A might recommend "buy" but broker B recommend "sell" even though they had the same information from the financial report.......Why?......because they had a different experience, knowledge, and attitude. For example, if I ask you whether $1,000,000 is big. For me, $1,000,000 is big because it is hard to get that amount of money. However, if you ask a billionaire, they might say that it is very tiny (might feel like $100 for them). My point is people have different experience and attitude. That's why we could come up with a different conclusion even though we have the same exact information. What I just said is a "Micro fundamental" that we deeply go into one company through its financial report, but in terms of "Macro fundamental", we will analyze the environment surrounding that company, such as monetary policy, government spending, tax, trade cooperation (i.e., NAFTA).

2. Technical mechanism

     The reason that we call "technique" because this mechanism needs some technical mathematical expertise. Shortly, technical mechanism is analyzing the historical information through mathematical tools. So, if stock A was just listed in the stock market yesterday, this approach is unlikely to be used because there is no historical information available.
     I will give you some examples how to use a technical approach. Given that in the past 5 days (Mon-Fri) stock A's price is 5  8  6  8  7 respectively. One of the popular technique is "price average". 5-day price average of stock A is (5+8+6+8+7)/5 = 6.8. If next Monday, price of stock A open at 6.5, some investors might buy this stock at 6.5 out right for the reason that it was lower that 5-day price average. In the real world, there are different price average ranges such as 10, 100, 200 days to name a few.

I hope this article might give you some idea about fundamental and technical approach. Next article, we will go into more depth.

Picking Stock: "Believe in yourself"

  

     Since you invest with your own money, why don't you pick stocks yourself rather than borrow other people's thought. (No one can understand you better than yourself!) However, someone might have a question that why do we need to pick the stock that is suitable for us? Why don't we just pick the stock that we can earn maximum profit? "I don't care about picking the right stock for me as long as I can make money" This might match with someone thought! I can tell you that if you have this kind of attitude, in the long term, you will have nothing left, because it is a greedy attitude. you need to have definite goals, such as retirement, child's education, and house or car. These targets will make you know how much you have to earn from investment. Someone might not need to invest in stock at all after they understand their relationships between goals and returns. For instance, single and married people, certainly, have different financial burdens, so single people might not need to invest in stock because of their lower financial burden. Let's come back to the important question here before we go too far about "goal setting".

The question is why do you need to pick stocks that are suitable for you?....because

1. Good for your health!

     It might be confusing, but it's true....because if you buy stocks that are suitable for you, those stocks will match with your life style, characteristic, experience, and expertise well. For instance, if you work in the hotel industry, you should  buy hotel or travel stocks, or any stocks related to your expertise (hotel), because you know about hotel more than other people on average. So, when hotel stocks go down sharply, you will be the very first group of people who know what happen, and understand it without anxiety. Imagine that, this year, there will be the Olympic in Brazil. Most of travelers will go to Brazil and ignore other attractions around the world. Consequently, most hotel stocks' price around the world go down because of this circumstance. If you work in the hotel industry, you will know that this is just a short term trend. Next year, hotel stocks' price will be back.
     On the other hand, Mr.D opened stock account with Mr.B (Broker representative). Mr.B recommended Mr.D to buy hotel stocks. Mr.D followed Mr.B's advice by buying hotel stocks with some considerable amount of money. Two months later, the hotel stocks Mr.D bought plunged dramatically with the same reason above (Brazil Olympic). After long discussion with Mr.B about the reason, Mr.D seemed to understand, but Mr.D still has acute anxiety about it in his mind. Over time, Mr.D kept thinking about it. Mr.D was so stressful that his thoughts started to affect his work and personal life. Eventually, he decided to sell the hotel stocks so as to know that their prices were going back in the next few months after he sold:(

2. Invest with fun!
 
     Picking stocks for me is like learning. Learning something that you don't like is hard to make an impressive progress. If you buy the stock that you have no idea what its business is, you will just look at the price of the stock, but not the value of that stock. You will not be able to connect the factors that have an effect on your stock, because you don't know the core business of it. When you could not connect your stock with the factors related to it, you will never be able to forecast what will happen with the price in the future. You will think that all depends on "fate". If you have that thought, try to think what is the purpose of CEO, business's strategy, education? These factors try to push up the company's performance and stock price, don't they? It is not the fate that drive the stock price, but the company's performance!

     Therefore, before you buy a stock, you should know what your expertise is and try to apply it to how you buy your stock. It will generate you more value than keep following other people's advice without real understanding. You might find that you can read or learn about a stock you like for many hours. You can get more fun and knowledge with this style of investment:)