Market Term - Bottom Up Investing

Bottom up investing is a approach that de-emphasizes the significance of economic and market cycles. This involves call on the stock based on fundamental analysis of the stock.

Stock Actions

Dividends

A dividend is a portion of a company's earnings that is returned to shareholders. Dividends provide an added incentive (in the form of a return on your investment) to own stock in stable companies even if they are not experiencing much growth. Many companies -- mature and young, large and small -- pay a regular dividend to their stockholders.


Companies use dividends to pass on their profits directly to their shareholders. Most often, the dividend comes in the form of cash: a company will pay a small percentage of its profits to the owner of each share of stock. However, it is not unheard of for companies to pay dividends in the form of stock. Dividends can be determined by a fixed rate known as preferred dividends, or a variable rate based on the company's latest profits known as common dividends. Companies are in no way obligated to pay dividends, although they will almost always pay them to preferred shareholders unless the company is experiencing financial troubles.

There are basically three dates to keep in mind when considering dividends. The first is the declaration date, on which the company sets the dividend payment date, the amount of the dividend, and the ex-dividend date. The second is the record date, on which the company compiles a list of all current shareholders, all of whom will receive a dividend check. For practical purposes, however, this is an obsolete date -- the more important date is the ex-dividend date (literally, without dividend), which generally occurs 2 days before the record date. The ex-dividend date was created to allow all pending transactions to be completed before the record date. If an investor does not own the stock before the ex-dividend date, he or she will be ineligible for the dividend payout. Further, for all pending transactions that have not been completed by the ex-dividend date, the exchanges automatically reduce the price of the stock by the amount of the dividend. This is done because a dividend payout automatically reduces the value of the company (it comes from the company's cash reserves), and the investor would have to absorb that reduction in value (because neither the buyer nor the seller are eligible for the dividend).

Why do some companies offer dividends while others don't? For that matter, why do any companies offer dividends? The answer, naturally, is to keep investors happy. The companies that offer dividends are most often companies that have progressed beyond the growth phase; that is, they can no longer sustain the rate of growth commonly desired by Wall Street. When companies no longer benefit sufficiently by reinvesting their profits, they usually choose to pay them out to their shareholders. Thus regular dividends are paid out to make holding the stock more appealing to investors, a move the company hopes will increase demand for the stock and therefore increase the stock's price.

So what is the appeal of dividends? They offer a consistent return on a low-risk investment. An investor can buy in to a company that has a stable business and stable (albeit low) earnings growth, rest easy in the knowledge that the value of his or her initial investment is unlikely to drop substantially, and profit from the company's dividend payments. Further, as the company continues to grow, the dividends themselves may grow, providing even more value to the investor. This is one way to treat dividends; however, there are other strategies for profiting from dividends. Some investors try to "capture dividends": they will purchase the stock right after the dividend is announced, and try to sell it for the same price after they've collected the dividend. If successful, the investor has received the dividend at no cost. This usually doesn't work, because the stock price usually adjusts immediately to reflect the dividend payout, as interested buyers know the stock no longer includes the current dividend payment and they adjust the amount they're willing to pay accordingly.

Splits

A corporation whose stock is performing well may opt to split its shares, distributing additional shares to existing shareholders. The most common split is two-for-one, in which each share becomes two shares. The price per share immediately adjusts to reflect the change, since buyers and sellers of the stock all know about the split (in this case, it would be cut in half). A company will usually decide to split its stock if the price of the stock gets very high. High stock prices are problematic for companies because they make it seem as though the stock is too expensive. By splitting a stock, companies hope to make their equity more attractive, especially to those investors that could not afford the high price.

Stocks can be split two-for-one, ten-for-one, or in any ratio the company wants. (The less common "reverse split" is when the number of shares decreases, for example one-for-two.) To illustrate what happens when a stock splits, let’s look at a simple example. Say you own 100 shares of stock in XYZ Corp. that are priced at 100 per share. XYZ decides that 100 per share is too high of a price for its stock, so it issues a two-for-one stock split. This means that for every share that you previously owned, you now own two shares, giving you 200 shares. When the stock splits, the price will be cut in proportion to the split ratio that was chosen by the corporation (in this case, to 50 a share). If you compare the amount of your investment before the split and the amount after the split you will notice that they are equal (100 shares x 100/share = 10,000; which is the same as 200 shares x 50/share = 10,000). So, in effect, nothing has changed from your perspective.

But although technically nothing changes for the investor during a stock split, in reality often times there are changes. Not only does the split tend to increase demand for shares by making the shares more accessible to small investors, it also usually garners favorable media attention. This tends to cause the price of a stock that has split to increase after the split. The split is interpreted by some as a sign that the company's management is confident that the stock's price will continue to rise. Of course, there is no guarantee that this will happen.

Buybacks

A buyback is a corporation's repurchase of stocks or bonds that it has previously issued. In the case of stocks, this reduces the number of shares outstanding, giving each remaining shareholder a larger percentage ownership of the company. This is usually considered a sign that the company's management is optimistic about the future and believes that the current share price is undervalued.

Companies may decide to repurchase stock for many reasons. They may be attempting to improve the price to earnings ratio by reducing market capitalization, or they may want to offer the stock as an incentive to employees. It's important to note that when a company's shareholders vote to authorize a buyback, they aren't obliged to actually undertake the buyback. Some companies announce buyback plans as a sign of confidence, but it's meaningless unless they actually go through with the repurchase.

Greed = Loss at the stock market

Here is a very intriguing first hand article from rediff.com on day trading.

You win some. You lose a lot.

This epigram is the perfect explanation for my pitiful experience as a day trader.

January 27, 2001. Monday, 9.55 am.

A day after the horrific earthquake traumatised Gujarat, I enter an air-conditioned room with a computer on which buy/ sell orders [for shares] are fed. They are then sent to a broker's server and from there on to the stock exchange's server where the transaction is completed.

This is referred to as a sub-broker's trading terminal.

My life, since that ill-fated day, has never been the same.

Those were the heady days when day traders either made a killing or got killed in the now much-maligned K-10 stocks.

Let's bust the jargon

Before I start my saga, let me explain some of the terms I will be using.

Day traders are those who buy/ sell stocks during the day and square up their position by the end of the day. Which means they either book a profit or a loss.

This breed traditionally likes a volatile market; it helps them rake in the moolah. And to say the markets were volatile those days would be an understatement.

K-10 refers to infamous broker Ketan Parekh's favourite stocks.

They spanned a spectrum that included software, media, banks and pharmaceuticals. To name a few: Silverline Technologies, Aftek, Infosys, Pentamedia Graphics, HFCL, Global Telesytems, Zee Telefilms, Global Trust Bank and Ranbaxy.

Buying into any of the K-10 stocks in the morning and selling them by evening (with the sole intention of making a huge profit) was how day traders like me evolved and finally perished.

Those who buy first and sell later are said to go long on that particular stock. They expect the share price to rise. So they buy shares at a low rate, hope the price will rise and sell when it does.

Those who sell first (without owning the shares) and buy later are said to go short on that stock. They expect the share price to fall. So they sell at the current rate, expect the price to fall, and buy them again at the lower rate.

The day begins

Now, that we have the jargon clear, let's flashback to my very first day as a day trader.

I went short on (sold) five shares of Infosys when it was worth some Rs 6,000, hoping to cover (buy) them at a lower price by the time the market closed for trading at 3.30 pm. I did this after a pink daily (a business newspaper) recommended going short on Infosys at that particular level.

Back then, the market regulator, the Securities and Exchange Board of India, was rather smug and complacent; most pink journals (business newspapers and magazines) offered their own recommendations on what to buy and what to sell.

After an initial nervousness following the earthquake, the market resumed its upward journey catching short sellers like me on the wrong foot. The stock closed higher than what I had sold it for.

Never one to accept defeat -- and to proclaim my fortitude to my peers -- I decided to wait until Friday to close my position (decide what I finally wanted to do).

Here I would like to remind you, dear reader, that you did not have settle your trade at the end of the week (pay for what you bought and take money for what you sold). All you had to do was pay a small amount (a margin) and you could settle it the next week. I did this hoping the price would fall the next week. This was called badla financing.

Finally, though, I reluctantly booked my losses (and there were many more that followed) on Friday as the stock did not come under selling pressure (nobody was interested in selling so the price remained high).

My first debit came to around Rs 1,200 (5 shares x the difference of Rs 240 at which I bought those shares to cover my position).

Got the picture?

I sold the shares at around Rs 6,000 and instead of buying them later at a lower rate (I had betted on the rates falling), I ended up buying them at a higher rate.

Thankfully, at the cost of snubbing my own ego, I'd decided not to go for badla financing. The stock climbed further the following week and my losses would also have climbed accordingly.

The sins of a day trader

Smarting from my first loss and determined to make up for it (the most unforgiving sin I ever committed in retrospect), I decided to go long on GTL and HFCL the next week at a very high price.

As luck would have it, the prices of both the stocks did increase and I would have definitely made up for my losses if I had the sanity to sell them. But then I remembered Gordon Gekko and his dictum: Greed is good. In fact, I went a step further and declared: Greed is God (another sin that a day trader should never commit).

No points for guessing right. I lost again. Lost in the sense that the prices fell down from their stratospheric levels and I had to sell them at a small profit (remember a bird in the hand is worth two in the bush; likewise book your profits when you see them. Don't be greedy).

I -- and many like me -- failed to read the coming correction.

I made a neat profit of some Rs 700 after paying brokerage and service tax: my first profit after the initial loss. My happiness knew no bounds that day and my chest grew an inch wider.

Thenceforth, I learned a lot of lessons in day trading from my peers who'd visit the same trading terminal, but never put them into practice. I went on making one mistake after another (always thinking that I knew better), kept losing money week after week until 9/11 happened (I had also lost a fortune following the Ketan Parekh scam, but that's another story).

Not that I made money after that devastating attack on the World Trade Centre.

What I did was to make up was my mind to finally quit day trading, but not before my losses had reached almost Rs 2,00,000 (I have preserved my final debit bill like a souvenir). Then, I knew I had only one option left. It was a wise one; I decided to put an end to my crazy punting ways.

This is what happened...

Reality hit home

A few days before 9/11, I had gone short on (an addiction I picked from my sub-broker, who went short on any stock that took his fancy) Aurobindo Pharma, Infosys (yet again), Moser Baer, Digital Equipment (now Digital Globalsoft), Ranbaxy and what have you...

I had made (notionally) a tremendous profit on Moser Baer itself, on which I had gone Rs 275 short. The price now was Rs 240. In the next few days, MBIL's market price plummeted to Rs 179.80 but, once again, I was possessed by Gordon Gekko and did not cover my position by buying the stock.

As my misfortune would have it -- though I think it was a blessing in disguise -- the stock started rising, as quickly as it had plummeted. I ended up covering my position at a marginal loss.

Even though I made profit on other stocks that I'd gone short on, the entire episode diminished my appetite for day trading.

Also, realisation had sunk in -- a day trader always wins some and loses a lot. I know of many punters who'd agree with me.

PS: Not satisfied with my own losses in Silverline Technologies -- of which I bought 50 shares at Rs 380 -- I convinced my aunt to buy 50 more at Rs 185. I told her what a value buy it was at that level and promised her that she would be soon selling it at double the price. Even as I write this piece the stock's quoting at Rs 4.05. Not to mention the fact that it is still languishing in my portfolio!