Future Contract Vs Option Contract

Derivatives are the securities which the value is derived from the underlying asset. Therefore, the underlying asset determines the price of the asset. If there are some changes in the price of the asset, the derivatives will also change along with it. There are few examples of derivatives, such as futures contracts, forward contracts and swaps contract which used by investors to hedge against risks. Today, we will look into the role of Future Contract and Options Contract.

 Future Contract

A future contract is a binding agreement between 2 parties, buyers and sellers where both of the parties promise to each other of buying or selling the underlying asset at a predetermined price at a future specified date. It is a standardized and transferable contract which traded on stock exchange. The future contracts include currencies, commodities, or financial instrument such as FGLD, FKLI, FCPO, FPOL, FUPO, FM70 and so on.

Futures contract put an obligation on the buyers to honour the contract on the stated date, so he is locked into the contract. Companies enter into these agreements because they need to buy or sell the underlying products anyway, and just looking to lock in the price.

 Risks

Both buyers and sellers in the future contracts face a lot of risks as the prices could move against them. Let us assume that the market value of the asset falls below the price specified in the contract. The buyers will still have to buy it at agreed upon price earlier and incur losses. In other words, future contracts could bring unlimited profit or loss.

Expiration Date

A future contract comes with definite expiration dates. Most of the future contracts are not held until expiration, because some short-term traders close their position before expired and there are only a few people or companies who are really want to buy or sell the underlying products will continue to trade and hold their position until expired date. Short-term traders do not hold until expiration because they simply make or lose money based on the price fluctuations that occurred after they buy or short a contract.

 Advance Payment

There is no upfront cost except commission when investors entering into a future contract. However, the buyers for the future contract are bound to pay the agreed-upon price for the assets eventually. This is done for the purpose of locking the commitment made by the parties.

Contract Execution

The execution of future contract can only be done on the pre-decided date as per conditions which have been mentioned in the contract. On this date, the buyer purchases the underlying asset.

Option Contract

An option is a type of derivative which provides holders with the rights but not obligation to buy or sell an underlying asset at a pre-determined price in the future.  Investors can compare the current market price (spot price) and the price on the option (strike price) to determine whether is it profitable to exercise in the option. By comparing both prices, investors can decide either to exercise the option or let it expire.

There are three positions on which the holder can find it themselves.

Call Option is “in the money” if the market price is greater than the exercise price. This is because the call option buyer has the right to buy the stock below its current trading price.

Call Option is “at the money” if the market price and exercise price are the same. In this case, an option contract may be exercised.

A call option is “out of the money” if the market price is less than the exercise price.  In this case, it will better to let the option expire and buy the commodity at the current market price.

Risks

The option seller (writer) can incur losses much greater than the price of the contract when compared to the option buyer (holder). The option buyers can opt out of buying it if the asset value falls below the agreed-upon price. This limits the loss incurred by the buyer. Option contract brings unlimited profits but it reduces the potential losses.

Expiration Date

The expiration date in the option contract is important to investors because it affects the price of an option contract. The longer the time for the expiration date, the higher the price should be and the longer the time the holders have for the option to exercise and potentially to make a profit. After the put or call option expired, time value does not exist anymore. In other words, once the derivative expired, the investor does not retain any rights to get along with owning the call or put option.

Advance Payment

In options trading, the options are either trade at a premium or discount offered by the seller of the option. The option premium is the price that you have to pay in order to purchase an option. The premium is determined by multiple of factors including underlying stock price, volatility in the market and days until the options’ expiration. The higher the premiums will be tied to the more volatile markets, even if the asset is priced less expensive, we also can see the premium rise when the market turns into a period of uncertainty.

Contract Execution

The buyer in an option contract can execute the contract anytime before the date of expiry. So, investors are free to buy the assets whenever they feel the conditions are right.

 Conclusion

In overall, both futures and options are derivatives contract which having its customization as per requirements of the counterparties. By reading this article, we will have more understand the difference between futures contracts and option contracts. As the name suggests, options come with an option (choice) while futures does not have any options but their performance and execution are certain.

Basic Comparison Future Contract Option Contract
Meaning Agreement binding counterparties to buy and sell a financial instrument at a predetermined price and a specific date in the future A contract which allows investors rights to buy or sell an instrument at a pre-agreed price. It will be executed on or before the date of expiry
Obligations / Rights A full obligation to execute the contract at the stated date Provides rights but not obligations to buy or sell
Risks High Restricted to the amount of premium paid
A degree of Profit / Loss Unlimited profit/losses Unlimited profit and limited losses
Expiration Date On expiry date, buy/sell underlying assets On expiry date, do not retains any rights
Advance Payment No advance payment Paid in the form of premiums
Execution of Contract On  pre-agreed date Any time before the expiry of agreed date

 

Written by Stella Goh | 10th March 2019

What is Exchange Traded Fund (ETF)?

ETF stands for an exchange-traded fund. It is an open-ended investment fund listed and traded on a stock exchange. There are 3 types of ETFs listed in Bursa Market, which are equity ETFs, fixed income ETFs and commodity ETFs. In Malaysia, the ETFs were managed under licensed asset management companies like Affin Hwang Asset Management Berhad, AmFunds Management Berhad, CIMB Principal Asset Management Berhad and i-VCAP Management Sdn Bhd.

Diversified Exposure

ETF combines the features of an Index fund and a stock, which you able to invest to a counter with various stocks or bonds or commodities included. The features offer you to gain exposure to a geographical region, market, industry, commodity or even specific investment style such as growth or value. For example, MYETF DOW JONES U.S. TITANS 50 (0827EA) is a Shariah-compliant equity ETF traded in US Dollar. It comprising the 50 largest companies listed on NYSE and Nasdaq. It is good for investors who like to diversify their capital in US market with just buying the ETF. Another example, CIMB FTSE ASEAN 40 MALAYSIA (0822EA) consists of 40 constituent stocks from 5 ASEAN countries namely Singapore, Malaysia, Thailand, Indonesia and the Philippines. Investors who like to diversify their capital throughout ASEAN countries, this ETF provides a good simplified solution.

Controllability

The combination basket of stock inside the ETF is predetermined and will be managed by the fund manager through the market. Once the transaction successful, the investor will become one of the unitholders of the fund. The controllability of an investor is just the same as holding a stock counter, can sell whenever it worth to sell and buy whenever it worth to buy with personal judgement.

Liquidity

The liquidity of an ETF relies on a combination of primary and secondary factors. The primary factors include the composition of the ETF and the trading volume of the underlying assets. ETFs can be invested in some asset types including real estate, fixed income, equities, commodities and futures. Within the equity universe, ETFs can focus on different market capital size and different level of risk. With the diverse selection of the ETF’s focus, the liquidity will be affected. Besides, the trading volume of underlying individual stocks does matter too. The more actively traded particular security is, the more liquid it is.

Secondary factors are the trading volume of the ETF itself and also the investment environment.  Taking an example to compare CIMBC50 with ABFMY1, CIMBC50 will get higher liquidity as more investors trading on. Due to trading activity is a direct reflection of the supply and demand for financial securities, the trading environment will also affect the liquidity. As Malaysia ETF market is not mature yet, investors could hardly to sell off their ETF at the desired price and make a big spread. Hence, it is more advised for a long-term investment for ETFs to trade on Bursa Exchange.

Transparency

The list of the ETF constituents will be updated on the ETF’s website by daily basis. Hence, investors can accurately know the current stocks or underlying assets been held within the ETF.

Conclusion

Overall, ETF is a financial product made up with the concept of a mutual fund but been sold or traded like a stock on the exchange. An investor can consider ETFs to diversify their portfolio and reduce their profile risk at a lower cost. However, for traders, ETFs are not that advisable as lower trading volume compared to stocks or commodities assets.

A comparison table between ETF with stocks and unit trust has been prepared and listed below.

  ETF Stocks Unit Trust
Purchasing platform Listed on Stock Exchange Listed on Stock Exchange Through unit trust consultant
Exposure High diversity on particular asset class Only individual shares Various diversity
Controllability Yes,

on volume, selling and buying timing

Yes,

on all decisions

No,

Had already passed the management right to the trustee

Price May change any time in trading hours May change any time during trading hours Disclose after market close
Liquidity Currently low,
as low trading volume
High,
anytime when match buying/selling price
Middle,

transaction available after market close

Cost-effectiveness Yes,
a minimum of RM10 or 0.1% of capital
Yes,
a minimum of RM10 or 0.1% of capital
No,
the various cost will be charged
Transparency High,

constituents updated by daily basis

High,

all actions were taken by own

Low,

the result of profile receiving once a year

Written by Evelyn Yong | 04 March 2019.

Understanding on Ordinary Shares Vs Preference Shares

Shares generally have two types, which will be known as “Ordinary Shares” and “Preference Shares”. Ordinary shares and preference shares are distinguishing from each other based on their characteristics, benefits and rights that they offer to the holders of such shares.

Let’s examine the different rights and benefits attached to them.

Ordinary Shares

Ordinary Shares are the equity shares of the company. Sometimes, ordinary shares are also known as “Common Stock”.  Shareholders who have ordinary shares indicate that they have ownership in the company based on the portion amount of shares that they owned. For examples, if you have purchased 30 shares out of 100 shares of XYZ Company, it means that you have held 30% of stocks of the company or you have owned the company 30%.

Ordinary Shares carry voting rights. Shareholders have some privileges to get voting rights at the general meeting. They can appoint or remove the directors and auditors of the company. Each of the shareholders has rights to gain profits that earned by the company as well as to take the dividend.

Ordinary Shareholders have rights to receive dividends if the company makes profits. The dividend paid by the company is not fixed. Usually, when a company is just getting started, they do not pay the dividend and the entire money earned will be reinvested into the business for further development. Sometimes, the dividend will be paid to the shareholders only after all the payment of the liabilities had been paid. They are referred to as “residual owners”. They received what is left after all other claims on the company’s income and asset that have been settled. However, equity shareholders have no rights to get arrears dividend for previous years.

In the event of winding up of the company, the company must pay costs, wages, statutory contributions and taxes first followed by its creditors. Any capital that remains after paying the creditors will then allocated to the shareholders. Ordinary shareholders receive their share of capital after the preference shareholders are paid.

When it comes to redemption, ordinary shares cannot be redeemed by the company.  Ordinary shares are also cannot be converting into preference shares.

Preference Shares

Preference shares represent an ownership stake in a company, and sometimes it called preferred stock. Preference shares can have both equity and debt characteristics, which favoured by investors who have different priorities and interests to safeguards. Preference Shares have a priority claim over the company’s assets and earnings. The shares are more senior than common stock but more junior relative to bonds in terms of claim on assets.

Preference shareholders do not have voting rights on preference shares. However, they have rights to vote on the matters that directly affect their rights like a resolution of winding up of the company, or in the case of reduction of capital. Besides, shareholders of preference shares may have statutory powers to claim if the dividend remains unpaid for not more than 12 months from the due date of the profit or lesser.

Preference Shareholders enjoy priority first in the payment of profits and dividend. It promises the shareholders with a fixed dividend, both when the business is operating, and also in the event of a company entering into liquidation in the future. However, they are not paid first since the company needs to pay off the liabilities. But, they get paid off before the ordinary stockholders. While for the arrears of dividend, the shareholders will get arrears of dividend along with the present year’s dividend if it does not pay in the last previous year.

In the event of winding up of a company, preference shareholders are entitled to receive payment of capital after the claims of the company’s creditors have been paid, at the time of liquidation. In short, preference shareholders have preferential claims over dividend and repayment of capital as compared to equity shareholders.

Sometimes, some of the companies may issue redeemable preference shares on the condition that the company will repay the amount of share capital to the holders of this category of stocks after the fixed period or even earlier at the discretion of the company. The redemption must come from available profits of the company which would otherwise have been available for distribution of dividends or it must from the proceeds of a new issue of shares that made for redemption.

There is also a share called convertible preference shares. Convertible preference shares are preference shares which are issued with the right or option to convert to ordinary shares in the future, often at a pre-determined time frame and rate.

Basis Comparison

Ordinary Shares

Preference Shares 

Meaning Represent ownership of shareholders in the company Carry preferential rights on the payment of dividend and repayment of capital
Voting Rights Have voting rights No voting rights.

In exceptional circumstance, they have

Payment Dividend  Paid or may not be paid Receive dividend In a fixed rate
Arrears Dividend  Not Entitled Entitled
Repayment Of Capital Upon Winding Up Repaid at the end Repaid before equity shares
Redemption Not Entitled Entitled
Convertibility Non-Convertible Can be converted into ordinary shares

 Conclusion

Investors must understand the difference between ordinary shares and preference share. Investors should consider preferred stocks when they want a steady stream of income. The preferred stocks dividends pay a higher income stream than bonds. Although lower, the income is more stable than stock dividends. Therefore, investors should consider themselves which types of stock are suitable for them.

Written by Stella Goh | 14 February 2019

Malaysia Best Performing Stocks in 2018

 

Price on
02-Jan 2018(RM)
Price on 31-Dec 2018(RM) Percentage changed
DUFU

0.78

2.06

164.10%

MERGE

0.34

0.885

160.29%

WATTA

0.32

0.795

148.44%

LEESK

0.35

0.85

142.86%

PANSAR

0.383

0.8

108.88%

PINEPAC

0.19

0.35

84.21%

PMBTECH

2.003

3.57

78.23%

SANBUMI

0.195

0.34

74.36%

SUPERMX

1.005

1.74

73.13%

IDEAL

0.675 1.09

61.48%

2018 was a turbulent year that experienced a lot of market changes. Now let’s see which the top 10 best-performing stocks in Malaysia are. The result is based on the initial price of 2018 annualize performance from ShareInvestor WebPro and stock warrant and convertible shares are not included.

The 10th – IDEAL (9687.MY)

The 2018 opening price of IDEAL was RM0.675 and rose to RM1.09 at the last trading day of 2018, total with 61.48% value appreciated in 2018. The business nature of IDEAL is developing properties at Penang area. The company had shown brilliant results in the 2nd and 3rd quarter results in the financial year of 2018. This good news had pushed their market price to a higher level.

The 9th – SUPERMX (7106.MY)

SUPERMX ranked at the 9th with 73.13% raised from RM1.005 to RM1.74. SUPERMX is a world-class latex glove conglomerate and leading among the international manufacturer. Their business activities are producing, distributing and marketing their high-quality medical gloves. In 2018, SUPERMX widely expanding contact lens business and get the license in Japan had contributed part of the share price rising as a good future prospect. SUPERMX had their uptrend throughout most of the time in 2018, however, there are few incidents causing their share price dropping. The biggest scandal, founder’s wife had been caught for insider trade and sentenced to imprisonment for 5 years and caused 2% drops in share price. Besides, a fire caught in a small plant had caused more than 20% drops in share price. Other than that, SUPERMX’s share price also slightly affected by the trade war and caused some drops in the middle and end of the year.

The 8th – SANBUMI (9113.MY)

With just 1.23% different, SANBUMI rank 1 place higher than SUPERMX. A total of 74.36% price appreciated from RM0.195 to RM0.34. SANBUMI is principally engaged in the business of investment holding. The principal activities of the subsidiaries are travel and tourism services, property development, general trading and other services. It was a hot counter in the 4th quarter in 2018, but the financial results were not performing well and causing the price fluctuated within gain and loss in 2018.

The 7th – PMBTECH (7172.MY)

Rising from RM2.003 to RM3.57, a total of 78.23% appreciation, PMBTECH has scored the 7th place among the highest price appreciated stock in 2018. PMBTECH is an established specialist in the designing, fabrication and installation of aluminium façade system for buildings. It is the largest aluminium smelter in South East Asia and the largest aluminium extruder in Malaysia. Few of the well-known successful projects are done by PMBTECH such as aluminium formwork system for KLIA, KLCC Skybridge, Bintulu Airport and UOA’s buildings, aluminium glazing works for Singapore’s Marina Bay Sand, Shanghai’s Plaza 66 and Hong Kong’s Chek Lap Kok Airport as well as aluminium scaffolding system for MRT Bukit Bintang, MAS-Airline, Pavillion, Sunway Velocity and Suria KLCC. There were experienced 2 up-trends in PMBTECH’s 2018 price chart, which are during the April and November period due to the announcement of high earnings by acquiring Leader Universal Aluminium Sdn Bhd, US Dollar appreciation, aluminium price rise and higher sales.

The 6th – PINEPAC (1902.MY)

84.21% of price appreciation gain by PINEPAC in 2018 from RM0.19 to RM0.35. PINEPAC’s main business activities is doing oil palm plantation and they have a total oil palm plantation area stands at approximately 3,723 hectares in Malaysia and 20,665 hectares of land for planting oil palm in District of Sintanf, West Kalimantan, Indonesia where around 170km away from Sarawak Kuching. PINAPAC had a thundering spike at the end of September due to the land sale to United Plantations. This land sale up to RM414 million has helped PINEPAC’s price spike up 286% in 2 days. The proceeds of selling 8,999 acres agriculture land in Perak will be used in bank loan repaid and the balance as financing and working capital.

The 5th – PANSAR (8419.MY)

PANSAR had experienced 108.88% of price appreciating in 2018. From RM0.383, has been doubled-up to RM0.80 before the market closed. PANSAR’s stock price was showing a strike-up line in the first quarter in 2018. PANSAR is engaged primarily in trading in hardware and building products. It has also become a major supplier and service provider of marine and industrial engineering products, construction and building materials and so on. PANSAR gain a high market expectation as the PE ratio for 2018 full year result is up to 30.

The 4th – LEESK (8079.MY)

LEESK had its uptrend since the starting of 2018 until August and gave 142.86% on the annual growth in 2018 from RM0.35 to RM0.85. It is a company doing mattress manufacturing which is one of the most extensive mattress manufacturers in South East Asia with one-stop production lines including natural latex foam, polyurethane foam and various spring productions. There are more than 50% of the producing are exported. Those countries involving include the United States, Australia, European countries, Singapore and China.

The 3rd – WATTA (7226.MY)

The opening price for WATTA in the first trading day of 2018 was RM0.32 and closed at RM0.795, showed a 148.44% appreciation. It is under industrial products and services industry and distributing automotive batteries and battery components in Malaysia. Besides, it also involves in the marketing and distribution of telecommunication equipment and its related products. WATTA has their long term cooperation with world-renowned brands such as Samsung, Sony, Microsoft, Huawei, Lenovo, Motorola, Xiaomi, Infinix and also local telecommunication giant YES.

The 2nd – MERGE (5006.MY)

MERGE has a 160.29% price gain in 2018 from the price RM0.34 to RM0.885. MERGE is a construction-based company listed on Bursa Malaysia Main Market since 17 November 1998. Their expertise in the construction is majorly in water treatment plants, sewage and sludge treatment plants, pipe laying and reservoirs construction, as well as refurbishment and maintenance. On 15 October 2018, MERGE received an unusual market activity (UMA) query from Bursa Malaysia regarding to the sharp rise in the share price and MERGE replied for the situation was due to few parties expressed interests in acquiring some stake in the company as well as to explore certain business opportunities.

The 1st – DUFU (7233.MY)

The hot technology stock, DUFU, from the 2018 opening price RM0.78 rose to RM2.06, showed a 164.10% gain and scores the highest percentage appreciation in 2018 among the Malaysia stocks. With the higher revenue grown, DUFU started the strike uptrend since the third quarter in 2018 and recorded its historic high at RM2.713 on 19 November. DUFU is a technology leader of micro precision components with running its business as an advanced one-stop manufacturing facility offering superior quality manufacturing, engineering capabilities and services. The second quarter result in 2018 shown their net profit rise by 72% compared to a year ago, due to higher demand of Hard Disk Drives components and favourable foreign exchange effect thanks to the strengthening of the US dollar.

Written by Evelyn Yong | 31 January 2019

Discounted Earnings Model

We had covered the topic of the Discounted Cash Flow Model last time, today we will focus on the next valuation calculation method, Discounted Earnings Model.

Also known as Discounted Future Earnings, this model is to forecast the earnings value of a firm and firm’s estimated terminal value at a future date. Terminal value represents all future cash flows that will reflect the returns occurred in future which they are nearly impossible to forecast.

The future earnings and then will be used to discount it back to the present value by using the appropriate discount rate. The sum of the discounted future earnings will be equal to the estimated value of the firm. By using this model, investors must make sure that the earning of the company is always positive. If it is negative, this model cannot be applied.

Note: We can use Adjusted Earnings per Share or Historical Earnings per Share of the company based on investor’s perspective and determination.

Let us look at How to fill Up the Figures in ShareInvestor WebPro to get the intrinsic value for Nestlé Berhad by using Discounted Earnings Model as an example.

1.Earnings per Share (RM)

Earnings per Share (EPS) is a financial ratio that used to measure or indicate the profitability of a company. To get Earnings per share, the total earnings of a company available to common shareholders will divide by the total number of common shares outstanding. In other words, this is the amount of money each of the shares will receive if all of the profits distributed to the outstanding shares at the end of the year.

ShareInvestor WebPro does provide an automatic calculation of Earnings Per Share for you as shown as the picture below:

Based on the photo above, insert 2.75392 to the Earnings per Share column.

Note: You have to right-click the stock and choose financial, then you can found Earnings Per Share in the part of Per Share Data (Adjusted).

2. EPS Growth Rate (%)

For EPS Growth Rate, we can use the industry average EPS growth rate of the company in the model provided, or we can use the average EPS growth rate for the company based on selected years.

We will use Nestlé Berhad as an example this time; we will choose the industry EPS average growth rate which has been providing as shown below:-

3. Years Of Growth

A company CEO may project the years of growth and announce it to the investors during AGM ( Annual General Meeting). Sometimes, we also can saw some news from the newspaper regarding the years of growth for a particular company. The other ways are looking into the past industry growth cycle. If the industry cycle usually tends to continue to grow for 10 years, you can take this number as a reference.

Let us assume that the years of growth for Nestlé Berhad is 10 years.

Therefore, insert 10 years into years of growth column

4. Discount Rate (%)

As we have discussed in the previous Article of “Understanding Discounted Cash Flow Model (DCF)to find intrinsic value”,  we know that Discount rate is the required rate of return for investors. The rate of return would be applied to the future earnings or cash flow to discount it back to the present value. It could be the risk-free rate of yields such as government treasury bonds or the expected rate of return.

We will use the Capital Asset Pricing Model (CAPM) as below to find the Discount rate for Nestlé Berhad based on its own risks level.

 

The formula of Capital Asset Pricing Model is as follow:-

Risk Free Rate (Rf) = 0.041

We will obtain the risk-free rate from 10 years of Malaysia Government Bond by Google it which is 4.10% equivalent to 0.041 as shown as the picture below:-Beta (β) = 0.40

Beta is a measure of stock’s volatility which will use to analyse how much returns will fluctuate about the overall market return. Beta equal to 1 indicates that the stock price moves together with the market. The beta of less than 1 means the stock is less volatile than the market. A beta which is greater than one means the stock price is more volatile than the market.

We will obtain the beta for Nestlé Berhad from the Factsheet of ShareInvestor WebPro which is 0.40 on 16Jan2019 as the picture below. The beta that I have selected is beta (500days). There is no right or wrong choosing beta (75days) or beta (500days).

Note: Select particular stock and select FactSheet, and you will found Beta (500days) at the vital statistic part.

Expected Market Return E(Rm) = 0.067

To find the expected market return of the stock, we can use the Compound Annual Growth Rate (CAGR).

Compound Annual Growth Rate is a useful tool which uses to determine the annual growth rate of an investment which the values have fluctuated widely from one period to another.

The Formula of Compound Annual Growth Rate (CAGR) as follow:-

I will take 10 years of the stock to measure the expected market return from the Year 2009 to the Year 2019 for FBMKLCI.

Beginning Value for FBMKLCI in the Year 2009 = 878.30

Ending Value for FBMKLCI in the Year 2019 = 1673.08 (On 16 Jan 2019)

The period from the Year 2009 to the Year 2019 = 10 years

We calculate the CAGR after we have all the beginning value, ending value and number of years in the FBMKLCI. The expected market return that we have is 0.06657. After we got all the figures as above, we can use it to calculate Capital Asset Pricing Model to get the Discount Rate. The discount rate we will get is 5.14%. Therefore, I will round off and insert it as 5% into the Discount Rate column.

5. Terminal Growth Rate (%)

Terminal Growth Rate will be used to estimate the company’s growth beyond the projection period to calculate the terminal value of a company that will expand its future income beyond the initial few years’ projections.

Note: the terminal growth rate used must always be lower than the discount rate. There is no right or wrong to use Real Gross Domestic Product (GDP) or Global Gross Domestic Product (GDP).

I will use Growth Rate of Global Gross Domestic Product (GDP) for this year 2019 which is 3% equivalent to 0.03.

 

After we have all the info, we can key into our ShareInvestor WebPro to get the intrinsic value of Nestlé Berhad. The intrinsic value for Nestlé Berhad is RM 169.37

Now we know that Nestlé Berhad has an intrinsic value of RM169.37. The current market value of Nestlé Berhad is RM147.30 (Based 16 January 2019). Based on the Discounted Earnings Model, it shows that Nestlé Berhad currently is in fair value due to the margin value of the stock is not much.

Written by Stella Goh | 23rd January 2019.

How do interest rates work?

The interest rate is a percentage charged as compensation on the cost of borrowing by a lender to a borrower. A central bank is responsible for formulating a country’s monetary policy and regulation. One of the ways is by controlling the benchmark of interest rate. They can adjust the interest rate to balance the economic status of the nation. But why a simple action on the rate adjusting can make a massive effect on the country economy and even the impact of US’s rate adjustment can swing the world?

US increased their interest rate several times in these few years in preparation for higher inflation, indicating the economy in fast recovery mode and worldwide investors turn their money to the US market to avoid missing the train.

How does the interest rates work?

When the economy is in recession, the central bank will lower the borrowing cost by reducing the interest rates. Hence, consumers are willing to make big purchases, such as houses and cars. For a businessman, this is perfect timing to borrow money in expanding their business and buying more equipment. Therefore, the output and productivity of an economy increased, and the stock market will also show a bullish sign as most industries will be expected to grow.

When the rate is deemed high, the cost of borrowing will become more expensive. Economist suggests that this is a time that the consumer spending will be moderate due to higher borrowing cost, so it is a way to slow down an overheated economy. But it will send a signal that the economy will start to normalise, translate to business will no longer growing exponentially in the foreseeable future. The investor will begin to pull back the money from the market and put it in a bond for a more stable return.

Economy takes place in a cycle. When the economy was in a downturn, economists suggested lowering the interest rate to stimulate a sluggish economy. The interest rate is a catalyst for the economy because it affects people’s decision whether to save more or spend more, which helps to achieve the overall economic situation. Therefore, economists pay a vital role at this moment; they need to observe the economy and identify the timing of raising interest rates.

However, an economic cycle cannot depend only the monetary policy; consumers behaviour is the core contributor to an economy. The subprime crisis is the exact example, the ratio of household debt to disposable personal income in the US rose from 77% in 1990 to 127% by the end of 2007. The situation has shown the market was overheated. Federal Reserve had raised the interest rate from 2.25% to 5.25% in the year 2004 to 2006. But, the situation has failed to calm down and then the bubble burst. In the Dot-com bubble in 2000, Hong Kong’s interest rate had declared up to 13.35% to entice an investor to stay invested in the economy. Sadly, the action deems too late and not enough to stop the crisis happened.

What will happen when the interest rate adjusted?

Capital Flows

When a country announced an adjustment on the interest rate, there is indeed a level of hot money flows occur. Hot money refers to the short-term capital which will flow to countries with higher interest rates. The higher the level of hot money within a state, the more severe the effect will suffer for the economy when hot money flows out. For example, companies and investors are more likely to park their capital into U.S. banks as the Federal Reserve engages in a series of interest rate hikes in 2018. When the foreign investment went out from Malaysia, our market will suffer a drop and value depreciated as low demand.

The value of a currency

An increase in interest rates may lead to a currency appreciation due the economy is on an upward path and Investor tends to invest in good economy. Hence, the currency will appreciate when the money outflow lesser than inflow in the country. However, currency appreciating is not that welcoming by export-domain country. When the currency increased, the exports become less competitive, and purchaser side will incur higher cost. Hence, the purchaser may try to change their supplier from another lower currency country to get cheaper cost.

Inflation rate.

An adjustment in interest rate can indirectly affect the inflation rate. As a higher interest rate can slow down economic spending growth to take some of the edges off of rising inflation. Vice versa, when the interest rates in a low period, more people tend to spend more and aggregate demand increased. Hence, causing the economy grows, follow with the increase of inflation.

Housing Industry

Adjustment in interest rates will have significant impact on property buying. Due to the house mortgage loan is a long term loan, a small increase in the interest rate can result in a substantial amount differing in total payment.

Conclusion

There is no specific answer whether it is good or bad in adjusting interest rate as there is no one size fits all. However, interest rate adjusting is still significant and is a MUST-do action to approach a normal economic cycle. Balancing is essential to achieve long-term sustainability. As a consumer, we need to control our spending in every phase; as an investor, we must adjust our portfolio in every period to maximise our profit and minimise our loss.

Written by Evelyn Yong | 16 January 2019.

Understanding Discounted Cash Flow Model (DCF) to Calculate Intrinsic Value

Investing in the stock market could be much more accessible nowadays as there are many resources and useful tools that help investors making an investment decision. In ShareInvestor WebPro and ShareInvestor Station, there are three new developed models which are Gordon Growth Model, Discounted Cash Flow Model and Discounted Earnings Model. Among all these models, they could help investors to find the intrinsic value of the particular stock — many complicated calculations and formulas to find the intrinsic value. ShareInvestor WebPro has simplified the process. It allows users to plug in the relevant figures and it automatically calculates the valuation of the company.

Today, we will talk about the Discounted Cash Flow Model to helps an investor assess the viability of a project or investment by calculates the Total Free Cash Flow based on the projected growth rate and discounts back to the present value. If the company value derived through Discounted Cash Flow Model is higher than the current market price per share, the investor shall start to monitor this type of company.

This model requires a positive free cash flow to derive the intrinsic value of a stock. If the free cash flow of the capital is a negative figure, this model cannot be applied. Let us look at “How to fill up the figures in ShareInvestor WebPro to get the intrinsic value for Air Asia Berhad” by using Discounted Cash Flow Model as an example.

1. Free Cash Flow Per Share (RM)

Free cash flow = Operating Cash Flow (CFO) – Capital Expenditures
Free Cash flow is the actual cash that would be available to the company’s investors after accounting for reinvestment in non-current capital assets by the company. The Free Cash Flow can be derived from the income statement and balance sheet of the company. On the other side, free cash flow also can be calculated by using the following formulas:-

By looking through this formula, it may sound complicated but ShareInvestor WebPro do provide automatic calculated of Free Cash Flow for you as shown as the picture below:


Based on the photo above, insert 0.0227 to the free cash flow per share column.
Note: You need to right-click the stock and choose financial, then you can found the free cash flow per share in the part of Per Share Data (Historical).

2. Cash Flow Growth Rate (%)

For the cash flow growth rate, we can use the industry average growth rate of the company in the model provided or we also can use the average growth rate for the company based on selected years. There is no right or wrong on which to be used. For Air Asia Berhad, I will use the industry average growth rate which will be automatically calculated as shown as the photo below: –

3. Years of Growth

A company CEO may project the years of growth and announce it to the investor during AGM (Annual General Meeting).
The other ways to are looking at the past industry growth cycle. If the industry sector usually tends to continue to grow for 5 years, you can take that numbers as a reference.
Let us assume that the year of growth is 5 years. Therefore, insert 5 years into years of growth column.

4. Discount Rate (%)

The discount rate is the required rate of return for investors. If he/she perceives the investment relatively risky, he may want to put a higher discount rate. For the public companies, there’s an assumption that the business was to continue to operate for longer compared to smaller private companies which may have a shorter life span.

To find the Discount Rate, we will use the Capital Asset Pricing Model (CAPM) formula as stated below.
Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for the assets. This model is also widely used for securities to generate the expected return for the stock. The risk-free rate in the CAPM will account for the time value of money.

The formula for Capital Asset Pricing Model is as follow:-

Risk Free Rate (Rf) = 0.041

We will obtain the risk-free rate from 10 years of Malaysia Government Bond by Google it which is 4.14% equivalent to 0.041 as shown as the picture below:-

Beta (β) = 1.112
Beta is used to measure volatility or systematic risk of a security. A beta of 1 indicates that the security price is moving together with the market. A beta of less than 1 means the security will be less volatile than the market. A beta which is greater than 1 indicates that the security’s price will be more volatile than the market.
For Beta of Air Asia Berhad, we will obtain it at the Factsheet from our ShareInvestor WebPro or ShareInvestor Station which is 1.112. I will choose the beta of (500days) which is 1.112 as common. There is no right or wrong choosing beta (75days) or beta (500days).


Note: Select particular stock and select FactSheet, and you will found Beta (500days) at the key statistic part.

Expected Market Return E(RM) = 0.066
We need to use Compound Annual Growth Rate to find the expected market return of the stock. Compound Annual Growth Rate is a useful tool which used to determine the annual growth rate on an investment which the values have fluctuated widely from one period to the next.
The formula for Compound Annual Growth Rate (CAGR) as follow:-

I will take 10 years of the stock to measure the expected market return from the Year 2009 to the Year 2019 for FBMKLCI.
Beginning Value for FBMKLCI in the Year 2009 = 878.30.
Ending Value for FBMKLCI in the Year 2019 is 1674.12 (On 10 Jan 2019)
Period from the Year 2009 to the Year 2019 = 10 years.

After we have the beginning value, ending value and number of years based on particular years in the FBMKLCI into the CAGR formula, the expected market return we get is 0.066. After we got all the figures, we can calculate the Capital Asset Pricing Model to get the Discount Rate.The discount rate we get is 6.89%. Therefore, I will round off and insert it as 7% into the Discount Rate column.

5. Terminal Growth Rate (%)

Terminal Growth Rate will be used to estimate the company’s growth beyond the projection period and will be used to calculate the terminal value of a company which will be expanding its future income beyond the initial few years’ projections.
Note: the terminal growth rate must always lower than the discount rate.

We will use Growth Rate of The Country Real Gross Domestic Product (GDP) for this year 2019 which is 4.6% equivalent to 0.046.
After we have all the info, we can key into our ShareInvestor WebPro or ShareInvestor Station platform and select calculate to get the intrinsic value of Air Asia Berhad. The intrinsic value for Air Asia Berhad is RM 1.01.

Now we know that Air Asia Berhad has an intrinsic value of RM1.01. The current market value of Air Asia Berhad is RM2.95. (based on 10 January 2019). Therefore, it indicates that Air Asia Berhad currently is overvalued since the current market value is larger than the intrinsic value of the company.

Written by Stella Goh | 11 Jan 2019.

Understanding on Stock Split Exercise

A stock split is common in nowadays stock market and some of the successful companies will exercise stock split multiple times throughout a decade. But, what does stock split means for the company and the shareholders? If you are holdings a stock which is going to split, don’t worry. We will discuss this topic for you to have a better understanding.

It is a corporate action declared by the board of the company with the purpose to increase their number of total share of a company by splitting each of the shares. When it happens, the share price drops proportionally due to the result that each of the shareholders will own more shares with the same proportion of ownership in the company.

How Does It Impact The Share Values?

Let us look at 1 of the example. If the company has 10,000,000 issued share priced at RM50 per share before share split, it will have a market capitalisation of RM 500,000,000 (10,000,000 x RM50). If the share split occurred at 2-for-1, the total company number of shares would double to 20,000,000 shares. The price for each of the share to be adjusted to RM25. (RM50,000,000 / 20,000,000). For example,  a shareholder with 1000 shares finally will have 2000 shares in total, but the value remains the same.

Based on the example above, it is also clearly indicated that there is no change in the total value of shares. The cost of a single stock will become cheaper, and only the total number of stock in the market will increase.

Why does Stock Split happen?

Stock splits occurred when the company management wishes to add liquidity of their stock by diluting it to reduce the cost per share to the reasonable price level. When the stock price has become less expensive, it may attract more new investors to invest in their company even though the underlying values of the company do not change.

Besides, a company that is practising a share split also can indicate a good signal that the company is doing well enough and investors will assume that the company will lead the share price to go higher in future.

Are Share Split Good For Investors?

When there is stock split occurred, it does not mean that the company will continue to do well in the future. The company split its stock when the share price has risen enough, but it does not indicate that the share price of a company will continue to grow in the future. Investors must always remember that when they owned more shares for the stock split, the overall value of their holdings will remain the same.

Some of the investors may say that stock split is a company doing well in their business and it may consider as a buy signal. It is not correct in this statement. Investors should always look at the whole picture of the company before making an investment decision. Investors can use stock split as an indicator, but further market evaluation is needed.

Should You Buy A Stock Before or After Stock Split?             

For the investors who will invest for long-term, it does not matter whether he/she buys the stock before or after the stock split. Let’s us look at scenarios as an example.  Let’s say I could purchase 1000 shares of a company which is trading at RM0.50 today, or I could purchase 2000 shares of the company at RM0.25 tomorrow after a split, the outcome will be identical. The only thing that can vary from the day before or after the split is the actual price of the shares.

Conclusion

Investors need to be methodical when they are trying to purchase the stocks before or after the split announcement. The stock split is a good thing for small investors who seek good company within their affordability. However, investors are not advisable to directly buy the shares before or after the split without doing further research.

Written by Stella Goh | 12th December 2018.

Importance of quarterly report to an investor

The quarterly report is a financial update by the public listed company on a quarterly basis to the public investors. Financial analysts put lots of focus in this report because it can affect the price movements of the stocks in the short term. There are several criteria cannot be ignored in the quarterly report as below.

EPS

Earnings per share (EPS) serve as an indicator of the profitability for a company. This measurement shows the indication of the company’s ability to generate, sustain and grow its profits. The higher the net profit, the higher the EPS (unless bonus issue or right issue occurred). The quarterly adjusted EPS can reveal the latest financial profitability and have a better understanding of business performance. The performance can be measured based on whether the EPS meets, misses or beats analysts’ predictions and will have a substantial impact on the short-term share price.

Sales and Earnings growth

Invest in a business is a long-term activity, so Investors tend to invest in good prospects company. Hence, stocks that can consistently grow their sales and earnings are expected to perform well in the long term. However, it is difficult for companies to outperform analyst expectation every quarter due to the short time unstable economic situation or political news. Therefore, for stocks that perform well in each quarter, they are usually the industry-leading stocks due to their ability to boost sales while controlling costs and expenses to ensure the earnings growth.

Cyclical Trend

For some industries like food and beverages industry, it has cyclical sales performance due to peak seasons like festive season and low season. Comparisons quarter by quarter may not accurately determine an overall business performance, so investor shall include past few years quarterly results into their analysis to understand the peak and off-season conditions. Then, they may get more ideas at the timing of entering or exiting the market.

Cash Flow

Stable cash flow is essential for a company to ensure its financial liquidity. When a company can generate high positive cash flows, this will create more value for shareholders and enables the company to expand their business, pay a special dividend for shareholders, repay debts and cushion future financial challenges. A profitable company can fail if the operating activities do not generate enough cash to maintain liquidity. If the company fails to convert sales into cash on time, their cash liquidity will lead to a cash flow shortage and affecting day to day operations.

Company’s Planning and Actions

The management always interprets the quarterly performance and discloses further plans in the quarterly result or in a press release. This is generally the moment investors will form their perception towards how effective and efficient the company overcome current obstacles and future challenges. More often than not, sharing related previous success stories of how issues and crisis were managed are able to display the company’s commitments towards the interests of its shareholders. On top of that, it also provides investors with clarity and to a certain extent, assurance, on the direction and dynamism of the company they have invested in.

Conclusion

Although the quarterly report is not audited, it is still essential for investors to make any decisions, as the annual report is only published once a year and many variables may occur within 12 months. To keep their investment safe, investors should not skip the company’s financial reports and protect your assets. Investors should not judge a company by just looking at one of the criteria because a good company will not be only good in one aspect. Instead, they should consider more aspects before making a decision.

Written by Evelyn Yong | 7th December 2018.

Understanding on Bonus Issue Vs Right Issue

By investing in the stock market, the investors are becoming a shareholder of a particular company through buying the specific stock. As a shareholder, investors will be updated from time to time about the company’s new direction including announcements of “Bonus Issue” and “Right shares Issue”. Both seem alike, but there are a different so all shareholders should understand what differentiates between Bonus Issue and Right Issue and react accordingly.

Bonus Issue

Bonus Issue defined as free new shares issued to the existing shareholders based on the specified proportion of shares they are holdings which will be at free of cost. Bonus Shares is a conversion of the company’s accumulated earnings which are not given out in the form of dividends but converted into free shares.

When the bonus share distribution happens, it will increase the total number of shares owned by the firm. The Bonus shares do not inject fresh working capital into the company, as there are to distribute among the shareholders without any conditions. The net worth of the company will remain the same. Usually, bonus shares will pay up in full, and the shareholders are also allowed to sell those bonus shares to make a quick profit or save it for future gain.

Let us look at the example of bonus issue. If the company declares 3:2 of bonus issues, it means that every 2 shares held by shareholders, 3 Bonus share will be allotted to them. A shareholder with 1,000 shares will be received 1,500 bonus shares which calculated as (1000 x 3/2 = 1500).

Why Issue Bonus Shares?

The purpose of the company issue bonus shares is to increase the active trading by increasing the number of outstanding shares in the market through a reduction in market price per share to a reasonable range.

The companies can increase their stock liquidity and promote more active trading of the shares. It also incentivizes the new investors to purchase the company shares that are performing well within an attractive price range. It will also help the company to avoid the outflows of cash in the form of dividends.

Right Issue

Right share is for the existing shareholders who have the privilege but not obligation to purchase the specified number of shares directly from the company based on the proportion of existing holdings at a discounted price within the specified period. The rights are transferable. Therefore, the shareholders can decide on himself whether or not to buy or even sell off his rights in the open market to other investors by wholly or partially.

The right shares issued to the shareholders have values that used to compensate the current shareholders for future dilution of their existing share’s value. Dilution will occur when a rights offering spreads a company’s net profit over a more extensive number of shares. Thus, the company’s earnings per share (EPS) will decreases as the allocated earnings result in share dilution.

Let us look at the example of the right issue. If the company give out a 1:4 right issue means that an existing investor can purchase 1 extra share for every 4 shares which already held by him. The issued price usually will be lower than the prevailing market price of the stock, which means that the share is to offer at a discount to the current market price.

Why Issue Right Shares?

A Right Issues is carried out by a company to raise additional capital. Companies will use the cash to acquired assets, takeover, corporate expansion or repays their debts. However, the company also can raise money by other ways, such as obtain a loan from a bank. There will be times when the banks are reluctant to lend, the rights issue will be an option. Besides, there will be a high interest incurred by the loans, which may force the company to raise the capital through the right issue of offerings to clear the credit. Therefore, investors need to make investment decision whether or not they want to take up the right issue.

Bonus Issue Vs Right Issue

 

Basis Comparison Bonus Shares Right Shares
Meaning Shares issued in the proportion of their existing holdings Issued to existing shareholders at a discounted price within a specified period

 

Price Issued at free of cost Issued at a discounted price

 

Objective Issued as an alternative to the dividend payment. Also used to bring the market price per share, within the lower price range Raise fresh capital from the market

 

Paid Up Value Always fully paid up Either fully or partially paid up

 

Share Price Shares dilution will bring down the share price in a short period and investors most of the time will not gain nor lose anything. Shares price may plunge due to shareholders will sell the rights to the open market which in discounted price. It also sends the signal to the market that the company may be in trouble so need to find new capital.
Minimum Subscription Not Required Mandatory

Conclusion

Both Right Shares and Bonus Shares have few similarities which offered to the existing shareholders as a tactic that company use to increase the number of their shares in the market.

Written by Stella Goh | 28 November 2018.

Site last updated October 10, 2019 @ 1:39 am