Vade Mecum - Motley Knowledge

Vade mecum – Motley Knowledge RIGHTS ISSUE  Cash strapped companies use it to raise money  Sell rights to existing shareholders to buy additional shares at less than market price at a future date  Ex-Rights Share Price – dividing total price you will hav paid for all shares by the total number of shares you will own after taking the right to purchase  Renouncable v Non-Renouncable rights  Nil Paid Rights when renouncable rights have been traded

EBITDA  Operating Income (EBIT) + Dep + Amortization  Useful for evaluting companies with different capital structures, tax rates and depreciation policies.  Metric of choice for highly leverage companies in capital intensive companies  Pitfalls  Not a CF measure 

Ignores changes in working capital

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Neglects Capital Expenditure

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Thus Overstates CFs of company

 Makes it look as if company has enough to make interest payments  Earnings misleading – hide ordinary costs as capital investments or under reserved warranty or bad debt costs

MARGIN TRADING  Borrowing money from brokerage to purchase stock  Create a Margin account Epili Sagar ©

Vade mecum – Motley Knowledge  Pay USD2000 as minimum margin  Borrow upto 50% of purchase price of stock – initial margin  PTN – when you sell, proceeds go to brokerage against payback of loan  Maintenance margin – a minimum balance to be maintained 

If not then forced to deposit funds or sell stock – Margin Call

 Mainly for ST investments – for LT interest accrues  Not all stocks – penny stocks, Over the Counter Bulletin Board, IPOs  Advantages  Leverage – more than proportional gains than stock price increase  The Risk  Leverage again – losses amplified much the same way as profits

SHORT SELLING  When expecting stock price to fall  Borrow from brokerage, sell them at price X  Dividends during period go to brokerage  Spilts means you owe twice as many shares  Buy back (Covering) when price falls to Y and return them to brokerage.  Why short?  Speculate  Hedge  Restrictions – not on penny stocks, done mostly on round lots  Short Interest - total number of shares of a particular stock that have been sold short by investors but have not yet been covered or closed out.  percentage short interest is the number of shorted shares divided by the number of shares outstanding.  PTN – good indicator of market sentiment

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Vade mecum – Motley Knowledge  Short Interest Ratio - number of shares sold short (short interest) divided by average daily volume. Tells us how many days it will take short sellers to cover their positions if positive news about the company lifts the price.  Short Interest Theory – large short interest is a predecessor of price rise  Since short positions must be covered meaning there will be more purchasers  The Risk  SS goes against the overall direction of markets – upwards  Losses are infinite because maximum a stock can go is infinite and min is 0  High leverage coz of margin trading nature – losses amplified  Short Squeeze – when short interest is high scramble fo covering, prices go up  Being right too soon – knowing its overvalued too soon then timing of SS may go wrong

PORTER’S 5 FORCES  Threat of New Entrants – loyalty, high fixed costs, scarcity of resources  Power of Supplier – single supplier, costly to switch  Power of Buyer – small no. of buyers, large volumes, switching to another pdt is easy  Availability of Substitutes – similarity of substitutes  Competition within Industry – many players, no dominant firm then higher competition

DEPRECIATION  Straight Line - if cut costs and boost earnings per share – boost bottomline  Accelerated - if save on taxes because of lesser EBT  Tools to manipulate Depreciation  Method of depreciation  Useful life of asset – the longer the better BL  Scrap Value – greater the better BL

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Vade mecum – Motley Knowledge

STOCK SPLITS  2 for 1 split – number of shares outstanding Doubles; share price Halves  NO Change in Market Cap of the company – No change in worth of company  Why?  Psychological – lesser price instigates more people buying stock  Increase Liquidity – helps to bring down bid-ask spread  Advantages to Customers  Good buying indicator – that company’s share price is rising  Since real value of stock therefore no value for customers

SUPPORT / RESISTANCE  At a lower level Support or “floor” is created below which price usually does not drop  At a relatively higher level Resistance  If  Resistance breached – old Resistance becomes new Support  Support breached – old Support becomes new Resistance  Vital Factors – Time and Volume  Strongest areas of S/R developed when large no. of shares traded for long period of time

HEDGE FUNDS Criteria Passive Active Benchmark Tactics

Mutual Funds Semi Active investing Beating the market/bogey Only Long positions (make

Hedge Funds Active Absolute Returns Aggressive (short selling,

buy or sell decisions) derivatives, use leverage)  Not usual to outperform index with hedge funds in bullish markets  Having them as uncorrelated assest in portfolio reduces risk Epili Sagar ©

Vade mecum – Motley Knowledge  GOOD  Absolute returns  Better returns even in bearish markets  Usually less volatile than market indices  BAD  Hedge Fund managers have their own set of risks – unique to each strategy 

For eg. Long/short funds – short squeeze

 Investments may be locked in for 4-5 years  High intial investment needed  Higher Fees  Poor Transperancy  Higher tax burden – due to frequent buy/sell – capital gains  Hedge Funds less volatile than S&P index  Measures of downside risk more useful than Sharpe Ratios – FAT TAIL  Funds of Hedge Funds GOOD  Diversification

BAD  Cost – double fee structure

 Selection expertise

 Risk of over-diversification

 Monitoring efficiency

CASH Theory  Diff appropriate cash lvl for each firm  Extra Cash  Dividends  Share buybacks  Extra investments  Capital Mkts

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Good  Signals strong company performance

Bad  Not put to good use  Opportunity Cost of holding cash  Risk of carelessness  Helps to avoid Capital Mkts – avoid scrutiny

Vade mecum – Motley Knowledge BETA  Measure of a security’s volatility  To what extent price of security fluctuates in relation to the overall market Value Comment <0 (negative) Moves opposite to market =0 Unchanged regardless of how market moves 01 More volatile than market >100 Impossible coz if market drops stock comes to 0

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