Warrants trading: What you need to know
IF THE experts are right, the current boom in this investment tool is far from petering out.
Sun, Dec 02, 2007 The Straits Times
IF THE experts are right, the current boom in this investment tool is far from petering out.
They say more and more market traders are jumping in, as well as investors looking beyond stocks and bonds to bolster their portfolios.
To get an idea of just how popular they have become, consider this: Warrants turnover on the Singapore Exchange has grown from zero in 2003 to about $3 billion a month now.
The number of active warrant accounts has also shot up more than tenfold, to 20,154 this June from 12 months earlier.
A key attraction of warrants is that they are cheap.
Warrants trade around 20 cents to 30 cents, so the minimum investment for one lot - 1,000 shares - could be as low as $200 to $300.
As with any instrument, money can be made and lost when trading warrants.
For example, say an investor bought a call warrant on stock X for 30 cents with an exercise price of $5. Also, assume the conversion ratio is one to one, which means one warrant can be converted into one share.
The current share price is $5.25.
If the investor holds the warrant to maturity and exercises it, he is effectively paying $5.30 apiece for the shares (30 cents warrant cost plus $5 exercise price).
If the price of stock X stays at $5.25, he will get back 25 cents, so effectively, he will lose five cents ($5.30 minus $5.25).
If the share price falls to $5 or below, he will lose just his investment capital of 30 cents, but no more, even if the share price falls drastically.
On the other hand, if the stock's market price shoots up to $5.35, converting the warrant into a share would mean a five cent profit.
Consultant Peter Ang, 32, started trading warrants this year with a principal sum of $15,000.
He made a 25 per cent return in just three days, after he bought DBS Group Holdings and CapitaLand warrants in September.
But he lost about $20,000 in two weeks when the stock market nosedived recently. 'I wasn't careful, so I didn't cut my losses fast enough,' he said.
Despite the spectacular growth in the Singapore warrants market, Hong Kong is still well ahead because of a flood of China listings there.
Previous attempts to launch warrants trading here in 1995, and again in 1999, tanked for various reasons - including overly stringent listing rules and inadequate investor education.
But three years ago, warrant issuers - some of the biggest players include Deutsche Bank, Macquarie Bank, Societe Generale and BNP Paribas - started to double as market makers.
This means these banks provided buy and sell prices on warrants to ensure that investors had the chance to enter or exit the market.
They also embarked on investor education seminars and dedicated websites featuring trading tools.
How to pick a suitable warrant?
Directional view
Without getting bogged down in technical terms such as 'implied volatility', you should consider one factor when picking a warrant: whether you think the underlying asset is likely to go up or down in value.
Your view will determine whether you select a call warrant or a put warrant.
For example, suppose the Government has announced a new project and the likelihood of CapitaLand securing the project is high.
If you think this is good news for CapitaLand, you could consider buying call warrants on the stock - since you would expect the stock price to rise.
But if you think CapitaLand's share price is more likely to fall, you might want to buy a put warrant.
'Theoretically, if one has a neutral view on a stock, it would not be advisable to invest in warrants,' Deutsche vice-president Sandra Lee cautioned.
Timing
You also need to factor in the timeframe - and be confident that the underlying asset price is set to reach your price target at the same time that the warrant matures.
Take a call warrant, for example. The longer the time to expiry, the more time there is for the underlying asset to appreciate, which in turn will increase the price of the call warrant.
A call warrant that is far 'out-of-the money' with very little time to expiry is considered highly risky. This is because it has an exercise price that is much higher than its underlying price and yet has little time to appreciate.
In contrast, when the call warrant's exercise price is lower than its underlying price, the warrant is regarded as 'in-the-money'.
For both call warrants and put warrants, if the exercise price is equal to the underlying price, the warrants are said to be 'at-the-money'.
'If you believe the market is going to have a sharp correction soon, you should choose a short-term out-of-the- money put warrant,' said Mr Simon Yung, BNP's head of retail listed products sales for Singapore and Hong Kong.
'If you expect a stock to move up gradually in one to two months' time, you should choose a mid-term at-the- money or a 1 to 5 per cent out-of-the- money call warrant.'
Why invest in warrants?
Gearing effect
The biggest advantage warrants trading has over stocks trading is the gearing effect, which means that you can make huge gains from a modest investment outlay.
For example, it can cost nearly $20,000 to buy one lot of DBS shares (assuming a market price of $20 a share).
An increase of 1 per cent in the DBS share price will give you a return of $200.
But if you buy a DBS warrant with an effective gearing of 10 times, it should roughly return the same profit of $200.
The effective gearing indicates roughly how many per cent a warrant price will move if the underlying stock changes by 1 per cent.
In this case, trading in the DBS warrant costs just $2,000 but reaps the same $200 return.
'If the share price moves in your favour, you will get higher returns with a higher level of gearing. But if you get your view wrong, losses will also be greater,' said Mr Barnaby Matthews, Macquarie's head of warrants sales.
Since warrants are typically cheaper than underlying shares, this potentially frees up investors' cash for other purposes.
A hedging tool
Buying a put warrant - which gives you the right to sell the underlying asset later - is like buying an insurance policy for your portfolio, as it protects you from falls in the market.
'If the underlying asset declines, then put warrants will appreciate in price to offset losses suffered by the underlying asset,' said Mr Ooi Lid Seng, Societe Generale's vice-president of structured products for Asia ex-Japan.
For example, one can hold OCBC Bank shares and buy OCBC put warrants. If the OCBC share price keeps falling, losses will be partially offset by the gain in the put warrant price.
As warrants can be used to capture both the upside (call warrants) and the downside (put warrants), they can be used as a tool for risk management in a stock portfolio.
Mr Yung said that warrants can be a perfect instrument for balancing a portfolio's risk profile. 'A portfolio with only bonds, property and stock may not be able to optimise the risk-taking capability of the investor,' he said.
Tips on investing
FIRST, investors should never invest all their investment capital in warrants.
'Generally, we do not advise them to invest more than 10 per cent of their total investment capital in warrants due to the high-risk and high-return nature of warrants,' Mr Ooi said.
Retirees should also not use retirement funds needed to maintain their lifestyle to invest in warrants, as they generally have a lower risk tolerance, he added.
Investors should also be disciplined about taking profits and cutting losses. Mr Matthews advised investors to monitor their positions closely as warrants tend to move in greater percentage terms than shares.
Customer service manager Jason Kua, 37, would know. Three weeks ago, he lost about $25,000 in just two weeks after trading in some Straits Times Index warrants.
'Greed made me lose a lot. I was hoping my initial losses could be recovered, but this didn't happen,' he said.
Finally, investors should attend a seminar or do some reading to ensure that they understand the product before investing.
'Asking the expert before you invest is always a good idea,' Mr Yung said.
gabrielc@sph.com.sg
What is a warrant?
WARRANTS are 'derivative' investment products - that is, they derive their value from an underlying asset such as a stock or a market index such as the Straits Times Index.
They give the investor the right to buy or sell the underlying asset from the issuer by paying a specific 'strike' or exercise price within a certain timeframe.
A call warrant gives the holder the option to buy, while a put warrant gives the option to sell.
Take a Keppel Corp call warrant for example.
If the price of the underlying Keppel stock rises above the exercise price before the expiry of the warrant, it will clearly be to your advantage to exercise the right to buy Keppel shares.
If you plan to exercise the Keppel warrant - that is, convert it into a Keppel share - you must do so before the expiration date. Of course, if Keppel's price stays below the exercise price, the warrants will expire worthless.
But investors often do not have to hold warrants to maturity. Normally, they simply buy and sell warrants on the stock market as they move in line with movements in the underlying share price.
'Warrants, unlike shares, have a finite lifespan,' said Deutsche Bank vice-president Sandra Lee. 'For each day the investor holds on to the warrant, the warrant loses some time value.'
Warrants usually have three- to six-month expiry dates.
Showing posts with label Stocks investment guide. Show all posts
Showing posts with label Stocks investment guide. Show all posts
Sunday, December 2, 2007
Monday, November 26, 2007
BT: Taking the pulse of a nation
Business Times - 26 Nov 2007
Taking the pulse of a nation
CHEN HUIFEN highlights some key economic data and explains what they reveal about a country's commercial performance
IN PREVIOUS instalments of this section, we looked at how companies' annual reports and financial ratios can help give an idea of the value of individual firms.
Those are very specific, and sometimes narrow, assessments of the well-being of a particular model. Very often, research into individual firms has to be undertaken with a larger perspective of what is happening in the industry or in the economy.
In Singapore, various government agencies are in charge of publishing different economic data. Some such historical data is published monthly, and some, quarterly. You can either access this information through the websites of the respective government agencies or, like many readers, count on financial newspapers like The Business Times to sieve through the information for you.
But with so much information overload, which are the key data to watch out for? We list below the first of two sets of major economic indicators that could have a bearing on the commercial health of a nation. The second set will be discussed and explained next week.
Gross Domestic Product
The GDP measures the aggregate sum of goods and services produced by a country, expressed in terms of their market value. It is usually stated in percentage terms to indicate how much the economy has grown from the previous year.
In Singapore, this data is released by the Ministry of Trade and Industry (www.mti.gov.sg) on a quarterly basis. The quarterly flash estimate - based on data in the first two months of the quarter - is usually available within two weeks from the end of the quarter. The actual growth figure comes out roughly two months later.
Observers tend to look at the real GDP figure, as this has been adjusted for inflation. For fast-growing emerging markets like China, India and Vietnam, GDP growth of 7-10 per cent is not unusual. But beyond a certain point, analysts would question if the economy is overheating.
This means that the demand for its goods and services is far more than what it can do to supply them. This could lead to higher prices, which in turn could cause reduced consumption and investment.
On the other hand, negative GDP growth for two or more continuous quarters would also raise alarm bells as the trend is indicative of a recession.
Consumer Price Index
Closely monitored with the GDP, the CPI measures inflation. In Singapore, the monthly data is released by the Department of Statistics (www.singstat.gov.sg), usually within three weeks of the following month.
It tracks the change in prices in a fixed basket of goods and services commonly purchased by the majority of households here.
Conventionally tracked in year-on-year terms, Singapore's inflation rate has been maintained at around 0-2 per cent in the last 10 years (with the exception of 1998 and 2002, when falling prices were actually recorded).
However, that figure is expected to hit as high as 5 per cent in the first half of next year, driven by record oil prices, rising food, transport, and housing costs, as well as adjustments for the 2 per cent hike in GST since July this year.
Generally speaking, high inflation rates disincentivises savings and may induce people to take up riskier investments with the goal of reaping returns that will beat the inflation rate.
High inflation may also make a country's exports more expensive, and prompt a country's monetary authorities to adjust its currency exchange rate, as a way to manage the demand for its exports.
Manufacturing output
With the manufacturing sector accounting for a quarter of Singapore's GDP, the sector's health is thus an important economic indicator.
Also referred to as industrial production, Singapore's manufacturing output data is released by the Economic Development Board (www.sedb.gov.sg) every month. It gives the raw value of goods produced by factories and plants in Singapore and is often expressed in terms of percentage growth.
Within this report, the output is further segmented into their respective industries. Analysts will be able to tell which are the ones that are suffering and which ones are driving the growth. The big three sub-groups of the manufacturing sector are electronics, biomedical sciences and the chemicals.
In Singapore, the biomedical sciences manufacturing industry is very volatile. It can swing the total manufacturing output into very high growth or drag the sector down with a double-digit contraction.
External trade figures
Data on non-oil domestic exports (NODX) is delivered monthly by International Enterprise Singapore (www.iesingapore.gov.sg), formerly known as the Trade Development Board.
The NODX tracks the shipment value of made-in-Singapore products to overseas markets. Oil exports are left out because Singapore does not produce oil on its own, but is a major transhipment centre for oil products.
Usually expressed in percentage growth terms, the NODX gives an idea of where the demand for Singapore goods is coming from, the types of goods that are popular and those losing their demand during a period.
Jobs data
The Ministry of Manpower (www.mom.gov.sg) looks after the jobs data in Singapore, including employment, jobless figures and the retrenchment rate. They provide a barometer of the labour situation.
When the market approaches full employment, it means that the job market is good, and bosses may have to offer higher wages to prevent their workers from hopping to competitors.
More people being employed also means a greater number of consumers who would be able to buy goods and services. And if wages are also rising in tandem, workers would have higher disposable incomes to fuel demand for consumption goods.
Conversely, a rising jobless rate could also reflect a weakening economy, especially if the retrenchment rate is high and the number of jobs created is low.
Taking the pulse of a nation
CHEN HUIFEN highlights some key economic data and explains what they reveal about a country's commercial performance
IN PREVIOUS instalments of this section, we looked at how companies' annual reports and financial ratios can help give an idea of the value of individual firms.
Those are very specific, and sometimes narrow, assessments of the well-being of a particular model. Very often, research into individual firms has to be undertaken with a larger perspective of what is happening in the industry or in the economy.
In Singapore, various government agencies are in charge of publishing different economic data. Some such historical data is published monthly, and some, quarterly. You can either access this information through the websites of the respective government agencies or, like many readers, count on financial newspapers like The Business Times to sieve through the information for you.
But with so much information overload, which are the key data to watch out for? We list below the first of two sets of major economic indicators that could have a bearing on the commercial health of a nation. The second set will be discussed and explained next week.
Gross Domestic Product
The GDP measures the aggregate sum of goods and services produced by a country, expressed in terms of their market value. It is usually stated in percentage terms to indicate how much the economy has grown from the previous year.
In Singapore, this data is released by the Ministry of Trade and Industry (www.mti.gov.sg) on a quarterly basis. The quarterly flash estimate - based on data in the first two months of the quarter - is usually available within two weeks from the end of the quarter. The actual growth figure comes out roughly two months later.
Observers tend to look at the real GDP figure, as this has been adjusted for inflation. For fast-growing emerging markets like China, India and Vietnam, GDP growth of 7-10 per cent is not unusual. But beyond a certain point, analysts would question if the economy is overheating.
This means that the demand for its goods and services is far more than what it can do to supply them. This could lead to higher prices, which in turn could cause reduced consumption and investment.
On the other hand, negative GDP growth for two or more continuous quarters would also raise alarm bells as the trend is indicative of a recession.
Consumer Price Index
Closely monitored with the GDP, the CPI measures inflation. In Singapore, the monthly data is released by the Department of Statistics (www.singstat.gov.sg), usually within three weeks of the following month.
It tracks the change in prices in a fixed basket of goods and services commonly purchased by the majority of households here.
Conventionally tracked in year-on-year terms, Singapore's inflation rate has been maintained at around 0-2 per cent in the last 10 years (with the exception of 1998 and 2002, when falling prices were actually recorded).
However, that figure is expected to hit as high as 5 per cent in the first half of next year, driven by record oil prices, rising food, transport, and housing costs, as well as adjustments for the 2 per cent hike in GST since July this year.
Generally speaking, high inflation rates disincentivises savings and may induce people to take up riskier investments with the goal of reaping returns that will beat the inflation rate.
High inflation may also make a country's exports more expensive, and prompt a country's monetary authorities to adjust its currency exchange rate, as a way to manage the demand for its exports.
Manufacturing output
With the manufacturing sector accounting for a quarter of Singapore's GDP, the sector's health is thus an important economic indicator.
Also referred to as industrial production, Singapore's manufacturing output data is released by the Economic Development Board (www.sedb.gov.sg) every month. It gives the raw value of goods produced by factories and plants in Singapore and is often expressed in terms of percentage growth.
Within this report, the output is further segmented into their respective industries. Analysts will be able to tell which are the ones that are suffering and which ones are driving the growth. The big three sub-groups of the manufacturing sector are electronics, biomedical sciences and the chemicals.
In Singapore, the biomedical sciences manufacturing industry is very volatile. It can swing the total manufacturing output into very high growth or drag the sector down with a double-digit contraction.
External trade figures
Data on non-oil domestic exports (NODX) is delivered monthly by International Enterprise Singapore (www.iesingapore.gov.sg), formerly known as the Trade Development Board.
The NODX tracks the shipment value of made-in-Singapore products to overseas markets. Oil exports are left out because Singapore does not produce oil on its own, but is a major transhipment centre for oil products.
Usually expressed in percentage growth terms, the NODX gives an idea of where the demand for Singapore goods is coming from, the types of goods that are popular and those losing their demand during a period.
Jobs data
The Ministry of Manpower (www.mom.gov.sg) looks after the jobs data in Singapore, including employment, jobless figures and the retrenchment rate. They provide a barometer of the labour situation.
When the market approaches full employment, it means that the job market is good, and bosses may have to offer higher wages to prevent their workers from hopping to competitors.
More people being employed also means a greater number of consumers who would be able to buy goods and services. And if wages are also rising in tandem, workers would have higher disposable incomes to fuel demand for consumption goods.
Conversely, a rising jobless rate could also reflect a weakening economy, especially if the retrenchment rate is high and the number of jobs created is low.
Monday, November 19, 2007
BT: Ratios to judge a firm's health
Business Times - 19 Nov 2007
Ratios to judge a firm's health
CHEN HUIFEN looks at key financial ratios that can help to evaluate the comparative performance of companies
IN OUR previous two instalments, we discussed the value of annual reports, and how investors can pick out useful information from both the prose and numbers.
We also looked at the fundamentals behind the three main financial statements - the profit and loss statement, the balance sheet and the cash flow.
Based on the information above, analysts can derive key financial ratios that help them in their assessment of a company's past and current health. To draw a simple analogy, some consumers base their car buying decisions on the fuel mileage they can get. Similarly, financial ratios are tools to judge the comparative performance of companies.
There are probably some 20 major financial ratios that analysts can churn out when they evaluate the operating performance and capital structure of companies. Here, we pick out some of the key ones.
Net profit margin
Net profit margin measures the amount of money a company makes for every dollar of sales generated. So, the higher the number, the better. It is typically presented in percentage terms. For example, Singapore Press Holdings (SPH) recently reported a full year net profit of $506.2 million, on a revenue of $1.16 billion. Its net profit margin is therefore
Net profit/revenue = $506.2 million/$1,160 million
= 43.6 per cent.
Return on equity
Commonly referred to as ROE, return on equity indicates how effectively a company generates profits out of its shareholders' funds compared to its peers in the same industry. There is more than one way of calculating ROE. The simplest is
ROE = Net profit/Shareholders' equity
So if a company makes $506.2 million and has shareholders' equity of about $2.2 billion, then its
ROE = $506.2 million/$2,200 million
= 23 per cent
Earnings per share
One of the key indicators of profitability, earnings per share or EPS is derived by dividing the net profit by the number of shares issued. So if a company makes $506.2 million and has 1.58 billion shares, then its
EPS = net profit/total weighted average number of shares
= $506.2 million/1,580 million shares
= $0.32 (or 32 cents)
Price to earnings ratio
With the EPS derived above, you can generate the price to earnings (PE) ratio. Analysts usually compare the PE ratios of companies in the same industry to judge if they are expensive or cheap when benchmarked against their peers. Note that the PE is influenced by a number of factors, including the price volatility of the company's share on the stock market and its earnings growth. Typically, the higher the PE, the greater the expectations of a company's future outlook.
Hence, if a company is trading at $4.50 and has an EPS of $0.32, then its
PE = Share price/EPS
= 4.50/0.32
= 14
Price to book value
Like the PE ratio, the price to book value (or PTB) is often used to compute stock values. The 'price' in PTB refers to the common stock price, while the 'book' is the book value of equity - the difference between a company's assets and its liabilities. In other words,
PTB = Market capitalisation/Total book value of its equity
One of the disadvantages of using PTB is that it is subject to accounting decisions on depreciation and other variables. On the other hand, it provides an alternative ratio to look at if a company is in the red, and therefore has no PE ratio to speak of.
Dividend yield
Dividend yield is the amount of dividend a shareholder can collect for every share that he owns.
Hence,
Dividend yield = Annual dividends received per share/Share price of the stock
As an example, SPH will be paying out 26 cents per share this year, so its dividend yield is therefore
26 cents/448 cents (price of stock as of Friday) = 5.8%
Gearing
Also known as financial leverage, gearing gives an idea of how a company funds its business - what proportion of its operations is being financed through debt, against shareholders' funds?
Gearing = Long-term liabilities/Shareholders' funds
Bear in mind that financial ratios should be evaluated together with knowledge of the company's operations, strategies and trends in the industry. None of them is meaningful on its own and should not be taken as the ultimate guide to a company's value. They should be looked at in conjunction with developments of the company, the performance of its peers, and not least, macroeconomic trends.
Ratios to judge a firm's health
CHEN HUIFEN looks at key financial ratios that can help to evaluate the comparative performance of companies
IN OUR previous two instalments, we discussed the value of annual reports, and how investors can pick out useful information from both the prose and numbers.
We also looked at the fundamentals behind the three main financial statements - the profit and loss statement, the balance sheet and the cash flow.
Based on the information above, analysts can derive key financial ratios that help them in their assessment of a company's past and current health. To draw a simple analogy, some consumers base their car buying decisions on the fuel mileage they can get. Similarly, financial ratios are tools to judge the comparative performance of companies.
There are probably some 20 major financial ratios that analysts can churn out when they evaluate the operating performance and capital structure of companies. Here, we pick out some of the key ones.
Net profit margin
Net profit margin measures the amount of money a company makes for every dollar of sales generated. So, the higher the number, the better. It is typically presented in percentage terms. For example, Singapore Press Holdings (SPH) recently reported a full year net profit of $506.2 million, on a revenue of $1.16 billion. Its net profit margin is therefore
Net profit/revenue = $506.2 million/$1,160 million
= 43.6 per cent.
Return on equity
Commonly referred to as ROE, return on equity indicates how effectively a company generates profits out of its shareholders' funds compared to its peers in the same industry. There is more than one way of calculating ROE. The simplest is
ROE = Net profit/Shareholders' equity
So if a company makes $506.2 million and has shareholders' equity of about $2.2 billion, then its
ROE = $506.2 million/$2,200 million
= 23 per cent
Earnings per share
One of the key indicators of profitability, earnings per share or EPS is derived by dividing the net profit by the number of shares issued. So if a company makes $506.2 million and has 1.58 billion shares, then its
EPS = net profit/total weighted average number of shares
= $506.2 million/1,580 million shares
= $0.32 (or 32 cents)
Price to earnings ratio
With the EPS derived above, you can generate the price to earnings (PE) ratio. Analysts usually compare the PE ratios of companies in the same industry to judge if they are expensive or cheap when benchmarked against their peers. Note that the PE is influenced by a number of factors, including the price volatility of the company's share on the stock market and its earnings growth. Typically, the higher the PE, the greater the expectations of a company's future outlook.
Hence, if a company is trading at $4.50 and has an EPS of $0.32, then its
PE = Share price/EPS
= 4.50/0.32
= 14
Price to book value
Like the PE ratio, the price to book value (or PTB) is often used to compute stock values. The 'price' in PTB refers to the common stock price, while the 'book' is the book value of equity - the difference between a company's assets and its liabilities. In other words,
PTB = Market capitalisation/Total book value of its equity
One of the disadvantages of using PTB is that it is subject to accounting decisions on depreciation and other variables. On the other hand, it provides an alternative ratio to look at if a company is in the red, and therefore has no PE ratio to speak of.
Dividend yield
Dividend yield is the amount of dividend a shareholder can collect for every share that he owns.
Hence,
Dividend yield = Annual dividends received per share/Share price of the stock
As an example, SPH will be paying out 26 cents per share this year, so its dividend yield is therefore
26 cents/448 cents (price of stock as of Friday) = 5.8%
Gearing
Also known as financial leverage, gearing gives an idea of how a company funds its business - what proportion of its operations is being financed through debt, against shareholders' funds?
Gearing = Long-term liabilities/Shareholders' funds
Bear in mind that financial ratios should be evaluated together with knowledge of the company's operations, strategies and trends in the industry. None of them is meaningful on its own and should not be taken as the ultimate guide to a company's value. They should be looked at in conjunction with developments of the company, the performance of its peers, and not least, macroeconomic trends.
Monday, October 29, 2007
BT: Enter the mature bull - and higher volatility
Business Times - 27 Oct 2007
Enter the mature bull - and higher volatility
But there's still room for equity prices to go higher
By TEH HOOI LING SENIOR CORRESPONDENT
STOCK investors need pretty strong nerves to stay invested in the market of late. It is not uncommon to see the Straits Times Index (STI) open up 50 points but end the day at -50. And a 100-point plunge in one day may be followed by a similar jump the next.
This is a sign that investors are jittery. On the one hand, equities around the world have done spectacularly well in the last four-and-a-half years. During that time, the STI has more than tripled. That's a lot of profits to lock up. On the other hand, there are just as many compelling reasons to hold on to, as there are to quit, equities now.
The economic force that the emergence of China and India unleashes into the world, as hundreds of millions of new consumers flood the marketplace in the next few years or decades, is unimaginable. Meanwhile, the wealth accumulated thus far in these two countries is scouring the world for viable investments. That liquidity flow will continue to support asset prices globally.
On the flipside, the economy in the United States - still the world's biggest market today - is slowing down. The impact of the sub-prime mortgage crisis on consumer spending is still a big question mark. If US consumers tighten their purse-strings as they see their home prices fall, then many of the exporters around the world will be hit by declining profits. Demand from Asia may not yet be enough to make up for the shortfall. But increasingly, the market wisdom is that problems in the US are not severe enough to cause a recession there, and hence the impact on the global economy may not be as great as initially feared.
Still, the increased volatility is symptomatic of a maturing bull market.
Four-phase cycle
In a report this month, Citigroup Global Markets' equity research said that the global equity bull market that began in March 2003 is maturing, but not finished yet. We are now into the third phase of a four-phase market cycle, according to Citi.
The first phase is when the economy is emerging from a recession. It follows the bottom of the credit bear market. Spreads fall sharply as companies repair their balance sheets, often through deeply discounted share issues. This, along with continued pressure on profits, keeps equity prices falling.
Phase two begins as profitability turns and equity prices start to rally. Credit spreads fall even further as corporate cashflows rise strongly. This is an immature equity bull market. In the current cycle, this phase began in March 2003.
The third phase is when the credit bull market comes to an end. Spreads start to rise as investor appetite for leverage wanes. The equity market decouples from credit and continues to rise. 'We think that the market is entering this phase now. This is the mature equity bull market,' says Citi.
And after that, the market enters the bear phase, when equity and credit prices are falling together. This is usually associated with falling profits and worsening balance sheets.
Insolvencies plague the credit market, and profit warnings plague the equity market. At this stage of the market, a defensive strategy is most appropriate - cash and government bonds are the best-performing asset classes.
Citi tries to identify the four phases in the last 20 years' market cycles. It found that the different phases are not equal in length. For credit market, phase one tends to be fast and furious. It lasted 18 months in 1991-92 and just five months in 2002-03. But the returns are significant - spreads collapsed by 29 basis points (bp) per month in 1991-92 and 50 bp per month in 2001-03.
Phase two tends to be longer. It lasted five years in the mid-1990s and just over four years in the early 2000s. Spreads fell by a more leisurely 3 bp a month in 1992-93 and 10 bp a month in 2001-03.
The credit bear market begins in phase three. Spreads rose by around 300 bp in 1988 and 1997-00. This time round, they have already risen by 120 bp since spreads bottomed on June 12, 2007.
Spreads keep rising in phase four as defaults increase and corporate profits fall. This tends to be the most painful period for credit investors, notes Citi. It lasted 30 months back in 2000-02.
While the credit investor makes money in phases one and two, an equity investor makes money in phases two and three. In phase three in 1988-90, global equities rose by 38 per cent despite a 317 bp increase in credit spreads. And in phase three in 1997-2000, equities rose by 57 per cent despite a 282 bp increase in credit spreads.
While equities perform well in phases two and three, phase two - the immature bull - lasts longer and is less volatile.
For example, the US Vix measure of implied volatility has averaged 15 in phase two and 22 in phase three. This is a key difference between a mature bull and an immature bull. 'The returns may be as good, but the quality of those returns is worse,' says Citi. 'Sharpe ratios and risk-adjusted returns deteriorate.' As for now, the Vix is 16 - having peaked at 30 in July. 'But we would expect the overall trend to be rising as the mature bull market develops.'
This suggests that while it is still right to be overweight equities in phase three, the overweight should not be as great as during phase two. And a leveraged strategy is less appropriate as volatility rises.
Among the sectors, Citi's analysis showed that travel and leisure, retail, media and industrial goods and services performed well in phase three of the last two cycles. Banks underperformed during this phase as credit spreads rose.
Meanwhile, the mature bull phases are also when major bubbles develop. In 1990, Japan rose to a 60 times trailing earnings multiple and accounted for 50 per cent of total global market cap. It now accounts for only 10 per cent. In 2000, technology, media and telecoms (TMT) also rose to 60 times PE and accounted for 40 per cent of global market cap. It now makes up 20 per cent of global market cap.
'These bubbles usually build on a theme that has already been performing strongly through phase two. Into phase three, easier monetary policy and rising capital inflows from other asset classes provide the fuel to drive prices to spectacular and ultimately unsustainable levels. This then bursts and proves a major downward force on global equities in the bear phase four,' says Citi.
Next equity bubble
The next equity bubble could be building in emerging market or commodity plays. 'These are stocks or markets which are perceived to be most positively exposed to a robust global economy, irrespective of the US slowdown.'
However, the Asia ex-Japan index, at 19 times PE, although a premium to the MSCI World's PE of 16 times, is still a long way off the 50-plus times multiple more typical of the peak in these mature bull market bubbles.
'The key point is that if the bubble for this cycle is to be created in the global growth trade, and the Asia Pacific/emerging markets indices in particular, then they could have a lot further to go.
'Investors who try to fight the current re-rating of these markets could suffer the same fate as those who tried to fight Japan in the 1980s and TMT in the 1990s. Probably the right call, but the timing could hit you,' says Citi.
According to Citi, signs of the end of the mature bull run include rate hikes and extended equity valuations. Both don't apply now.
So while the recent dislocation in financial markets suggests the end of the credit bull market, it is not the end of the equity bull market. We are entering the mature bull phase, which will still provide decent returns for equity investors. However, it is becoming increasingly unstable. This is the phase where a major speculative bubble typically develops in the global equity market.
Perhaps this time round, it is in emerging markets and commodity plays. However investors should remember that these bubbles can go a lot further than anybody expects - it can prove fatal to bet against them too early, cautions Citi.
The writer is a CFA charterholder.
Enter the mature bull - and higher volatility
But there's still room for equity prices to go higher
By TEH HOOI LING SENIOR CORRESPONDENT
STOCK investors need pretty strong nerves to stay invested in the market of late. It is not uncommon to see the Straits Times Index (STI) open up 50 points but end the day at -50. And a 100-point plunge in one day may be followed by a similar jump the next.
This is a sign that investors are jittery. On the one hand, equities around the world have done spectacularly well in the last four-and-a-half years. During that time, the STI has more than tripled. That's a lot of profits to lock up. On the other hand, there are just as many compelling reasons to hold on to, as there are to quit, equities now.
The economic force that the emergence of China and India unleashes into the world, as hundreds of millions of new consumers flood the marketplace in the next few years or decades, is unimaginable. Meanwhile, the wealth accumulated thus far in these two countries is scouring the world for viable investments. That liquidity flow will continue to support asset prices globally.
On the flipside, the economy in the United States - still the world's biggest market today - is slowing down. The impact of the sub-prime mortgage crisis on consumer spending is still a big question mark. If US consumers tighten their purse-strings as they see their home prices fall, then many of the exporters around the world will be hit by declining profits. Demand from Asia may not yet be enough to make up for the shortfall. But increasingly, the market wisdom is that problems in the US are not severe enough to cause a recession there, and hence the impact on the global economy may not be as great as initially feared.
Still, the increased volatility is symptomatic of a maturing bull market.
Four-phase cycle
In a report this month, Citigroup Global Markets' equity research said that the global equity bull market that began in March 2003 is maturing, but not finished yet. We are now into the third phase of a four-phase market cycle, according to Citi.
The first phase is when the economy is emerging from a recession. It follows the bottom of the credit bear market. Spreads fall sharply as companies repair their balance sheets, often through deeply discounted share issues. This, along with continued pressure on profits, keeps equity prices falling.
Phase two begins as profitability turns and equity prices start to rally. Credit spreads fall even further as corporate cashflows rise strongly. This is an immature equity bull market. In the current cycle, this phase began in March 2003.
The third phase is when the credit bull market comes to an end. Spreads start to rise as investor appetite for leverage wanes. The equity market decouples from credit and continues to rise. 'We think that the market is entering this phase now. This is the mature equity bull market,' says Citi.
And after that, the market enters the bear phase, when equity and credit prices are falling together. This is usually associated with falling profits and worsening balance sheets.
Insolvencies plague the credit market, and profit warnings plague the equity market. At this stage of the market, a defensive strategy is most appropriate - cash and government bonds are the best-performing asset classes.
Citi tries to identify the four phases in the last 20 years' market cycles. It found that the different phases are not equal in length. For credit market, phase one tends to be fast and furious. It lasted 18 months in 1991-92 and just five months in 2002-03. But the returns are significant - spreads collapsed by 29 basis points (bp) per month in 1991-92 and 50 bp per month in 2001-03.
Phase two tends to be longer. It lasted five years in the mid-1990s and just over four years in the early 2000s. Spreads fell by a more leisurely 3 bp a month in 1992-93 and 10 bp a month in 2001-03.
The credit bear market begins in phase three. Spreads rose by around 300 bp in 1988 and 1997-00. This time round, they have already risen by 120 bp since spreads bottomed on June 12, 2007.
Spreads keep rising in phase four as defaults increase and corporate profits fall. This tends to be the most painful period for credit investors, notes Citi. It lasted 30 months back in 2000-02.
While the credit investor makes money in phases one and two, an equity investor makes money in phases two and three. In phase three in 1988-90, global equities rose by 38 per cent despite a 317 bp increase in credit spreads. And in phase three in 1997-2000, equities rose by 57 per cent despite a 282 bp increase in credit spreads.
While equities perform well in phases two and three, phase two - the immature bull - lasts longer and is less volatile.
For example, the US Vix measure of implied volatility has averaged 15 in phase two and 22 in phase three. This is a key difference between a mature bull and an immature bull. 'The returns may be as good, but the quality of those returns is worse,' says Citi. 'Sharpe ratios and risk-adjusted returns deteriorate.' As for now, the Vix is 16 - having peaked at 30 in July. 'But we would expect the overall trend to be rising as the mature bull market develops.'
This suggests that while it is still right to be overweight equities in phase three, the overweight should not be as great as during phase two. And a leveraged strategy is less appropriate as volatility rises.
Among the sectors, Citi's analysis showed that travel and leisure, retail, media and industrial goods and services performed well in phase three of the last two cycles. Banks underperformed during this phase as credit spreads rose.
Meanwhile, the mature bull phases are also when major bubbles develop. In 1990, Japan rose to a 60 times trailing earnings multiple and accounted for 50 per cent of total global market cap. It now accounts for only 10 per cent. In 2000, technology, media and telecoms (TMT) also rose to 60 times PE and accounted for 40 per cent of global market cap. It now makes up 20 per cent of global market cap.
'These bubbles usually build on a theme that has already been performing strongly through phase two. Into phase three, easier monetary policy and rising capital inflows from other asset classes provide the fuel to drive prices to spectacular and ultimately unsustainable levels. This then bursts and proves a major downward force on global equities in the bear phase four,' says Citi.
Next equity bubble
The next equity bubble could be building in emerging market or commodity plays. 'These are stocks or markets which are perceived to be most positively exposed to a robust global economy, irrespective of the US slowdown.'
However, the Asia ex-Japan index, at 19 times PE, although a premium to the MSCI World's PE of 16 times, is still a long way off the 50-plus times multiple more typical of the peak in these mature bull market bubbles.
'The key point is that if the bubble for this cycle is to be created in the global growth trade, and the Asia Pacific/emerging markets indices in particular, then they could have a lot further to go.
'Investors who try to fight the current re-rating of these markets could suffer the same fate as those who tried to fight Japan in the 1980s and TMT in the 1990s. Probably the right call, but the timing could hit you,' says Citi.
According to Citi, signs of the end of the mature bull run include rate hikes and extended equity valuations. Both don't apply now.
So while the recent dislocation in financial markets suggests the end of the credit bull market, it is not the end of the equity bull market. We are entering the mature bull phase, which will still provide decent returns for equity investors. However, it is becoming increasingly unstable. This is the phase where a major speculative bubble typically develops in the global equity market.
Perhaps this time round, it is in emerging markets and commodity plays. However investors should remember that these bubbles can go a lot further than anybody expects - it can prove fatal to bet against them too early, cautions Citi.
The writer is a CFA charterholder.
Tuesday, October 23, 2007
Reverse stock splits: boon or bane?
Business Times - 20 Oct 2007
Reverse stock splits: boon or bane?
By TEH HOOI LING SENIOR CORRESPONDENT
AT LEAST seven Singapore-listed companies have carried out share consolidation so far this year.
Share consolidation - also known as a reverse stock split - is a corporate action through which a number of shares are consolidated into one.
Various reasons are given by companies for deciding to implement a reverse stock split.
For example, one company said in a statement that prior to consolidation, small movements in its share price represented large percentage movements that resulted in volatility.
'It is anticipated the consolidation will benefit the company and its shareholders by reducing the volatility in the share price,' the company said.
On the Singapore Exchange, the minimum bid for a stock below $1 is half a cent. So a stock trading at one cent can move up or down by half of its value - a 50 per cent swing.
In January this year, Time Watch, after completing a reverse takeover, consolidated 50 shares into one. The company said in a statement: 'Time Watch believes the share consolidation may reduce the fluctuation in magnitude of the company's market capitalisation, lower trading costs for investors and also renew market and investors' interest in the shares.'
In the trading-range hypothesis, it is suggested that stock splits regroup share prices to a preferred price range. An optimal price range is when prices attract investors big and small.
Smaller investors may be unable or unwilling to buy shares if the unit price is too high. So companies do a stock split or bonus issue.
If a share price is too low, it is an indication of poor performance and the stock is also viewed as a speculative stock. Institutions tend to avoid such shares. So companies that are willing to court small investors and large institutional ones try to have a stock price that is acceptable to both sets of investors.
Meanwhile, according to the signalling theory, management sends messages to investors via its financial decisions. A bonus share issue or stock split is generally associated with management's confidence in future performance. And so a reverse stock split sends the reverse signal, according to some studies.
Spudeck and Moyer (1985), among others, argue that reverse splits seem to be taken by the market as a strong signal of management's lack of confidence in the future stock prices.
Woolridge and Chambers (1983) even suggest that when a reverse split is impending, investors should sell their shares.
SGX-listed stocks
I've decided to look at the share performance of those stocks on SGX that have been consolidated in the past three years. Of these, only seven have had six or more months of performance since consolidation.
The companies are Integra2000, Lankom, Digiland, Wilmar (formerly Ezyhealth), Hup Soon Global (formerly Twinwood), Delong (formerly Teamsphere) and Time Watch (formerly Wee Poh).
Of these seven companies, four saw their share price underperform the SES All Shares Index by 35 to 86 percentage points in the 12 months leading up to their share consolidation. The exceptions were Ezyhealth, Twinwood and Teamsphere, which saw their share prices shoot up sharply after news of their reverse takeover deals was announced.
In general, reverse stock-split companies did not see their performance improve subsequent to consolidation.
Six months after consolidation, the median excess return of these companies relative to the SES
All Shares Index was 45 per cent. The average was -27 per cent.
And 12 months subsequent to reverse stock splits, the median underperformance widened to -58 per cent. The average was -28 per cent.
Based on the limited sample size, it does appear that share consolidation is generally not good news for investors.
Indeed, investors have had an inkling of that. Radcliffe and Gillespie (1979), Woolridge and Chambers, Spudeck and Moyer and Peterson and Peterson (1992) document that significantly negative abnormal returns surround reverse split announcements.
Ho, Nelling and Chen (2005) studied US companies listed on the New York Stock Exchange and Nasdaq that conducted reverse stock splits between 1980 and 2000. They also found that companies that carried out reverse stock splits significantly underperformed the various market benchmarks and stocks with similar characteristics one to three years later.
They said the results suggest that 'reverse-splitting firms are unable to change the pattern of post-split underperformance ... since the reverse stock splitting firms are relatively pessimistic about future prospects'.
There are, of course, exceptions. And a notable exception in Singapore is Wilmar. The stock has performed spectacularly since its reverse takeover of Ezyhealth.
It has been helped by several factors, among them the injections of assets by the Kuok family into the Singapore company, and the interest in biodiesel as a alternative fuel source.
So, for companies that did a reverse-split after a reverse takeover, ultimately, what happens depends on the quality of assets injected into the company.
The writer is a CFA charterholder.
Reverse stock splits: boon or bane?
By TEH HOOI LING SENIOR CORRESPONDENT
AT LEAST seven Singapore-listed companies have carried out share consolidation so far this year.
Share consolidation - also known as a reverse stock split - is a corporate action through which a number of shares are consolidated into one.
Various reasons are given by companies for deciding to implement a reverse stock split.
For example, one company said in a statement that prior to consolidation, small movements in its share price represented large percentage movements that resulted in volatility.
'It is anticipated the consolidation will benefit the company and its shareholders by reducing the volatility in the share price,' the company said.
On the Singapore Exchange, the minimum bid for a stock below $1 is half a cent. So a stock trading at one cent can move up or down by half of its value - a 50 per cent swing.
In January this year, Time Watch, after completing a reverse takeover, consolidated 50 shares into one. The company said in a statement: 'Time Watch believes the share consolidation may reduce the fluctuation in magnitude of the company's market capitalisation, lower trading costs for investors and also renew market and investors' interest in the shares.'
In the trading-range hypothesis, it is suggested that stock splits regroup share prices to a preferred price range. An optimal price range is when prices attract investors big and small.
Smaller investors may be unable or unwilling to buy shares if the unit price is too high. So companies do a stock split or bonus issue.
If a share price is too low, it is an indication of poor performance and the stock is also viewed as a speculative stock. Institutions tend to avoid such shares. So companies that are willing to court small investors and large institutional ones try to have a stock price that is acceptable to both sets of investors.
Meanwhile, according to the signalling theory, management sends messages to investors via its financial decisions. A bonus share issue or stock split is generally associated with management's confidence in future performance. And so a reverse stock split sends the reverse signal, according to some studies.
Spudeck and Moyer (1985), among others, argue that reverse splits seem to be taken by the market as a strong signal of management's lack of confidence in the future stock prices.
Woolridge and Chambers (1983) even suggest that when a reverse split is impending, investors should sell their shares.
SGX-listed stocks
I've decided to look at the share performance of those stocks on SGX that have been consolidated in the past three years. Of these, only seven have had six or more months of performance since consolidation.
The companies are Integra2000, Lankom, Digiland, Wilmar (formerly Ezyhealth), Hup Soon Global (formerly Twinwood), Delong (formerly Teamsphere) and Time Watch (formerly Wee Poh).
Of these seven companies, four saw their share price underperform the SES All Shares Index by 35 to 86 percentage points in the 12 months leading up to their share consolidation. The exceptions were Ezyhealth, Twinwood and Teamsphere, which saw their share prices shoot up sharply after news of their reverse takeover deals was announced.
In general, reverse stock-split companies did not see their performance improve subsequent to consolidation.
Six months after consolidation, the median excess return of these companies relative to the SES
All Shares Index was 45 per cent. The average was -27 per cent.
And 12 months subsequent to reverse stock splits, the median underperformance widened to -58 per cent. The average was -28 per cent.
Based on the limited sample size, it does appear that share consolidation is generally not good news for investors.
Indeed, investors have had an inkling of that. Radcliffe and Gillespie (1979), Woolridge and Chambers, Spudeck and Moyer and Peterson and Peterson (1992) document that significantly negative abnormal returns surround reverse split announcements.
Ho, Nelling and Chen (2005) studied US companies listed on the New York Stock Exchange and Nasdaq that conducted reverse stock splits between 1980 and 2000. They also found that companies that carried out reverse stock splits significantly underperformed the various market benchmarks and stocks with similar characteristics one to three years later.
They said the results suggest that 'reverse-splitting firms are unable to change the pattern of post-split underperformance ... since the reverse stock splitting firms are relatively pessimistic about future prospects'.
There are, of course, exceptions. And a notable exception in Singapore is Wilmar. The stock has performed spectacularly since its reverse takeover of Ezyhealth.
It has been helped by several factors, among them the injections of assets by the Kuok family into the Singapore company, and the interest in biodiesel as a alternative fuel source.
So, for companies that did a reverse-split after a reverse takeover, ultimately, what happens depends on the quality of assets injected into the company.
The writer is a CFA charterholder.
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