Tuesday, November 27, 2007

Articles - ethics

Does payment for order flow to your broker help or hurt you

IPO Analysis

Investing in IPOs and recent IPOs is much like investing in seasoned stocks, but with the noted exception of the limited availability of information.

For IPO and recent IPO firms , a good place to start your research is the prospectus.

The prospectus generally provides information related to the offering details, the company’s business, its markets, its products, its strategies, risks associated with the company, and the all important financial information.

How can you evaluate a newly-public company? Here are factors that need to be considered:

Do you understand what the company does?

Is its industry in a growth mode?

Does it have a competitive advantage?

How does a company compare to its peers on its most basic financial criteria?

Price-earnings ratio
Operating cash flow growth (make sure cash flow is positive)
Historical sales growth
Historical earnings growth

The biggest obstacle you will find is lack of data. Even if you buy after the initial public offering has settled in, IPO's are still speculative, with little or no public trading history. So, make sure IPO's are relegated to a very small portion of your portfolio.

As always, we recommend that you perform the needed due diligence prior to acquiring a position.(Does this sentence have any meaning?. Most of the organizations write this sentence at the end. If we can not describe a due diligence methods, why say do a due diligence? But this is the statutory warning?)

A final tidbit – recent IPOs with positive GAAP earnings tend to be the ones that turn into winners.


Saturday, November 17, 2007

Analysis of Risk and Return

You have to analyze various investing and trading opportunities in securities market and undertake only those transactions that offer more expected return for more risk.

securities markets do not offer every opportunity with the rule that more risk means more expected return. The opportunities in the market are offered by people like you only. There is no reason for them to calculate and offer you a proper opportunity always.

If you are a rational buyer or a rational seller, you have to analyse the opportunity. You may employ an advisor or an analyst to help you.

The subject of security analysis is created to help you in this endeavour.

Finding average and standard deviation of past data of returns is one alternative to evaluate the risk and expected return. The average of the past data is taken as an estimate of expected return in the future.

Thursday, November 15, 2007

India Can Grow at 10% for a Decade

Lehman Brothers Report October 2007

.India could grow at 10% or so per annum over the coming decade.

. This judgement is contingent on India continuing to actively pursue structural economic reforms.

. Structural changes behind India’s growth acceleration, contributing to capital deepening and rising productivity. They include the development of the financial system, trade and capital account liberalisation, and more prudent macro management.

. India has reached “take-off” stage.

. There is clear evidence that India’s rapid economic development, high growth and
reforms have started to interact positively with each other – the economy appears to
be taking on many of the characteristics exhibited by other large Asian economies during the early stages of economic take-off.

• While business continues to prove impressively adept at working round systemic
and structural challenges, sustaining higher growth in the medium term will require
continuing structural reform.

. further financial sector reforms could add 1 to 1½ percentage points to India’s long-term GDP growth.

• Even larger economic gains could flow from removing constraints such as weak
(soft and hard) infrastructure, bureaucracy, and labour market rigidities. Breaking
down these barriers is key to enabling business to achieve increasing returns to scale by capitalising on its global comparative advantages in labour-intensive
manufactured and agricultural exports.

. India’s trade-to-GDP ratio could double over the coming decade, also adding 1½ points to GDP growth.

• However, pushing through structural reform will remain a political challenge in the
face of headwinds from vested interest and coalition politics. That said, there should be a new window for reform after the next general election due in 2009.

• Given the powerful trends of demography and urbanisation, India needs “a faster
and a more inclusive” growth strategy to correct its inter- and intra-regional
imbalances and avoid social unrest. The social and economic costs of not pursuing
inclusive growth are potentially enormous.

• Inclusive growth can be facilitated by further easing the shackles on business, by
making education and health available to all of society and by developing the rural
sector, which employs nearly 60% of the total workforce. Labour market reforms to
spur the necessary job creation over the next decade will be a key challenge.

• India’s growing economic clout is encouraging a more proactive regional policy and
greater engagement on the global stage, for example in trade liberalisation and the
climate change debate, which also stand to boost economic growth.

• In short, in India there is still much growth potential to be unlocked.

For full report - download from


Friday, November 9, 2007

Inexperience Fund Managers and Bubbles

In the recent paper, "Inexperienced Investors and Bubbles," Harvard Business School's Robin Greenwood and Stanford's Stefan Nagel compared the returns of young and older mutual fund managers during and after the technology stock bubble starting at the end of last decade.

The results show that inexperienced fund managers as defined by age (under thirty-five) exhibited trend-chasing behavior that produced over-investment in tech stocks. The results fit well with adaptive expectations models of learning," the coauthors write. "According to this interpretation, the trend-chasing behavior of young managers reflects their attempts to learn and extrapolate from the little data they have experienced in their career."

The evidence is still out, but it is known that at the peak of the market a significant fraction of institutional money was controlled by young managers.

One well documented feature of the technology bubble was that younger investors were lured in. If you read historical accounts of the Tulip Bubble, as well as other famous examples, it turns out that this is pervasive.

The author's intuition was that this might explain how these stocks became overvalued in the first place. That we cannot prove. However, we can show that inexperienced mutual fund managers were much more likely to deviate from their benchmarks and purchase technology stocks during the 1998-2000 period.

The hypothesis is that younger managers, and inexperienced investors more generally, are more likely to extrapolate past price movements when forming their forecasts of future returns.

There are countless examples of bubbles throughout history in which inexperienced investors were lured in. Somewhat surprisingly, young managers were not that good at evaluating technology stocks. Although they experienced high returns when technology stocks did well, we show that if one controls for their exposure to technology, younger managers underperform. Underperformance gets worse after 2000, not surprisingly.

Q: Why aren't older managers as likely to chase a bubble?

A: For two reasons. First, they have had more market experience, and know that past returns do not imply future performance. Second, they may have lived through some years of particularly bad returns. This tends to make investors more cautious.

Interestingly, fund managers older than forty—just old enough to have lived through the 1987 crash—were particularly unlikely to bet on technology stocks relative to their younger counterparts.

Q: Your research focuses on inexperienced (as reflected in age) fund managers, yet you would think these folks are still experienced investors. They must have some track record to have a fund handed over to them to manage. So is it really a matter of time and experience that deepens your investment skill, or is there also something to being a fund manager (as opposed to being a lone or non-professional investor) that broadens the experiences you learn from?

A: We were surprised to find these results among mutual fund managers, who a priori one would not expect to be subject to these kinds of biases. After all, they are better trained than your typical investor. We expect these biases to be even more severe among the general public.

Q: What have we learned about how inexperienced fund investors affected financial bubbles before the 1990s? Can't we learn by past mistakes?

A: Our research shows that, unfortunately, investors do not take the time to look at history. Learning occurs by doing, or in our case, by investing and experiencing the returns that result from one's investment decisions. I remember several commentators criticizing legendary (and older!) value investor Warren Buffet for his reluctance to invest in technology stocks. It turns out he was right.

Q: How did your research advance previous knowledge on bubble formation, "herd" mentality, and other work in this area?

A: While there are scores of anecdotal accounts of inexperienced investors being lured into the market during times of bubble, our paper is the first systematic evidence. Having said that, there is some interesting experimental work, conducted during the 1980s, in which participants in a simulated financial market were asked to make investment decisions. The overwhelming conclusion from this work is that investors that had not yet experienced a downturn in returns are more likely to infer that prices would continue to go up.

We thought the experimental work was interesting, but wanted to know whether those results had anything to do with real-world financial markets. Our main contribution, I think, is that we show that the identity of the marginal investor can change over time. We usually think of mutual funds as relatively sophisticated investors, perhaps even exerting a stabilizing influence on price at times when individual investors are going crazy. Unfortunately, during bubble periods, the mutual funds that receive the most inflows are being managed by the most inexperienced people. Thus, at the peak, inexperienced investors end up controlling a significant portion of assets and thus have the power to sway prices.

Source: http://hbswk.hbs.edu/item/5618.html