Equity Market Characteristics

 Stock Indicators
- As investors, we are mostly interested in business valuation ratios. The following ratios provide
indicators to tell us if the stock market is valuing the stock fairly. The judgment of fair valuation
depends on the typical valuations for similar companies in similar industries. Many factors come into
play and often times these ratios can get out of the typical range due to certain atypical business or
industry conditions. Investors should take these ratios as merely indicators of value, not the final
arbiter of value. These indicators are some of the useful financial ratios to supplement you when
investing in a stock market . We are talking about the following financial ratios:

1.) Earnings per Share (EPS)

- When buying a stock, you participate in the future earnings or risk of loss of a company. Then, EPS
would be very helpful for you. Earnings per share (EPS) measures net income earned on each share of
a company's common stock, indicating a company’s profitability to investors.
- Calculate EPS by dividing the company’s net income minus any preferred dividends by the number of
outstanding shares, which are the stock currently held by all shareholders.

Example:

- For the example shown in the following figures, the company’s $32.47 million net income is divided by
the 8.5 million shares of stock the business has issued to compute its $3.82 EPS.

- EPS can tell you how companies in the same industry compare. Companies that show steady,
consistent earnings growth, year after year, will often outperform companies with volatile earnings
over time.

2.) Price to Earnings Ratio (P/E)

- The price to earnings ratio, also known as the p/e ratio, is probably the most famous financial ratio in
the world. It is used as a quick and dirty way to determine how "cheap" or "expensive" the stock is.
The best way to think of it is how much you are willing to pay for every $1 in earnings a company
generates.
- It’s calculated by dividing the current price per share of a company’s stock by the company’s earnings
per share.

Example:
BSAIS Corporation stock is currently trading at $50 a share and its earnings per share for the year is 5
dollars.

- The P/E ratio can tell you whether a stock’s price is high, or low, compared to its earnings.
- Some investors consider a company with a high P/E to be overpriced. But sometimes a company with
a high P/E today may offer higher returns, and a better P/E, in the future. How do you know? You’ll
likely have to look at other indicators before you decide.
- If you are tempted to buy a stock because the p/e ratio appears attractive, do your research and
discover the reasons. Is management honest? Is the business losing key customers? Is it simply a case
of neglect, as happens from time to time even with fantastic businesses? Is the weakness in the stock
price or underlying financial performance a result of forces across the entire sector, industry, or
economy, or is it caused by firm-specific bad news? Is the company going into a permanent state of
decline?
- Just because a stock is cheap doesn't mean you should buy it. Many investors prefer the PEG Ratio,
instead, because it factors in the growth rate. Even better is the dividend-adjusted PEG ratio because
it takes the basic price-to-earnings ratio and adjusts it for both the growth rate and the dividend yield
of the stock.

3.) Price to Earnings to Growth Ratio (PEG)

- While the price to earnings ratio (or p/e ratio for short) is the most popular way to measure the
relative valuation of two stocks, the PEG ratio goes one step further. It stands for the price-to-
earnings-to-growth ratio. As you can tell by its title, the PEG ratio factors in a company's growth.
- This helps you understand the P/E ratio a little better. It’s calculated by dividing the P/E ratio by the
company’s projected growth in earnings.
- Projected growth is the amount that a company expects its earnings to grow by some future date.

Example:
Let's say you're analysing a stock that is trading with a P/E ratio of 16. Suppose the company's
earnings per share (EPS) have been and will continue to grow at 15% per year. By taking the P/E ratio
(16) and dividing it by the growth rate (15), the PEG ratio is calculated as 1.07.

- The PEG can tell you whether a stock may or may not be a good value. The lower the number, the less
you have to pay to get in on the company’s expected future earnings growth.
- The PEG ratio is used to know the relationship between the price of a stock, earnings per share (EPS)
and the company's growth.
- A very generally rule of thumb is that any PEG ratio below 1.0 is considered to be a good value.

4.) Dividend Yield Ratio

- The dividend yield of a stock represents the return you are likely to receive on a periodic basis by
owning the stock.
- Dividends are the main way companies return money to their shareholders. If a firm pays a dividend,
it will be listed on the balance sheet.
- Dividend yield is used to compare different dividend-paying stocks. Some people prefer to invest in
companies with a steady dividend, even if the dividend yield is low, while others prefer to invest in
stocks with a high dividend yield.
- To calculate dividend yield, just divide the annual dividend per share of the stock with the current
stock price. The result when expressed as a percentage is the dividend yield of the stock.

Example:
If stock XYZ had a share price of $50 and an annualised dividend of $1.00, its yield would be 2%.
- $1.00 / $50 = .02
- When the 0.02 is put into percentage terms, it would make a 2% yield.

- Dividend yields are a measure of an investment’s productivity, and some even view it like an "interest
rate" earned on an investment.
- A security's dividend yield can also be a sign of the stability of a company and often supports a firm's
share price. Normally, only profitable companies pay out dividends. Therefore, investors often view
companies that have paid out significant dividends for an extended period of time as "safer"
investments. Thus, should events occur which are detrimental to the share price, the allure of the
dividend combined with the stability of the company can support the price somewhat.
 - Normally, if you find a dividend yield in double digits, you should dig deeper and see why the yield is
so high. These kinds of yields are not normal.
- First, you need to figure out if the company can afford to pay a dividend this high. In some cases, the
business may have taken a turn for the worse, and the company may be forced to cut the dividend in
the future (it may still be a great investment, but not for the dividends that may have attracted you to
this company in the first place).
- In some cases though, the company can actually afford and is willing to support the dividend at a high
level as it words through some temporary business issues. These could be rare opportunities to buy a
very undervalued stock that pays you a sufficiently high dividend to wait for the business to turn
around.

5.) Dividend Adjusted PEG Ratio

- Often, when a company is very large and profitable, it returns most of the earnings to its stockholders
in the form of a cash dividend. This can result in a situation where the company appears to be growing
slowly, but in addition to the earnings-per-share growth, stockholders are receiving large checks in the
mail that they can spend, give to charity, or reinvest in additional shares of stock. When this is the
case, the PEG ratio alone is not sufficient because it will appear that an otherwise attractive stock is
significantly overvalued, which may not be true.
- In these situations, the PEG ratio doesn't work well because stocks with high PEG ratios might still
generate an attractive total return. In fact, the odds are good that when you analyse most high
quality, blue-chip stocks such as Procter & Gamble, Colgate-Palmolive, Coca-Cola, or Tiffany &
Company, to name a few real-world companies, you will need to use the dividend-adjusted PEG ratio,
instead.
- Dividend-Adjusted PEG Ratio = (Price ÷ Earnings Per Share) ÷ (Annual Earnings Per Share Growth +
Dividend Yield)

Example:
~ Let's look at The Coca-Cola Company. When this article was first written on September 29th, 2012,
the stock traded for $38.85 per share and had earnings per share of $2.05. The dividend was $1.02
per share, resulting in a 2.6% dividend yield. The ValueLine Investment Survey estimated the growth
in earnings per share over the upcoming 3-5 years to be 8%.

- If you were using the regular PEG ratio formula, you would have calculated Coke's PEG as:
- Step 1: PEG Ratio = ($38.85 ÷ $2.05) ÷ 8
- Step 2: PEG Ratio = 19 ÷ 8
- Step 3: PEG Ratio = 2.375

- Is Coca-Cola really that overvalued? Had you paid attention to the cash you will be getting as a
stockholder in the soda giant, which has very real value, you would use the dividend-adjusted PEG
ratio formula:
- Step 1: Dividend Adjusted PEG Ratio = ($38.85 ÷ $2.05) ÷ (8 + 2.6)
- Step 2: Dividend Adjusted PEG Ratio = 19 ÷ 10.6
- Step 3: Dividend Adjusted PEG Ratio = 1.793

- In both cases, if the growth in earnings per share was accurately predicted, it would appear that
Coke is not attractively valued. However, we can tell from the second set of numbers that the
company, while certainly no steal, is much cheaper than the PEG ratio alone would have you believe.

 Stock Market Indexes

- It measures the price performance of stock portfolios, which are formed to represent a stock market
as a whole or a specific segment of the market, or sub-indexes.
- To measure and monitor market movements.
- To provide a means of ascertaining changes in aggregate wealth over time.
 - To perform a role as a barometers of the economy.
- To provide the basis for derivative instruments such as futures and options.

 Three (3) Methods of Weighing Indexes

1.) Unweighted Indexes
- comprised of securities with equal weight within the index.
- It is basically means that each stocks in an index has an equal importance or influence to the whole
Index, no matter how pricy the stock is or how much its market capitalisation is.

Example:

- We’re calculating the movement of prices on each stock rather than focusing on each day’s prices
because each stock has an equal importance to the whole index which then added with every stock in
an index to find the total price relative. The answer is divided by the total number of stocks and which
will be multiplied with the last day’s index which we assumed that is was 1,000.

 Standard and Poor’s 500 Equal Weight Index (EWI)

- Most prominent of the unweighted index
- The unweighted version of S&P 500 index
- Includes the same constituents as the value-weighted S&P 500 Index, but each of the 500 companies
has a fixed percentage weight of 0.2%.

2.) Value Weighted Indexes

- Currently the most popular of the three stock index weighting types.
- The weights of individual stocks in a value weighted equity index are proportional to their market
capitalization.
- It means that the higher the market capitalisation of a stock is, the higher its importance or weight to
the whole index.

Example:

- To find the market capitalisation, you’ll just simply multiple the outstanding share of the stock by its
price currently. Then, you’ll add the market capitalisation of all the stocks on Day 1 and also in Day 2.
Next, divide Day 2 total Market cap to The total on Day1 and multiply the answer by the last day’s
index which we always assumed to be 1,000 to get today’s index which is 1,150.
 Standard & Poor’s 500 Index
- Value weighted index of the stock prices of 500 Large U.S. firms.
- Act as more representative of the U.S. stock market than any other index.
- Includes the Dow Jones Industrial Average (DJIA) 30 Large Firms.

 Nasdaq Composite Index

- Along with the Dow Jones Average and S&P 500, it is one of the three most-followed indices in US
stock markets.
- The composition of the NASDAQ Composite is heavily weighted towards information technology
companies.

 Financial Times Stock Exchange 100 Index

- The FTSE 100 is an index composed of the 100 largest companies listed on the London Stock Exchange
(LSE).
- These are often referred to as ‘blue chip’ companies, and the index is seen as a good indication of the
performance of major companies listed in the UK.

3.) Price Weighted Indexes

- Stock index in which each stock influences the index in proportion to its price per share.
- It basically means that the weight of a stock is in proportion to its price. The higher the price of a stock
is, the higher its influence to the whole index.

Example:

- Find the average price of the stocks per day. Divide the average price of the current day by the last
day’s average price, then the answer is multiplied by the Index last day, which will give as an index of
1,150 today.

 Dow Jones Industrial Average Index

- Dow is a price weighted index that measures the stock performance of 30 large listed US companies.
- One of three most followed indices but not the best representation of the whole US stock market.

 Nikkei 225 Index

- The Nikkei is short for Japan's Nikkei 225 Stock Average, the leading and most-respected index of
Japanese stocks.
- It is a price-weighted index composed of Japan's top 225 blue-chip companies traded on the Tokyo
Stock Exchange.
- The Nikkei is equivalent to the Dow Jones Industrial Average Index in the United States.

 Stock Market Indicators

1.) Market Liquidity
- The ability to buy and sell an asset without changing the price materially and without incurring large
transactions costs.
- Market Illiquidity can be measured by turnover ratio, or sometimes called share turnover velocity
 Turnover Ratio
- Share Turnover Ratio = Trading Volume / Total number of Outstanding Shares
- It indicates how easy, or difficult, it is to sell shares of a particular stock on the market.
- It compares the number of shares that change hands during a particular period with the total number
of shares that could have been traded during that same period. 
- Investors may be unwilling to put their money at risk by acquiring the shares of a company with low
share turnover. That said, share turnover is interesting as a measurement.
Example:
At the end of 2018, Apple had approximately 4.8 billion shares outstanding. Its trading volume for
December averaged 46.4 million. So Apple's share turnover ratio for the month of December was just
shy of 1%.
- It means that only 1% of the stocks are moving in the market annually.

2.) Market Breadth

- It attempts to find how much underlying strength or weakness there is in a given stock index.
- One way to calculate the breadth of a market is the Advance-Decline Index.

 Advance- Decline Line

- This indicator, also known as the A/D line, calculates a running total of the difference between the
number of advancing and declining stocks.

Example:

- The advance/decline line (A/D) is a breadth indicator used to show how many stocks are participating
in a stock market rally or decline.
- When major indexes are rallying, a rising A/D line confirms the uptrend showing strong participation.
- If major indexes are rallying and the A/D line is falling, it shows that fewer stocks are participating in
the rally which means the index could be nearing the end of its rally.
- When major indexes are declining, a falling advance/decline line confirms the downtrend.
- If major indexes are declining and the A/D line is rising, fewer stocks are declining over time, which
means the index may be near the end of its decline.

 Simple Moving Average

- It takes the arithmetic mean of a given set of prices over the past number of days, for example over
the previous 15, 30, 100, or 200 days.
 Example:

- A simple moving average is customizable in that it can be calculated for a different number of time
periods, simply by adding the closing price of the security for a number of time periods and then
dividing this total by the number of time periods, which gives the average price of the security over
the time period.
- A simple moving average smooths out volatility, and makes it easier to view the price trend of a
security. If the simple moving average points up, this means that the security's price is increasing.
- If it is pointing down it means that the security's price is decreasing. The longer the time frame for the
moving average, the smoother the simple moving average.
- A shorter-term moving average is more volatile, but its reading is closer to the source data.

3.) Price Volatility

- The amount of uncertainty or risk related to the size of changes in a security's value.
- Volatility is often calculated using variance and standard deviation. The standard deviation is the
square root of the variance.

Example:

For example, month one is $1, month two is $2, and so on.

- The mean value is calculated by adding all the data points and dividing by the number of data points.
 - The variance for each data point is calculated, first by subtracting the value of the data point from the
mean. Each of those resulting values is then squared and the results summed. The result is then
divided by the number of data points less one.
- The square root of the variance is then taken to find the standard deviation.

 Transaction Execution Costs

- Expenses incurred when buying or selling a good or service.

 Two (2) Major Components

1.) Explicit Trading Costs
- The direct costs of trading, such as broker commissions, custodial fees, transfer fees, taxes, etc.
2.) Implicit Trading Costs
- Indirect costs as the price impact trade and the opportunity costs of failing to execute in a timely
manner or at all.
- It includes impact costs, timing costs and opportunity costs.

 Methods of Reducing Transaction Costs

1.) Internal Crossing
- e.g. when the manager attempts to cross the order with an opposite order for another client of the
firm.
2.) External Crossing
- e.g. when the manager sends the order to an electronic crossing network.
3.) Principal Trade
- e.g. when the manager trades through the dealer, who guarantees full execution at a specified
discount or premium to the prevailing price. The dealer then acts as principal, because he commits to
taking the opposite side of the order at the firm price.
4.) Agency Trade
- e.g. When fund manager negotiates a competitive commission fee and selects a broker on the basis of
his ability to reduce the total execution costs. This way the search for the best execution is delegated
to the broker.