The book A Random Walk Down Wall Street proposed the Random Walk theory.
It says that share / security prices change randomly – and hence cannot be predicted by charts or technical analysis. Price changes are like a person out for a walk – they can change direction at a whim.
Chart and technical analysts will argue fiercely that they can predict future price movements.
We think that both are right! Prices do move randomly, but technical analysis does provide a good guess about the path ahead.
Risk parity is a strategy to reduce portfolio variability.
The volatility of each potential portfolio asset is assessed. Then the portfolio is constructed to achieve the overall portfolio volatility target. Leverage may be used to enhance the contribution of a particular asset (e.g. bonds) on the portfolio.
A Financial Times article in 2015 Investing: Whatever the weather? has an interesting anecdote about Ray Dalio (he built Bridgewater Associates).
McDonald’s wanted to buy chickens from its supplier at a fixed price. At the time a futures market for chickens did not exist.
Ray Dalio found that the most expensive part of producing chickens is their feed (corn and soybean meal). Ray combined these into a “synthetic” future that allowed the chicken producer to quote a fixed price to McDonald’s.
Ray Dalio refined the concept of breaking portfolio assets into their volatility and return contributions to build the successful Bridgewater Associates.
There are many strategies used to build and manage portfolios. Risk parity is one method. Depending upon the portfolio construction, it can be vulnerable in an environment of rising interest rates. Others techniques include investing in themes, investing in trends and mathematical algorithms.
A country’s economic growth has less of an affect on share market performance as many think.
These factors influence share market performance more:
Charlie Munger (of Berkshire Hathaway Inc.) says Bitcoin is a rubbish investment.
He says they tell you they’re not going to do create more Bitcoin. Charlie says they will create more if they want to!
He also says don’t believe them if they tell you their rules are that they can’t make more Bitcoin.
“When there’s enough incentive bad things will happen” – Charlie Munger
Jack Bogle (Founder of Vanguard) agrees. Jack says:
“Avoid bitcoin like the plague. Did I make myself clear? It may well go to $20,000 but that won’t prove I’m wrong.”
Do you know your numbers?
When you start a growth strategy, knowing the earnings per customer gives a good handle on the expected outcomes.
Also know these key numbers:
ABC Focus activity based costing software.
Activity based costing gives you a competitive pricing advantage based on real costs rather than “guesstimates”.
It is useful to be able to create and report budgets for each profit center.
The advantages include:
Visual Cash Focus Gold edition is designed to produce and report budgets per profit center.
A free trial is available to qualified businesses here.
Start with the cash-flow statement. Use it to work out the free cash flow. This is the cash available to shareholders after the company has used the cash required for its business needs.
Free cash flow is the operating cash flow less investment cash flow. Interest and tax payments should be deducted (if they are not already deducted in the operating cash flow). Investment cash flow is mainly payments for property, plant and equipment.The cash-flow statement also shows how much cash has been paid out as dividends, how much debt has been raised or repaid, and how much cash has been raised from shareholders via the issue of new shares, or returned to shareholders via any share buy-backs.
The next financial statement to look at is the balance sheet. This can be used to assess the financial health of the company.
First calculate net debt. It is borrowings (short and long term) less cash.
Then calculate the net debt to equity ratio by dividing net debt (determined above) by shareholders’ equity.
Calculate the traditional financial ratios and use these to assess the financial performance and health of the company.
Look at the trend is the ratios over time. Are they improving or deteriorating? See if you can find out why they are changing.
Look at working capital. Are debtors days under control, are inventory levels sufficient to meet the company’s needs, but not increasing out of control?
Any acquisitions made by the company will impact intangible assets (goodwill). Keep an eye on the level of intangible assets over time and understand why they are changing.
Review all the rows in the balance sheet. It is a financial snapshot of the company and useful information may be revealed.
The next financial statement to look at is the income statement.
Start with the EBIT line and work up.
EBIT is earnings before interest and taxLook at revenue, cost of sales and expenses. Calculate the traditional ratios (gross margin, operating profit margin). Again review the trend in the ratios over time. Are they improving or deteriorating? Why? Are costs as a percentage of revenue improving or getting worse – why?
Have profits increases or decreased as a result of any one-offs? Examples: The sale of an asset at a profit or loss, the write-down in the value of the assets?
A review of the three financial statements may raise questions that should be answered in the notes to the accounts or in the management commentary.
Anything unusual in the financial statements should be explained in the supporting documents. Has operating cash flow changed significantly – why?
What is management expecting in the future? Does management have a record of beating its expectations?
Take time to think about the company’s future. What are the prospects for this kind of company going forward. Are its products and services likely to be in demand, does it have pricing power, what could happen to hold it back or propel it forward?
Consider the future earning and cash flows for the company – the strength of these determine its future valuation.
Visual Cash Focus in action:
See how Visual Cash Focus is used to create and deliver professional financial budgets and forecasts, including profit and loss / income statements, balance sheets and cash flows.
Budgeting and Forecasting Software -Visual Cash Focus.
Cash Focus a financial forecasting software company with an international presence.
To visit the Cash Focus web site, please click this link: www.cashfocus.com
