What is Quantitative Easing and was it successful?

During the 2008- 2009 Great Recession, the Federal Reserve tried to create stability within financial markets and spur economic activity. To do this, the Federal Reserve lowered interest rates. But as the Federal Funds rate neared zero, interest rates remained high due to fears of insolvency within companies and illiquidity within financial markets. To solve this divergence in interest rate spreads, the Federal Reserve pursued unconventional monetary policy such as Quantitative Easing.

 Quantitative Easing works by the Federal Reserve purchasing assets, such as Mortgage-Backed Securities, long-term bonds, or treasuries, from banks in return for cash. This results in the bank holding excess reserves that can be loaned out to create economic activity. (When the bank’s supply of money increases, interest rates go down because banks want to be able to loan out their money to make a profit.) Quantitative Easing also allowed the Federal Reserve to create liquidity within financial markets, which freed up investors capital.  

Last week, the chair of The Federal Reserve Janet Yellen declared the end of Quantitative Easing, as the economy has improved and unemployment figures have lowered. Though the economy has improved and interest rates have been at near zero levels for the last four years, Quantitative Easing has become a controversial issue. Some people believe that this program has created a bubble in equity markets, and that it will lead to high inflation and a jump in interest rates after the program has been ended. The S&P 500 has returned over 130% since the start of QE1. Quantitative Easing may have helped make stocks an appealing choice to investors because businesses are able to take advantage of the low interest rates and bonds were had very small returns, but it is hard to say if Quantitative Easing has created a bubble in the equities market. The Fed has expanded its balance sheet by almost $3.6 trillion dollars through monthly asset purchases, but QE should be looked at as an asset swap rather than an inflationary program. (See link at bottom for more info) The last criticism, interest rates will jump after this program has ended, may become true, but the Fed has said that it will keep interest rates at similarly levels after the end of QE.

Quantitative Easing has not created economic wonders by creating a fast growing economy, but it may have helped make the Great Recession less damaging. Yet, there are still many economic side affects that may come of Quantitative Easing.

During the Great Depression, the Federal Reserve failed to pump liquidity into the system and help failing financial institutions. This led to a deflationary spiral and economic collapse. During the Great Recession, the Federal Reserve did many controversial things, but it fulfilled its duty of trying to create liquidity and stability within financial markets.

Here is the link mentioned above: http://pragcap.com/mechanics-qe-transaction

I am still unsure whether Quantitative Easing was a successful program. Please comment below on what you think or any information that has led you to view it in a certain way

The Rise of MOOCs

In an article I posted a few months ago, I tried to explain changes that are affecting our world, from the way we get information to how we create energy. The Internet has been one of the largest contributors to these changes, allowing people to communicate and share ideas with each other from across the globe.

In the field of education, the Internet has brought innovation by providing billions of people with the ability to explore any topic they desire, independent of their age or socioeconomic class. One creation that has stemmed from the Internet are Massive Open Online Courses or MOOCs. These are online classes that are taught by professors, available to anyone free of charge. Through university initiatives and startup companies such as Udacity, Coursera, and edX, colleges are able to distribute their courses to online audiences.

Finding a way to make MOOCs profitable has become a problem for these universities and companies. Udacity has partnered with large companies such as AT&T and Google to provide training for employees, while Cousera offers certificates of completion for a fee. Some universities have begun using online courses to teach supplemental programs to students. Harvard has begun using online classes to teach credit or degree classes through the Harvard Extension School, and Harvard Business School has begun offering online degrees through HBX. In 2013, Wharton was the first business school to publish MOOC versions of its first year MBA classes.

This summer, I was able to participate in a MOOC offered by Harvard called CS50. CS50 is an introductory to computer science class. Through filmed lectures, supplemental videos, and online coursework, I was able to participate in a class that was similar to what undergraduates at Harvard were taking. The CS50 staff has incorporated online chat groups, forums, and videos into the online class to allow students to interact with one another online, but there is still a large aspect of social interaction that is lost.

Though, I believe MOOCs are a great way to learn additional knowledge or refresh skills, I do not think that they are a replacement to a college education, yet. Peer interaction, study groups, and extra-help sessions are not very accessible when participating in a MOOC. San Jose State University recently found that their students who were taught via online courses received lower test scores than those who were taught in a classroom. Online lectures do provide students with valuable resources, as teachers are able to “flip” their classroom and students can watch lectures that they may have missed or not understood. In the future, I believe that more students will begin replacing college classes with MOOCs if universities are able to recreate an experience that is similar to what students in a physical classroom atmosphere experience.  

What is Monetary Policy?

The Federal Reserve was created in 1913 through the Federal Reserve Act.  The purpose of the Federal Reserve, or central bank, is to provide the country with a safe, liquid, and stable monetary system. The Federal Reserve does this by manipulating the Federal Funds Rate and changing the monetary supply..

In times of financial panic, the central bank tries to keep financial markets liquid and prevent the monetary supply from tightening. To keep the monetary supply from decreasing, the Fed can lower interest rates. When interests are low, individuals and businesses are more likely to borrow money, because it is cheaper. When businesses and individuals take out loans, they have money to spend, which can create economic growth.

 In the recent collapse, the Fed took many unprecedented measures to create loose monetary conditions. They created multiple programs that bought toxic assets from investors, which created liquidity within markets. (If a market is liquid, the asset can be converted to cash easily. This allows people to sell assets in return for cash, rather than being stuck with assets that they couldn’t sell.) Another program called Quantitative Easing was created to lower interest rates and increase the monetary supply. This was achieved by buying Treasury Securities.

            The Fed influences the money supply and interest rates by setting a target for the Federal Funds Rate. To reach this target, the Fed will either buy or sell large quantities of Treasury Securities. When the Fed sells Treasury Securities, they deduct the total cost the purchasing bank bought from that bank’s reserves. This bank is then required to borrow money from other banks so they have enough money to meet their required reserves. (The rate at which banks loan each other reserve money is called the Federal Funds Rate, which influences almost every interest rate.) The Federal Funds Rate will rise because there is more demand for borrowed reserves. The opposite occurs when the Fed sells Treasury Securities; interest rates decrease and the monetary supply increases. The Fed credits the bank’s account allowing the bank to lend out more of their deposits. 

Treasury Securities, such as bonds, bills or notes, are debt obligations issued by the US government. They a very liquid asset and are considered riskless because investors do not believe that the United States will default on their loans.

Why I am Bullish on Ford 2/2

Metrics and Valuation (All data came from Morningstar Inc)

This is the second part of my analysis of Ford Motor Inc (F)

Valuation:

Price/Earnings: PE ratio gives you the amount of money you are spending for $1.00 of a company’s earning. A high PE ratio means that the stock is expansive relative to its earnings and may be overvalued. Growth companies tend to have high PE ratios because investors are expecting large earnings growth in the future, even if the current earnings do not justify such a high price. The PEG ratio takes the growth rate into consideration. Any stock with a PEG ratio <1 is considered to be undervalued.

I tend to look at companies that have a PE ratio of 13.00 or below, but it can change dependent on the industry and company. Ford’s PE is 9.07 compared to the S&P 500 PE of 19.39. I believe that Ford is undervalued at this price.

Price/Book: PB ratio is the Price of the stock/Shareholders Equity. This is another valuation that can help investors find undervalued companies. There are some shortcomings to this metric because Shareholders Equity can be easily manipulated. If a company has a low PB ratio (<2.0 I think) then either the company is undervalued or may have financial problems.

Ford has a PB ratio of 2.5, which I think is still a semi undervalued rating.

Metrics:

Return-On-Equity(Net Income/Shareholder’s Equity): ROE is a metric that tells you how efficiently the company is using shareholder’s money. I usually look for an ROE greater than or equal to 18%.

Ford had an ROE of 33.81& in 2013, which means that Ford returned 0.3381 dollars in profit for every shareholder dollar invested.

Return-On-Invested Capital: ROIC is a measurement that shows the rate of return that the company is making off invested capital, such as common equity, preferred shares, and long term bonds. If the cost of capital is greater than the return on invested capital, the company is losing value and vice-versa. The equation for ROIC is: Net Profit after Taxes/Operating Capital

Operating Capital=Average Stockholder Equity + Average Debt Liability

Ford has an ROIC of 6.08% for 2013, while General Motors had an ROIC of 6.42%. Although I usually look for an ROIC between 15%-20%, automobile manufacturers tended to have an average ROIC ratio around 4% for fiscal year 2013.

Dept/Equity: This ratio helps investors determine if the company is actively issuing debt or issuing new shares of stock to raise capital. Ford currently has a debt/equity ratio of 2.9. Though this ratio is high compared to a computer company, auto manufacturers require lots of capital due to the capital-intensive nature of the business. These companies tend to have Debt/Equity ratios above 2.

When conducting financial research, it is important to learn about the financials of other companies within the same sector.

I believe that Ford is undervalued and has very strong growth potential domestically and abroad. China and Africa are two large markets that Ford has just begun to grow in. Ford is also developing innovative solutions to create more fuel-efficient cars. This is very important that a company of this size is still able to make such large changes. Ford is creating value for its shareholders, and I believe that it will continue to.

Disclaimer: I am just a kid with no proper financial training. This report will not guarantee investing success.

Why I am Bullish on Ford

This will be a multiple part analysis of the Ford Motor Company Inc. Ford’s ticker symbol is F.

Income Sheet:

Here is a chart of the company’s Income Sheet. The Income Sheet is one part of the Financial Statement. The income sheet shows the amount of revenue earned by the company for a specific period of time. It also incorporates the costs that the company has incurred to earn its revenue.

 




Morningstar Inc

Revenue growth for Ford(F) over the last three years has averaged 4.4%, compared to General Motors’ (GM) 4.66. The significant decrease in revenue in 2012 was due to the incredibly weak car market in Europe and poor economic conditions in the United States, which resulted in losses for many auto manufacturers. Ford took an active approach to the European crisis. The company closed factories and began to build cars that appealed to the consumer’s taste in the area, a lesson that they used to turn around their North American unit.  

Earnings-per-share rose 23.94% in fiscal year 2013, signaling that Ford has been able to make a come back from a challenging 2012. As well, in the first quarter of 2014, Ford reported its first profit in its European segment in three years.

A worrying concern is Ford’s shrinking margins. In 2014, Ford will launch 23 new models globally, which is one of the most aggressive plans in the history of auto manufacturers. This new line of products has resulted in lower margins, due to costs from research and development, redesigning factories, and special advertisements. But Ford’s dedication to innovating and creating new products that consumers will buy is evident in its lofty goals and actions, such as building F-150s out of aluminum which will save approximately 700 pounds per vehicle.

Area Growth:

In the second Quarter of 2014, Ford’s market share in South Africa increased 1.9% since 2011 to 10.3%. Ford has also had record growth in China. Ford controls 4.6% of the market share, compared to just 2.7% in 2011. As Ford’s market share has grown, the company has surpassed its rival, Toyota Motor Inc, in the number of car sold in China. Though Ford has been successful in many foreign markets, they are expecting larger losses in South America than in previous years.

Ford has exhibited strong growth in these two countries, which have large amounts of growth potential within their car markets. I believe Ford will continue to grow in these foreign markets because of their new product lineup.  

Balance Sheet:

The balance sheet of a company shows the current financial position of a company, such as how much debt does the company have or how many assets does the company hold.

Shareholder’s Equity=Assets-Liabilities

Shareholder’s Equity- The amount of money that would be left if a company sold all of its assets and paid off all of its liabilities. The amount of money a company keeps after paying for its expenses, taxes, and dividends or stock buy-backs is called retained earnings. Retained earnings and the money a company earns from selling stock are two main components of shareholder’s equity.

Assets- Include items that the company holds that are of value: Physical plants or stores, machinery, products, and supplies. Intangible Assets are items that do not have a definite monetary value, such as brand recognition, the company’s relationship between their employees, customer loyalty, and trademarks and patents.  

Liabilities- The amount of money the company owes to other people. This includes expenses such as the payroll to employees or loans that it owes to a bank.

Here is a link to Ford’s Balance Sheet http://www.marketwatch.com/investing/stock/f/financials/balance-sheet

Ford has significantly decreased the amount of debt the company holds in the last five years. This also means that the company will be spending less on debt interest payments.

Marketwatch

Ford’s total amount of liabilities has risen but at a smaller rate than their asset, resulting in Shareholder Equity to increase. Ford has not had a large increase in the amount of shares outstanding, meaning retained earnings have increased.

Disclaimer: I am just a kid with no proper financial training. This report will not guarantee investing success.

Growth Stocks Vs. Value Stocks

Growth vs. Value:

Growth companies are companies that are expected to or have experienced periods of high growth, such as technology companies or smaller companies that have increased revenue and profits at very high rates.

Value companies, such as Blue Chip companies, are very large and diversified, with revenue and earnings growing at a stable rate. For example, Proctor & Gamble would be considered a value company, whereas, Tesla would be considered a growth company.

Investing Vs. Trading

Long-term Investing vs. Short-term Trading:

There is a large difference between investing and trading. As Warren Buffett says, when you buy a share of stock think of it as if you are buying the whole company. Is this investment so great that you would like to own the whole company? Investing is a long-term approach that uses analyses of the company's financials, such as the balance sheet. Aside from looking at the financials, an investor should always research the risk and growth potentials of a company and the current management of the company.

Long-term investing is an approach that focuses on the fundamentals of a company and not the price movement of a stock. Long-term investing can be less risky, dependent on what you are invested in, while also having lower brokerage fees, since you are not buying and selling as much.

Trading on the other hand is short-term. Rather than purchasing a stock because of the company’s fundamentals, trading places a focus on the movement of a stock’s price within a short time period, from a day to a month. Market trends, trading volatility, stock volume, moving averages, and technical analyses are some fundamental tools used to determine short-term trading opportunities. Short-term traders commonly use alternative investment tools, such as stock shorts and derivatives.

Short-term traders can range from day traders who buy and then liquidate all positions at the close of the market to traders that purchase companies for a few weeks. Short-term trading can also be risky because you are buying into market trends, not investing in the fundamentals of the company. This means that if you have a short-term investment horizon and a stock experiences volatility, (Large movements in the price of the stock) your investment horizon does not allow the stock the opportunity to regain losses. Stocks tend to move in a cyclical nature, moving up and down, like a roller coaster. Short-term investing can also be costlier due to a larger amount of brokerage fees.

Book Review: The Third Industrial Revolution by Jeremy Rifkin

The Third Industrial Revolution, by Jeremy Rifkin, is one of the most intriguing books that I have ever read. In this book, Jeremy Rifkin describes the revolutionary economic and social changes that are occurring due to a new information system, the Internet, and a new energy system, renewable energy, merging. These changes are coined The Third Industrial Revolution.

The Internet has created a new way of sharing and creating information that has never been scene before. People are able to instantly interact with each other around the globe, access an infinite amount of information on any desirable topic, and influence society no matter how poor or young they may be. The Internet will increasingly make our world more efficient and interconnected by allowing devices to communicate with one another, such home appliances or medical records, furthering the use of efficient manufacturing processes, such as 3-D, and developing a smart grid for energy. The Internet has also fostered a way of thinking that democratizes power and fosters creative disruption. The Internet has allowed everyone the opportunity and ability to develop and create what they wish, transferring the power from the select to the masses. Anyone who has access to the Internet has the ability to take Harvard classes online, start a movement, build an app, or rent a couch in a stranger’s apartment for the night. The Internet has become a platform for disruption within every part of our lives, by allowing anyone to explore and redefine the limits

Renewable energies will become more proliferous as improved storage mechanisms are developed, reigning over fossil fuels. The shift to renewable energies in conjuncture with the Internet will allow for a monumental shift in the way our society produces energy. For example, each home will have the capacity to become a small power plant, generating enough electricity to power itself and sell to other homes through virtual markets. Energy monitoring programs will enable appliances within a home to be switched on and off remotely, according to the energy demands of the grid, and turn off unused lights or lower the heat when the home is vacant.

The Third Industrial Revolution is lateralizing power among the world. The Internet has already changed and democratized many industries, such as the hotel and wedding dress industry by embracing human’s desire to share. Renewable energies will empower the homeowners by allowing them to produce their own energy, ending our society’s reliance on large and monopolistic energy companies. These changes are all around us, in every possible form.

I highly recommend reading The Third Industrial Revolution, as it has changed my view on current changes within our world and opened my eyes to the possibility of the future.

The Basics of Stocks

A share of stock is a small piece of ownership in a company, just like a piece of pie. By owning a piece of a company, you are entitled to a share of the profits, through dividends, and voting rights on substantial changes in the corporation. As a shareholder of a public company, you do not hold any legal obligation to the company. This means that you cannot be held liable if a company’s product results in deaths or injuries, or be sued if a company that you hold stock in is sued.

A company that has shares of stock and is traded on a public exchange such as the New York Stock Exchange, or the NASDAQ, is called a public company. Private companies may have shares of stock, but they are not traded on a public market. For example, Ford Motor Inc. is considered a public company while the local ice cream shop in your town is probably a private company. The stock exchanges create a place to buy and sell shares of stock, which creates a more efficient market by increasing the liquidity of assets.

If you buy a share of stock in XYZ Corporation at $10 and it rises to $15 in a week, the stock has appreciated $5. This does not mean you have made a profit. You can only make a profit from dividends and the money that you receive after you have sold the stock. When you sell your stock of XYZ Corporation, at $15, then you will have made a $5 profit. If you held onto your share of XYZ Corporation for another week and the price decreased to $5 and you sold it, you would have lost $5. The price of the stock will appreciate, as more people want to own the stock, usually because the business is growing and becoming more profitable and vice versa.

The laws of supply and demand fundamentally determine the price of a share of stock. There are a finite number of shares, meaning that stocks that are in higher demand will be more valuable. The opposite also holds true. If a company is under performing, the demand for the stock will decrease and so will the price. Just because the price of a stock is low does not mean that the company is a poor investment, maybe the company just missed their quarterly earnings or a tsunami in Asia disrupted their supply chain. The company may still have sound fundamentals and a strong management team. There are a lot of factors that go into play to determine the price of a stock. When buying a stock there is always one idea that is necessary to keep in mind, there is always someone that thinks it’s time to sell and someone that thinks it’s time to buy.

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Time Value of Money

Time Value of Money is a concept that is essential to investing. Time Value of Money or TVM states that money in the present is worth more than the same amount in the future, because that money can be invested and earn a return. For example, if you were to receive $100 today, or in two years, you would choose to receive $100 today. Why? If treasury bills have a theoretical yield of 4%, then the $100 that is received today could be invested and earn $8 over two years. (Interest is not compounded in Treasury Bills) This mean that $100 today is worth $108 in two years.

The Wonders of Compound Interest

Exponential functions are incredibly powerful and are very important to understand. Compound interest, an example of an exponential function, plays an important role in investing. Albert Einstein once said, “Compound interest is the eighth wonder of the world.”

There are two types of interest, compound interest and simple interest. When one receives interest only on the principal amount invested, or the original investment, this is called simple interest. For example, if I buy bond ABC for $1,000 that has an interest rate of 10%, I would receive $100 or 10% of $1000 each year until the bond matures. If the same bond had annually compounded interest, I would receive interest on the principal amount plus previous interest payments. For example, I would receive an interest payment of $100 for the first year, but in the second year I would receive an interest payment of $110 or 10% of $1100. (Principal amount + First Year Interest Payment) In the third year, I would receive $121, or 10% of $1210. (Principal amount + First Year Interest Payment + Second Year Interest Payment) An additional $31 over three years may not seem like a big difference, but if this bond matured in 100 years, my original investment would be worth $137,806.34 compared to $11,000 if it was not compounded annually.

Compound Interest Formula: A=P(1+r/n)nt

A= Total amount of money accumulated after n years
P= Principal Investment (Initial amount of money invested or borrowed)
r= Interest Rate
n= Amount of times interest is compounded per year
t= Number of years the principal investment is invested for

Simple Interest Formula: A=P(1+rt)

A= Total amount of money accumulated after n years
P= Principal Investment (Initial amount of money invested or borrowed)
r= Interest rate
t= Number of years the principal investment is invested for

Compound interest is also important within the stock market. The S&P 500, which is an index of 500 of the largest publicly traded companies by market capitalization, had an annualized return of 10.26% for the last 25 years with reinvested dividends. If someone were to have invested $1,000 in the S&P 500 25 years ago, it would now be worth $11, 493. In this calculation, interest was compounded annually. Starting to invest at a young age, even with a small amount of money, can result in large profits due to compound interest.


To leave you with a final thought on compounded interest here is a story:

There is a story about an Emperor of China who was so excited about the game of chess that he offered the inventor of the game one wish. The inventor replied that he wanted one grain of rice on the first square of the chess board, two grains on the second square, four on the third and so on through the 64th square. The unwitting emperor agreed to the modest request. But two to the 64th power is 18 million trillion grains of rice - more than enough to cover the entire surface of the earth. The Emperor, realizing that he had been duped, had the inventor of the game beheaded.

Data for S&P 500 annualized returns: http://financeandinvestments.blogspot.com/2014/02/historical-annual-returns-for-s-500.html