What Are Dividends & DRIP Plans?

April 2022

Dividends are a distribution of a company’s earnings that are given to eligible shareholders. Some notable companies that pay dividends to shareholders are Apple (NASDAQ: AAPL). Chevron Corp. (NYSE: CVX), and the 3M Co. (NYSE: MMM). It is more common to see energy, healthcare, and utility companies paying out dividends, compared to technology companies.

Dividends can be in the form of cash or more stock, but cash dividends are most common and typically paid out to investors on a quarterly frequency.

Important Dividend Dates

  • Announcement Date: the date of which the dividend is announced, but it must be approved by the shareholders with voting rights
  • Ex-dividend date: this is the date of dividend eligibility expiration. For example, if the ex-date is February 17, then the shareholders who purchased shares on or after February 17 will not be eligible for the dividend reward
  • Record Date: this is the cutoff date to determine which shareholders are eligible for the dividends
  • Payment date: the date of which the dividends are paid out to shareholders on record as of record date

Why do Companies Payout Dividends

Dividends are simply a portion of a company’s earnings that are paid out to shareholders. Companies can offer dividends as a means to build trust and respect with shareholders. Dividends can be a reflection on how well a company is performing. This trust may allow investors to either invest into the company, invest more, and/or keep their investments for the long-term.

However, it is important to note that a company may decrease their dividend payout for various reasons. It can be that they had lower earnings, or the company’s board of directors may believe that they can retain their earnings and reinvest for other ventures.

Because of this, not all companies offer dividends. Many companies instead believe that by retaining the earnings for themselves, they can reinvest into the company and continue to grow. This is one of the reasons many technology and growth companies do not pay out dividends.

Investment Strategies with Dividends

Some investors utilize dividend-paying stocks as a form of an investment strategy. The Dividend Reinvestment Plan (DRIP) is a program that allows investors to reinvest their cash dividends into additional shares of the underlying stock. Some companies offer this formal program for their shareholders, but now, some brokerages offer this program to be automated for the investor.

The strategy is built around compounding returns over time by accumulating more shares. As the investor earns cash dividends that are then reinvested for additional shares, those additional shares can yield more dividends that can also be reinvested. This allows for compounding returns.

Tax Implications

Dividend income is taxable, yet it is taxed based on if it is a qualified or nonqualified dividend. Qualified dividends are paid out by U.S. companies. Qualified dividends are taxed on long-term capital gains rate. Nonqualified dividends, such as Real Estate Investment Trust (REITS), are taxed at the regular income rate

A qualified dividends must be paid out by one of following in order to qualify:

  • A U.S. company
  • A company in U.S. possession
  • A foregin company resident in a country that is eligible for benefits unders U.S. tax treaty
  • A foregin company's tax stock that can easily be traded on a major U.S. stock market

For the DRIPs, the dividends are taxed as ordinary dividends, even if the dividend payout is used to purchase additional shares.

Tax Withholding for Foreign Investors

The U.S. withholding tax rate charged to foreign investors on U.S. dividends is 30%. Taxable Canadian investors are charged 15% for the U.S. dividends. There are certain exemptions, however, for certain conditions and investors.

Taxes & How to Minimize Impact

April 2022

When investing, it is crucial to understand how managing a portfolio, buying and selling assets impact taxes. There are some investment decisions that may minimize tax liabilities but also decisions that may increase tax liabilities and reduce overall after-tax returns. Here are some common methods to minimize tax impact while investing and managing a portfolio.

Tax Advantaged Accounts

In the United States, income tax is based on the gross income. One of the best ways to reduce gross income is to contribute a portion of the income to tax-advantage accounts such as an employer-sponsored retirement plan or individually held traditional Investment Retirement Account (IRA).

A common employer-sponsored retirement plan is the 401(k). This plan allows an employee to contribute a certain amount of their income to a retirement account. Although there is a maximum contribution per year of $20,500, some employers will match the contribution up to a certain percentage, such as 2%. For example, if you contribute $1,000 to your 410(k) and your employer does a 2% match, you will receive an extra $20 for your retirement account. If financially possible, it is best to max 401(k) contributions in order to maximize your employer’s matching contributions. Since the contributions to the 410(k) is reduced from your gross income, your reported gross income to the IRS is reduced and minimizes your tax liabilities.

Roth IRA

A Roth IRA is another type of retirement account that allows for a tax-free withdrawal under certain conditions. While a traditional IRA is funded by pre-tax contributions, Roth IRA is after-tax contributions. Since the contributions are after-tax, the future withdrawals are tax free.

There are certain conditions that need to be met in order to not be penalized. First, single filers cannot contribute to a Roth IRA if they earn more than $144,000 in income, starting in 2022. The contribution limit is $6,000 per year, but those who are age 50 or older can contribute up to $7,000. Finally, Roth IRA withdrawals are only tax-free if they are withdrawn at retirement. There are fees and tax implications if contributions are withdrawn prior to retirement.

Tax-Loss Harvesting

Tax-loss harvesting is a strategy to minimize tax liabilities by using investment losses to write off investment gains. The IRS set the limit to up to $3,000, but any additional losses can be carried forward to other years.

Imagine that some of your investments made realized gains of $1,000, but some of your other investments came out to a loss of $300 (and are not wash-sale disallowed). Instead of paying taxes on the $1,000 for the gains, you can use the $300 loss to write off a portion of your gains. Therefore, you only have to pay taxes on the $700 worth of gains.

Focus on Long Term

Capital gains from short-term investments that are bought and sold for less than a year, are subject to short-term capital gains tax which is the same as ordinary income(up to 37% as of 2021). However, long-term investments held for more than a year are subject to lesser longer-term capital gains tax of 0%, 15% or 20% and the qualification varies by income bracket. Because of this, it may be best to hold investments for at least a year for lesser tax liabilities.

It is equally important to consider the impact of wash sales on short-term investments. Wash sales rule is a policy that prevents a taxpayer from taking a tax deduction on securities that are sold in a “wash sale.” A wash sale is when an investor sells a security for a loss and purchases the same or “substantially identical” security within 30 days before or after the sale.

What are Wash Sales?

April 2022

The Wash Sales rule is a policy enforced by the Internal Revenue System (IRS) that prevents a taxpayer from taking a tax deduction on securities that are sold in a “wash sale.” A wash sale is when an investor sells a security for a loss and purchases the same or “substantially identical” security within 30 days before or after the sale.

Wash Sale Rule Example

For example, an investor purchases 100 shares of ABC Global Corp at $10 per share on March 3. The stock then falls to $8 per share, and on March 30, the investor sells their stake in ABC Global Corp for a net loss of $200. On April 5, the investor purchases 50 shares of ABC Global Corp at $9 per share. Since the sale then repurchase of ABC Global Corp occurs within the 30 day period, the investor cannot claim the original $200 capital loss as tax deductible.

Who and What does the Rule Apply to?

Not only does this rule apply to the individual, it also applies to the individual’s spouse or company of which the individual controls - and even across accounts.

The Wash-Sale Rule applies to sale and purchase of “substantially identical” securities. The IRS does not define this term explicitly. Generally, the common stock of one company is not considered substantially similar to the common stock of another. Bonds, as well, are generally not considered identical. Due to the lack of specific guidelines on the definition, it is important for each investor to use their best judgment and speak to a professional in regards to what is and is not considered “substantially identical.”

What is the Purpose of the Wash-Sale Rule?

The IRS placed this rule as a means to stop those who aim to manipulate the tax laws. The wash-sale rule eliminates the loophole of claiming capital loss as a tax deductive while still maintaining a position in the security.

What Happens if an Investor Violates the Rule?

If an investor violates the Wash-Sales rule, the investor cannot claim the initial capital loss as a tax deductive. The investor must now add the loss to the cost of the new stock.

For example, an investor purchases 100 shares of ABC Global Corp for $10 per unit, sells the shares at $8 per unit, and within 30 days bought 100 shares at $9. Since the investor violates the Wash-Sale Rule, the original net loss of $200 is added to the cost basis of the new stock purchase. Now, the investor’s new total cost basis for the repurchase is $1100 or $11 per share.

How to avoid violating the Wash-Sale Rule?

To avoid violating the rule, investors must wait at least 31 days before repurchasing the same security. Even if the investor is not repurchasing the same exact security, the IRS may deem it as “substantially similar.” It is important to track the date of purchase, sale, and repurchase. Furthermore, it is best to speak with a tax professional in regards to the Wash-Sale Rule.

Dollar-Cost Averaging vs Lump Sum: What’s the Difference?

April 2022

When an investor has disposable income to invest into the stock market, there are two options on how to invest, dollar-cost averaging and lump sum. Dollar-cost averaging is the investing of an equal amount of money on a regular basis over a period of time. Lump sum investing is taking all the cash available and investing it at once.

In general, dollar-cost averaging is a more conservative approach to investing. It limits risk but at the expense of potentially lower returns, as compared to lump-sum investing. Lump-sum has a higher risk attached due to locking in an investment at a specific price and time, but there is a greater potential for higher returns.

Typically, lump-sum investing is associated with timing the market. Some investors choose lump-sum in order to lock in their cost per share basis to be at a bargain value. However, there are inherent risks associated with timing the market. Scheduled investing, like dollar-cost averaging, removes the timing and risk associated with locking into a specific cost basis.

Imagine you have $1,000 in cash and want to buy Company XYZ’s stock. If you choose to lump-sum, you will invest that $1,000 upfront all at once. If you choose to do dollar-cost averaging, you can schedule with a broker to purchase $100 worth of shares on each Monday for ten weeks, regardless if the stock price has moved up or down.

Regardless of choosing either lump-sum or dollar-cost, there is no guarantee that there will be higher returns or even positive returns; however, the investor can minimize risks by choosing dollar-cost averaging.

What is Market Timing?

April 2022

Market timing is the act of buying and selling at a very specific time or price. Active investors and traders use market timing in order to get in and out of investments or switch asset classes. They believe that market timing is an important action to beat the market and make high returns.

Some investors and traders use certain technical and quantitative analyses in order to determine exactly when an equity will move up or down. These individuals can then trade or investment within that time horizon. Although there are those that practice market timing, there is also a significant population of investors and economists that believe it is impossible to time the market. It may be possible in the short term but nearly impossible in the long run.

Market timing is a common strategy used by professional day traders who tend to trade within a day or sometimes minutes. While market timing is popular amongst short time horizon traders and investors, having a general idea of a timing is important for long-term investors. The analyses done to determine market timing can be intricate and data-driven; therefore, the practice is more common with professional traders and investors.

In order to do market timing, an investor or trader must constantly be watching price movements of their equities. Because of this, passive investors typically use the buy-and-hold strategy. Furthermore, there are financial consequences associated with market timing. For example, market timing traders have to move in and out of investments many times over a period of time. This can mean high fees associated with each trade, and if those assets are held for less than a year, the profits are subject to short term capital gains tax.

It may not be in the best interest for many investors to time the market. Instead, the proverb that many follow is that “time in the market is better than timing the market.” It is difficult to time the market and determine its highs and lows. Desired time horizon and risk tolerance are essential in building a portfolio, and market timing may or may not be appropriate for certain investment strategies.

What is Historical Market Return?

April 2022

Before investing, an individual should research the past performance of a security, fund or index. Historical market returns help investors assess how an investment has performed during periods of economic growth or lag. Arguably, the most important historical market return is that of the S&P 500 Index. This index is the baseline of market returns for the U.S. stock market.

Comparing Time Periods

While past performance is not a guarantee of future returns, many investors view previous market returns for an investment in order to see how it performs during certain market cycles. For example, investors specifically see if overall the company stock has grown over time, and they view how the stock has performed during periods of recession, such as that of 2008. This way, investors can know what to expect during certain business or economic cycles. Historical market returns do not predict future returns, but it is a guideline for investors. When comparing investment returns, it is important to ensure that the returns are over the same time period.

S&P 500 Returns

Investors typically view the returns of the S&P 500 as a baseline for average stock market returns. Active portfolio managers are trying to beat the returns of the S&P 500 while many investors are content with making average market returns.

Since its inception in 1926, the S&P 500 Index has had a compound annual growth rate of 9.8%, including dividends. This is only an average. There have been several years with over a 30% decline. Considering inflation, the index has on average returned 6%. Without dividends reinvested, the S&P 500 only has an annual average return of 6.57%. This shows the power of dividends and reinvested earnings.

To be or beat the market?

Some investors are content with making the average market returns. Historical market returns are important baselines for long-term investors. Active investors or traders are trying to beat the average market return but at the expense of greater risk.

Inflation & How to Minimize Impact of Inflation

April 2022

Inflation is an integral factor in economics, government policies, and personal savings and investments. Inflation is the increase in prices and fall in purchasing power of a currency. Often expressed as a percentage, inflation reflects the change in price level for goods and services.

Every investor must be informed about how inflation impacts their assets. There are some stocks that can be heavily affected by inflation rates. It is important to track the inflation rates, such as the Consumer Price Index (CPI) and Personal Consumption Expenditure Price Index (PCE). Inflation should also be accounted for when calculating investment returns. For example, if your portfolio has grown 10% in a year but the inflation rate is 2%, the actual earnings for the investments is 8%. This is because the value of the currency has decreased over the years.

To learn more about inflation, we recommend reading our article on inflation and time of money, Understanding Inflation & Time Value of Money.

How to minimize the impact of inflation

Inflation will inevitably impact your portfolio, but there are ways to minimize its impact.

It is important to reduce the rate of devaluation of your assets. For example, simply holding cash in a bank account generates no growth. Inflation each year devalues that money, meaning you are technically losing money by holding it. Savings accounts do earn interest on your cash but usually not enough to beat inflation.

The historical market returns of the U.S. stock market have generated a healthy growth of 10% per annum. However, it is important that this is only an average growth rate over decades. Past performance does not guarantee future growth, and there are years where the stock market's value declines.

If you are exposed to the stock market, having investments that are “inflation-friendly” can be a hedge against rising prices. For example, Treasury Inflation-Protected Securities (TIPS), commodities, and reduced bond exposure are common investments and strategies during periods of higher inflation.

Regardless, the most important way to minimize inflation is to not allow your cash to sit and not grow. Even if it does not beat inflation, it can minimize its impact.

Brokerage Account vs. IRA: What’s the Difference?

April 2022

Other than knowing what to invest in, it is also important to know where to invest. There are generally two main investment accounts an individual can open, a brokerage account and an investment retirement account (IRA).

Brokerage accounts are taxable accounts that allow you to buy and sell securities. There is no contribution limit, no withdrawal penalties or restrictions on what you can invest in. IRAs can be tax-deferred or tax-free based on the type of IRA. There are also strict contribution limits and withdrawals as well as limited investment options.

IRAs have strict rules. For 2022 tax years, you can only contribute up to $6,000 to IRA accounts or up to $7,000 if you are age 50 or older. Roth IRAs have an income limit. For 2022, you can only contribute the full amount if your income is less than $129,000 for single tax filers or $204,000 if you are married filing jointly.

There are penalties associated with withdrawing early from an IRA. Withdrawals made before age 59.5 years can trigger a 10% penalty and can be subject to taxes. Roth IRA contributions can be withdrawn anytime tax-free and penalty-free. However, it is important to keep updated around new IRA policies each tax season to see if any policies have changed.

Brokerage and IRA Taxes

Brokerage accounts are taxable, and you will owe taxes on the income earned from the account. In general, you will need to pay taxes on earned interest, such as bonds or certificates of deposit. Some stocks pay out dividends which are also subject to taxes, but qualified dividends like from a public company are taxed differently than unqualified dividends. Read more about dividends from the article, What are Dividends and DRIP Plans? Finally, if your investments generate a profit, those profits are subject to taxes. If these investments are held for less than a year, they are also subject to a short-term capital gains tax.

For IRAs, tax rules depend on the type of IRA. Earnings in IRAs are tax-advantaged. Roth IRAs allow for withdrawals in retirement tax-free, and you can withdraw your contributions without penalty. Traditional IRAs have penalties associated with withdrawals before the age of 59.5 years Those withdrawals can be subject to taxes, as well.

Key Takeaways

There is not necessarily a better type of account. It depends on your financial goals. There is also no restriction to choose either or. IRAs are great for retirement savings. Brokerage accounts can be great for day trading, long-term investment, and to save for any other financial goals.

Investing vs. Speculating: What's the Difference?

April 2022

The difference between investing and speculating boils down to the level of analysis done on the investment. When compared to speculating, investing demands a thorough analysis on the fundamentals and technicals of the stock. Thorough research and due diligence on an investment bolsters the prospect of the safety of principal and can increase the probability of a healthy return on investment. Anything less than thorough is speculating which can posesess higher risk.

Thorough Research

Investing requires much prior research on an investment before any purchases. It starts with the fundamentals. Understanding the financials and balance sheets of a company builds a strong foundation on which to determine if a stock is a good investment. For active managers and traders, price and volume are equally as important. Understanding technicals, such as volume, RSI, and moving averages, can help an investor determine entry and exit strategies.

Each investor must also understand how an investment fits within their portfolio and financial goals. Investing demands the investor to know risk tolerance and time horizon. Before any investment, it is crucial to have an idea of how much risk you are willing to accept and what is your minimum acceptable return.

Crossing the Speculation Line

Anything but thorough research would be considered speculating. Speculation means making a decision based on little to no evidence. Many individuals believe that they are investing when in reality they are speculating which possesses a large risk to their portfolios and principals.

Recently, there are many articles, videos, and social media posts that are meant to help people know what stocks to buy. Although rare, there may be some research done on these investments, but if there is no research done on your part, then it is speculation.

For example, buying shares of a company for simply gaining media attention can be considered speculating. This is because the individual has done no research on the company’s balance sheet, no research on the multiples, and no research on the company’s future growth plan.

It is important to note that speculating does not automatically mean there is no chance of positive returns on investment, yet speculating can be unfavorable because you are accepting unknown risks. To best manage a portfolio, an individual wants to maximize returns and reduce risk.

Key Takeaways

The level of research into an investment separates the worlds of investing and speculating. Each individual should do a complete, thorough analysis on each potential investment.

Strategies for a Bear Market

April 2022

A bear market is a term to describe a widespread and significant decline in stock prices in the stock market. It can be difficult to see positive earnings across a portfolio, and many worry about its impact on their financial goals. Despite these rough market conditions, there are some simple strategies that can be performed that may help during a bear market.

Dollar Cost Averaging

In a bear market, some asset prices are lower than the price of which you originally bought for. For long-term investors, this can be an opportunity to increase a position and purchase more shares at a reduced price. This would reduce the average cost per share basis of your portfolio. Over the long run, the cost basis will average down. To learn more about dollar cost averaging, you can learn more from the article, Dollar Cost Averaging vs. Lump Sum Investing.

The No-Strategy Strategy

Investing can be extremely emotional. Depending on an individual's risk tolerance, a bear market can be a difficult situation to understand and invest in when the market holistically is falling in value. Because of this, an investor can play it safe by investing in money money market securities, such as certificates of deposits and U.S. Treasury bills. Although these securities do not generate high returns, the risk is very low, and an investor can wait out until they feel more comfortable entering the markets.

Non-Cyclical Industries

During bear markets, some investors may choose to have exposure in non-cyclical or defensive industries. Non-cyclical companies continue to generate positive earnings regardless of the overall economic conditions. Real estate, construction, financial services, and consumer cyclical (groceries, food, beverage) are examples of non-cyclical industries. These stocks are generally less volatile and lower risk but at the expense of generally lower returns.

Key Takeaways

A bear market is a market condition where the entire market is declining in price. There are some strategies that may help during these rough conditions, such as dollar cost averaging, weathering out the markets, or having exposure to non-cyclical industries. However, it is important to speak with a financial professional in regards to how to best manage a portfolio during a bear market.

What are Stock Buybacks?

April 2022

A stock buyback is when a company repurchases shares of its own stock on the open market. The shares of a company that are available for purchase on the stock market are called outstanding shares. Similar to a normal investor, a company can also purchase shares of its own stock.

The main reason why a company will do a stock buyback is to create value for its current shareholders. Buybacks reduce a company’s outstanding share count, boosting its per-share profit and improve multiples. Additionally, they can signal to investors that executives are optimistic about the company’s prospects and balance sheets.

The board of most companies approve a stock buyback using cash on its balance sheets. Some critics say that this is a poor use of a company’s available cash since that available cash could be used to fund other ventures and products. Regardless, some companies still do stock buybacks as it can help create value for the company. For example, a stock buyback can impact key fundamental metrics like earnings per share (EPS). EPS is the company’s net profits divided by the number of outstanding shares. Since the stock buyback decreases the number of outstanding shares, the EPS metric increases which makes the company appear that it is performing better.

What is Fractional Trading?

April 2022

A fractional share is any share that is less than one full share of an equity. Fractional shares are not available on the open market. Some major brokerages offer fractional shares to its users. Prior to major brokerages offering it, fractional shares rose from certain corporate actions such as stock splits, dividend reinvestment plans (DRIPs), and mergers.

DRIP is a program that some dividend-paying companies offer to its shareholders. Instead of receiving a cash payment for dividends, the investor may opt to receive additional shares, which may be fractional. Due to the share distributions and dollar-cost averaging, the investor may have fractional shares.

Some stock splits are not even and may result in fractional shares, such as a 5-for-4 stock split which is if an investor owns 4 shares of a company, they will receive one additional share.

Finally in a merger and acquisition deal, the new common stock will combine at a predetermined ratio which also results in fractional shares.

Recently, fractional shares have become an immensely popular program offered by some major brokerages. Because of this, it has allowed more retail investors and traders to enter the financial markets as they can afford to buy 1/1000000 of a share. Furthermore, more investors are able to invest in companies with expensive share prices.

It is important to note that all the same taxes and financial rules apply to fractional shares, as they did with whole unit shares. For example, investors may still receive dividends for ownership with their fractional shares, but they would also receive the proportionate dividend payout.

What is A Stock Split?

April 2022

In early February this year, Google’s parent company, Alphabet (NASDAQ: GOOGL), announced a 20-for-1 stock split which will complete in July. This is not the first time a prominent company announced a stock split. In August 2020, Apple (NASDAQ: AAPL) completed a 4-for-1 stock split.

However, what do stock splits mean for current and future investors?

A stock split is when a company increases the number of outstanding shares in order to decrease the price per share. Since the number of shares increases but the price per share decreases, the total company value, or market capitalization, stays the same.


The math for stock splits is simple:
As seen in the 4-for-1 stock split for Company XYZ, the share price is divided by 4 while the number of outstanding shares is multiplied by 4. It is important to note that the market capitalization is still the same before and after the split: $1,000,000.

Reverse Stock Splits

It is important to note that there are also reverse stock splits where a company may want to decrease the number of outstanding shares, resulting in a greater cost basis per share. The number of outstanding shares decreases; the share price increases; market capitalization and fundamentals, similar to a stock split, remains the same.

Impact on Current Investors

For example, Apple completed a 4-for-1 (or 4:1) split on August 28, 2020. An investor who owned one share of Apple stock will now have four shares of Apple stock, but the total value of those shares are still the same before and after the split.

Some investors may see a bump increase in stock price when a stock split is announced, yet this is often speculative since the fundamentals of the company stays the same.

Impact on Potential Investors

Similar to the example provided with Company XYZ, $100 per share can be expensive for some investors, especially retail investors. When the stock split is complete, the share price decreases. Now, the price per share is lower and may be more affordable. This can be an attractive investment for many retail investors, who prior may not have been able to purchase one share. With the emergence of financial technology apps and brokerages, there are more retail investors, and many companies hope to attract these investors.

Impact on Taxes

With prominent companies announcing and completing stock splits in recent years, many investors are left questioning if stock splits have any implications on their taxes. Since stock splits are simply a restructuring of outstanding shares and only affects the cost basis per share, there is inherently no gain or loss from this restructure. Because of this, the stock splits do not affect taxes until the stock is sold. Regardless, it is important to speak with a financial advisor and tax professional to best understand how stock splits may potentially affect their specific tax situation.

Stock Splits in the World of Fractional Shares

Some brokerages offer fractional shares to investors. Fractional shares are a portion of an equity share that is less than one. This allows investors to be able to invest in a company at virtually any minimum instead of the minimum cost of one full share. Stock splits can allow investors to purchase shares of a company at a lower cost basis per share than prior to the split. However, some argue that stock splits may be unnecessary due to the rise of fractional shares. Similar to how stock splits may increase investing from retail investors, fractional shares allow investors to invest for fractions.

Important Takeaways

  • In a stock split, the share price decreases but number of outstanding shares increases
  • Reverse stock splits are when the number of outstanding shares decreases, resulting in a higher share price
  • In stock splits and reverse splits, there is no change to the fundamentals or market capitalization of the company
  • There are no tax implications from a stock split
  • Some may believe that stock splits are obsolete due to the rise of fractional shares offered by some brokerages

What are IPOs?

April 2022

The process for which a private corporation can offer shares to the general public is called an initial public offering (IPO). An IPO allows a private company to become a public company which can now attract new investors and raise capital.

A private company will hire an underwriter, usually an investment bank, to help with the process. In order to IPO, the private company must go through a series of analyses conducted by the underwriter, Securities and Exchange Commission (SEC), and themselves. The underwriter will help determine the share price, market capitalization, date of IPO, and number of outstanding shares to issue.

Not every private company eventually becomes public, nor do some try to IPO. Private companies that IPO must meet revenue metrics before it would be logical to raise public capital. Private companies will privately raise money through venture capital in series, such as Series B and Series C. Eventually, a leadership team of a private company can decide to raise more capital through the public financial markets.

Historically, the number of IPOs in a given year is often dependent on the state of the financial markets and economy. For example, during the internet tech boom, there were 486 IPOs. Then two years later, there were only 104. During the 2008 financial crisis, there were only 69 IPOs. During the bull run of 2019, there were 407 IPOs.

IPOs can become highly anticipated financial news based on the popularity of the company. For example, some notable IPOs were Facebook (currently Meta) and Alibaba. There can be a lot of trading and investing frenzy around the IPO. However, it is important to understand the risk with investing in IPOs.

IPOs are new public companies. This means that there is not much data and information about the company’s financial performance when it was a private company. Because of this, it is difficult to make comprehensive fundamental analysis on these companies.

What Are Interest Rates & Why Does It Matter?

April 2022

Interest rates are the amount a lender charges a borrower for borrowing money. Interest rates are denoted as percentages and typically charged on an annual basis. People often see the impact of interest rates through their mortgage loans and savings accounts.

Homeowners typically get mortgage loans to purchase a house, but they also must pay interest on the amount of money they borrow. On the other hand, when you put money into a savings account, you become the lender and the bank is the borrower. In exchange for putting your money in a savings account, the bank will pay you an interest on your deposit.

Therefore, interest rates can mean the cost of debt for a borrower and the rate of return for a lender. The higher the interest rate, the more risky it is for the lender to lend money.

There are two types of interest, simple and compound. Simple interest rates are similar to interest from a mortgage loan. Simple interest is the principal multiplied by the interest rate multiplied by the time. Compound interest is an interest applied to the principal and applied to the accumulated interest from previous periods. To learn more about compound interest, read the article on compounding interest.

There are many layers to how interest rates are determined, but the main factor is the US Federal Reserve, or the Fed. The Fed sets the range of the Fed Funds rate which impacts banks and other large corporations. These banks and corporations will then determine their own annual percentage rate (APR) which in turn influences consumer behavior, as consumers borrow more when interest rates are low and cutback when rates are high. Therefore, the Fed impacts the money supply in the economy by setting the Fed Funds rate.

Interest rates change during specific economic cycles. Interest rates are a powerful tool to combat inflation. If the money supply is too high and prices increase, the Fed can increase interest rates to reduce the demand for loans.

Why Interest Rates are Important

Interest rates affect everyday life. Interest rates impact how much it will cost to get a loan to purchase a home, buy a car, or start a business. Individuals with savings accounts can earn interest on their deposits by simply saving their money.

On the federal level, interest rates can be an indicator of how the economy is performing. The Federal Reserve may lower interest rates in order to stimulate the economy. During periods of low interest rates, the U.S. economy has historically seen higher economic and stock market growth. This is because more companies and people are getting loans to make big purchases. However, inflation can increase to levels where the Fed deems it necessary to increase interest rates. Although inflation may fall during periods of higher interest rates, the economy has historically slowed, as compared to periods of lower interest rates.

Bond Price vs Yield

April 2022

Before understanding the difference between bond price and bond yield, we must understand what a bond is. Bond is a type of fixed-income instrument and serves as a loan from an investor to a borrower. Typically, these borrowers are companies and governments.

The bond yield is the return on the bond investment while the bond price is the monetary value of the bond. When a bond is issued, the bond issuer agrees to pay the investor an interest on the bond over a specified period of time and agrees to pay the bond price or face value of the bond upon maturity.

There are some ways to calculate the bond yield, but the simplest is called the coupon rate. The coupon rate is equal to the annual coupon payment divided by the bond’s face value. For example, if the issuer agrees to pay $100 on a $1,000 bond, the coupon rate will be 10%.

It is important to understand the relationship between bond price and bond yield. As bond prices increase, the bond yield decreases. For example, if interest rates are at 4% and the coupon rate for Bond A is 2%, the price of Bond A will decrease. This is because Bond A is no longer an attractive investment because investors will now invest in the newly issued Bond B with a coupon rate of 4%.

The reverse is true, as well. If interest rates are at 3% and Bond A has a coupon rate of 5%, the bond becomes an attractive investment because it is paying out more interest than other bonds on the market. Therefore, when interest rates decrease, the bond prices increase. Newly issued bonds are going to pay less in interest compared to older bonds that are earning more interest. On the secondary bond market, the prices of those older bonds will increase until the yield is the same as the new bonds.

Bonds are a form of investment, and the bond’s yield can give insight to the risk level. Typically, low-yield bonds are lower risk, compared to high-yield bonds. Some investors use low-yield bonds as a hedge for their portfolios.

Cyclical vs. Non-Cyclical Stocks

April 2022

Cyclical and non-cyclical stocks are ways to describe how closely related a stock’s share price is to the economy. Cyclical stocks have a direct relationship with the economy while non-cyclical stocks have historically outperformed the market when the economy slows down.

Investors keep an eye on cyclical and non-cyclical stocks when building their portfolios and tracking the economic cycles. There have and will most likely always be growth and declines in the economy, but exposure to certain types of stocks can help grow a portfolio during these economic conditions.

Cyclical stocks’ share prices have historically gone up when the economy grows while they go down when the economy slows down. It is best to think of what companies and industries do really well when the economy is doing great. These can be airlines and hotels, restaurants, and automobiles.

Non-cyclical share prices have historically outperformed the stock market when the economy slows down. Non-cyclical type industries are those that produce goods and services that people will still buy and use when the economy is not doing too well. These products and services can be items that are necessities for daily life. This includes groceries, energy and utilities, and real estate.

Investors try to have exposure to cyclical stocks when the economy is doing well and there is a bull market. On the other hand, investors try to have a larger exposure to non-cyclical stocks during bear markets.

The best way to determine if a company is cyclical or non-cyclical is to see how the share price moved overall during periods of slow economic growth.

Calculating Gains & Losses: What’s the Difference?

April 2022

Calculating gains and losses are an integral part of managing a portfolio, but luckily, it is straightforward.

To calculate the gain or loss on an investment, we subtract the original purchase price of the investment from the selling price of the investment. We divide this number by the original purchase price and multiply by 100 to get a percentage. If the percentage is greater than zero, then we made gains. If it is less than zero, there are losses.

Usually, the broker will display the gain or loss on investments on their platform. It is important to calculate gain or loss as a percentage because it shows how much was earned from an investment, not by how much money was originally invested to generate a gain/loss.

Some investments have fees or can pay out dividends. If there are fees, we subtract the fees from the selling price of the investment. If they are dividends, we add that total to the sale value of the investment.

What is Compound Interest?

April 2022

Compound interest is when the earnings from an asset are reinvested to generate more earnings over time. Compound interest is exponential, which means that it can be a powerful tool to grow a portfolio.

For example, imagine you have a savings account that earns you 2% in interest. The earnings generated from that 2% interest can be reinvested back into the savings account. Now, the original principal of the savings account and the earnings earn 2%. This process repeats over time, meaning your savings grow exponentially every year thanks to the power of compounding.

Compound interest is great for assets but can be detrimental to debts and liabilities. For example, unpaid loans can increase your debt obligations because of compounding interest.

Some investments pay out earned interest at specific frequencies, such as annual, quarterly, or daily. The more frequent the interest is earned, the more powerful compounding interest becomes.

A great example of the power of compound interest is dividend reinvestment plans (DRIPs). Check out our article on dividends and DRIPs.

What Is Downside Risk & Why Is It Important?

April 2022

Downside risk is an estimate of potential losses of an investment if certain conditions were to occur, such as the worst-case scenario. Each investor should know their comfort level with downside risk before investing. Some investments have a finite downside risk while others have unlimited downside risks, for instance for derivatives or borrowed funds (leverage) are used in the investment.

If you buy a company’s stock, the worst case scenario is that the share price goes to zero. This is a finite downside risk. If you sell a naked call option, there is unlimited risk and theoretically no limit to how much you can lose.

Downside risk is important when building a portfolio and knowing risk tolerance. Volatile stocks can have higher downside risks, but this risk will only be accepted by an investor if there is potential for high returns.

When making an investment, there needs to be a minimum acceptable return (MAR). This is the minimum amount of returns an investor is comfortable with making, given the risk they accept by making the investment. The downside risk for an investment may be high, and therefore, the MAR should reflect that. Typically, an investor will be more comfortable with a higher downside risk if their potential returns or MAR are higher.

Each investment has downside risk. The probabilities of a worst-case scenario for some investments may be very small but should not be ignored. One way an investor can better protect themselves from downside risk is through diversification. An investor can diversify their portfolio to best reduce their risk exposure in certain industries or types of assets. Prior to any investment, an investor should understand their investment time horizon, risk tolerance, and maximum willingness to lose.

What Are Multiples: P/E, EPS, P/S?

April 2022

Multiples are financial ratios that are used to gauge the value of a stock. The most commonly used multiples are the price-to-earnings ratio (P/E), earnings per share (EPS), and price-to-sales ratio (P/S).

Price-to-Earnings Ratio

P/E ratio is the price per share divided by the earnings per share. Investors use the P/E ratio to compare how it has changed over time and compare a company’s P/E to its competitors.

P/E ratio is great for comparing companies within the same industry. It can help determine if a company is undervalued or overvalued, or if investors expect high growth in the future.

For example, imagine Company XYZ is a telecommunications company with a P/E ratio of 35. If the average P/E ratio of the telecom industry is 25, it can either mean that Company XYZ is overvalued or that investors expect high growth rates in the future.

P/E ratio is only one piece of information that can help create a better picture if a company is worth investing in or not. However, not every company has earnings and therefore will have no P/E ratio.

Earnings Per Share

EPS is the company’s profits divided by the number of outstanding shares. This multiple helps determine the profitability of a company. Generally, the higher the EPS, the more profitable.

Similar to P/E, EPS is one piece of information that can help determine picking stocks. It can be used to compare profitability between companies. Investors will compare EPS with the current share price to determine the value of its earnings.

However, it is important to note that EPS can be manipulated by companies by buybacks. A buyback is when a company repurchases its own shares on the open market. This decreases the number of outstanding shares and increases the EPS value.

Price-to-Sales Ratio

The P/S ratio is the current share price divided by the sales per share. A low P/S ratio could mean that stock is undervalued while a high ratio could indicate it is overpriced. The P/S ratio tells how much investors are willing to pay per dollar of sales.

P/S ratio is great in order to compare between companies in the same sector, but the ratio does not take into account if the company makes any earnings or not.

Key Takeaways

Multiples are a great way to gain further insight of picking stocks. P/E, EPS, and P/S are common multiples used to understand if a company’s stock may be overvalued or undervalued. However, multiples are not useful on their own. They are just one piece of the puzzle in determining whether to invest in a company.

What is Stock Beta?

April 2022

When managing a portfolio or determining the risk associated with buying or selling a stock, an important factor is the risk. Beta is a popular indicator to measure the risk of a stock or portfolio.

Beta is the measure of a stock’s volatility in relation to a market index. A general rule of thumb is that an index, such as S&P 500, has a beta of 1.0. This is the benchmark many investors use to compare stocks.

For example, if Company XYZ has a beta greater than 1.0, then the stock is more volatile than the S&P 500 Index. If Company XYZ has a beta less than 1.0, then it is less volatile than the index. In fundamental analysis, this means that a higher beta means more risk but potentially higher returns, while a low beta indicates less volatility and risk but potentially less returns.

Beta is a great factor to consider when building a portfolio or making an investment decision. Risk tolerance is an important characteristic for an investor on which companies to invest in. High-growth tech companies commonly have higher volatility, risk, and beta. A 50-year-old utility company will most likely have a lower volatility and beta.

Beta has its limitations. It is only one indicator that an investor should use to determine investment decisions. Beta uses past price movement to predict the future which is not a good practice, especially for long-term investors. Because of this, beta is not a good predictor for the outlook of a company. A company that currently has a low beta may in just a couple months become more volatile.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Xantos Labs does not guarantee its accuracy.

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