Q&A with CMMB Securities

Q. What does the price of a stock represent and when a company is first listed on the stock market who sets its initial price?

Sheldon, Couva

A: From a fundamental standpoint, the price of a stock represents the market value of that company on a per share basis and is also relative to the amount of dividends that company pays periodically. Therefore, the total market value of the equity of that company is the product of the amount of shares outstanding by the price of one share. Factored into the stock price, in an efficient market, would be all historic public information and expectations of the future performance of that company in terms of growth opportunities, probability etc. When a stock is first listed on a Stock Exchange, as in an Initial Public Offering (IPO), the price it will eventually list at depends on many factors. Most companies however, base the IPO price on multiples such as price/book and price/earnings of other companies in their peer group. This valuation is normally done by an independent, professional in-vestment manager. Most IPO’s are normally offered at a discount (or what is known as under-pricing), making them very attractive to investors.

Q. As it’s almost year-end, I was wondering whether to add extra money to my annuity to get the full tax allowance or put the funds (about $3,000) into some sort of high return investment account. What’s the best way to go?

Sharon, San Fernando

A: The trade-off between these two options is of course return for liquidity. An annuity is a long-term savings/retirement plan, for which contributions of  up to $12,000 can be deducted from your income thereby reducing your taxable income. For instance, if you fall in a 30 % tax bracket and contributed up to or over $12,000, total tax savings derived from your annuity plan is $3,600. In your case, if you contributed your $3,000 towards an annuity plan and provided that your total contributions (including this new contribution) do not exceed $12,000, your savings would be an additional $900, given a tax rate of 30 %. That amount would be equivalent to your return for other investment comparison purposes.
The drawback is your contributions would be tied up until the year specified by the annuity contract to receive your payments. This maturity period will depend on the type of annuity plan you hold — whether it is a deferred, fixed or ordinary annuity plan. If, on the other hand, you placed the funds into a money market fund or a capital or income and growth fund, your returns would be lower. Money Market Funds are currently offering returns in the range of 6 % to 7 %. However, if you have a greater need for your cash this may be the better option for you.

Q. What is meant by Cyclical Stock?

Luis, Tunapuna

A: A cyclical stock is the stock of a company whose reve-nues/profits are sensitive to the level of business activity within the economy. For example, a company that sells luxury goods/services eg yachts, travel etc, may have strong revenue growth in times of high business activity ie when the economy is expanding, but will have declining revenues when the business cycle is trending downward, as in times of recession. However, there are companies that do not do that well when the economy is growing rapidly. For instance, banks do well when the business cycle is coming off its peak as interest rates decline and there is greater demand for credit. Stocks that do well when the business activity is decreasing and poorly when the economy is peaking are called counter-cyclical. Basic consumer goods companies/stocks are generally non-cyclical given demand for these products are inelastic if they are not easily substituted and are referred to as defensive stocks eg wheat, utilities etc.