Q&A with CMMB Securities

Q. I recently heard about “value investing”. Isn’t all investing really value investing?

— Peter, St. Augustine    

A: Value investing refers to an investment style whereby investors seek stocks whose market prices are lower than the company’s intrinsic worth. Intrinsic worth is determined by an analysis of the fundamental characteristics of the company.  Fundamental characteristics refer to items such as revenue, earnings, profit margins and return on equity. All these are used to determine the company’s underlying value and future growth in the context of the overall economy and industry.  In order to determine which stocks are value stocks, an investor can examine the price-to-earning ratios or price to book ratios of the company. The price to earnings ratio is simply the market price divided by the company’s earnings per share.

The price to book value is the market price divided by the company’s shareholder’s equity per share. If these ratios are relatively low when compared to similar companies, it may be a signal of a value stock.  Further examination of the company is of course required by looking at measures to determine intrinsic worth. One measure is the Return on Equity (ROE). This is calculated as net income divided by shareholder’s equity. Advisably, ROE should be examined over the past five to ten years to get a good idea of the historical growth and consistency. Wide fluctuations of ROE are generally not a good indication of a value stock.  The debt to equity ratio is another item to examine and is measured by dividing total liabilities by shareholder’s equity. The ratio indicates the level of debt and/or equity the company is using to finance its assets. 

A higher ratio indicates the company is using more debt to finance assets and thus is obligated to pay interest every year, which results in more volatile earnings. If the company used more shareholders’ equity they would not have an obligation to common shareholders. In good years the company can pay a dividend to common shareholders and in bad years they can reduce their dividend payments.  Another measure to look at is the company’s profit margin and the ability to improve it. This margin is calculated by dividing net income by net sales. Historically, a high profit margin indicates the company’s product is strong, that it’s been able to maintain market share as well as controlling expenses and using resources efficiently. All these are measures investors can use to pick value stocks.

Q. The advice and explanations in your columns are often very good, but why do you never mention the credit union movement as a good place to invest? Credit unions are doing a great job for ordinary people.

Rodney, Chaguanas   

A: Credit unions have been providing good returns recently, given the low interest rates offered by banks and money market funds. In 2003 some credit unions were offering interest on deposits ranging from 8% to 9%. This is comparatively better than the fixed deposit rates offered by some banks and money market funds, which had rates ranging from 5.5% to 7%.  Of course these rates are more attractive, but as a wise investor you must ask yourself why this differential rate of interest exists and is it sustainable. As with all forms of investment it’s wise to remember that higher returns more than likely mean higher risks. Generally, a credit union, being a not- for- profit organization, will disburse any earnings in excess of operational costs, whereas a profit organization, such as a bank, must make profits for their shareholders. 

The income earned by credit unions is generally from loans, loan fees, investments or any other income generating activity the credit union may undertake. Members who own shares in a credit union are of course entitled to disbursements in the form of dividends. When credit unions offer financial products such as fixed deposits, the investors in these fixed deposits would normally earn a locked in rate for one year. The investor should examine the ability of the credit union to guarantee a fixed rate for the year. If the credit union is able to pay out of earnings received from investing deposits or loans, then this is all well and good. If however, the credit union is using its reserves, sacrificing the dividends paid out to members or investing in risky instruments or illiquid assets, then there is a need for investors to be cautious.

An interested investor must examine the annual reports of a credit union, specifically its investment portfolio, its assets, including loans and long-term assets, as well as reserves.  Keep in mind also that unlike the commercial banks, it is not mandatory for credit unions to hold reserves for depositors’ funds. If the credit union is investing in long-term assets such as real estate or offering mortgage loans, then there is a greater mismatch between assets and liabilities. When depositors need to withdraw their funds they may not be able to do so if the credit unions assets are not liquid.  The short story is that a credit union is a good savings vehicle and may offer good returns. However, as with all forms of investment, it is important to examine the level of protection offered for your deposits as well as the risk associated with the returns being offered.   

Disclaimer for Articles:
“All information contained in this article has been obtained from sources that CMMB believes to be accurate and reliable. All opinions and estimates constitute the Author’s judgement as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by CMMB in any form whatsoever. CMMB and/or its employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed, shall be construed to be, or constitute an offer or a solicitation to buy or sell.”