FINANCIAL NOTEBOOK

Q. What does the term “selling short” in the stock market mean?
Terry, Barataria

A: In the stock market most investors buy stocks with the projection that the price may go up thus generating a capital gain on investment. However, it is also possible to profit from the projection that the price of a share may fall. This can be achieved by selling short the particular share which one feels may depreciate in value. Here’s how it works. The “short-seller” simply borrows the shares from a broker, sells them on the open market and then later buys the shares back on the open market and re-delivers to the broker. This is being undertaken with the premise that when the shares are repurchased on the open market the price would have fallen thus affording a gain to the short-seller.

For example, there is a share in company A trading at $22 and an investor projects that the price may fall. The investor may then borrow 100 units of this share and sell at $22. He then obtains $2,200. Later on the projection is right and the share falls to $20. When the trader repurchases the shares to re-deliver to the broker the amount spent would be $2,000. He thus nets $200 ($2,200-$2,000) on the transaction. Short selling is not available on the local stock exchange. However, it is available in the US market. In fact, selling short is a very important feature of any stock market in that it allows a greater degree of opinion to be factored into the share price. In this way the market can efficiently factor both good and bad news into the share price.

Q. How can I tell if someone is a fully qualified or licensed stockbroker?
Savitri, Arouca

A: A qualified stockbroker is one who has two years experience in a brokerage firm and a first degree in Econom-ics/Finance. The Trinidad and Tobago Securities and Exchange Commission lists annually all those who are qualified as such. The list can also be viewed on their web site. There is also another class of authorised persons, named traders who act in the capacity of authorised dealers and are allowed to trade on the floor of the Stock Exchange. No formal qualifications are required for this position.

Q. What is the P/E ratio referred to by stockbrokers?
Sasha, Palmiste

A: The P/E ratio is defined as the price of a share divided by the earnings per share of the company. The price of a share can be gotten off the stock exchange at the close of trading, while the company’s earnings per share is calculated by dividing the company’s net profit by the total number of shares in issue. Over time analysts have been able to determine the average P/E level for individual shares in the market. They assume that this ratio remains constant in the long-term once nothing significant changes with the company or industry. Therefore, if the earnings of a company increase or decrease they assume that the price of the share would change proportionately so as to keep the P/E ratio on or around the historical average.

For example, assume company B with a price of $12 and earnings per share of $1.50 per share, the P/E ratio is 8 (12 divided by 1.5). If analysts believe that the earnings per share (EPS) is going to increase to $1.75 per share, the expectation would be that the price of the share would increase to $14 in order to keep the historical P/E of 8 constant. (14 divided by 1.75 = 8) The higher the P/E ratios for shares the greater would be the demand for the share. This is because for shares with the same EPS the same dollar value increase would result in a greater price increase for the share with a higher P/E ratio.

Questions can be sent to Po Box : 1830, Wrightson Road, Port-of-Spain.
E-mail : cmmbsecurities@mycmmb.com