Introduction
There is a wide spectrum of benefits that come with owning stocks whether purchased collectively or individually. Beside their historical value appreciation, stocks can yield income from dividends. Owning stocks has been proven as one of ways to deal with inflation since their returns consistently exceed the inflation rate. It follows hence that when the inflation rises, most corporations transfer their higher costs to consumers thus implying that their profitability as well as the resulting stock prices is seldom affected by inflation. In addition, there is tax benefits associated to owning stocks. It is important to note that capital gains are not taxed until one sells. The capital gains tax rates are often lower than the ordinary income tax rates.
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Stocks hold more potential than most investments over the long run. It is reported that stocks have yielded an average annual return in excess of 10 percent since 1962. Purchasing in stock of a company allows one to have a share of the company’s success as well as failure. In the course of the last century, the prices of stocks have been seen to rise or fall subject to a corporate profits or earnings. Although stock prices can temporarily undershoot or overshoot the true value of the stock, ultimately, prices follow earnings. While the potential profit from a stock investment is unlimited, the potential loss is subject to the amount of investment. It should be noted that the price of a stock and consequently the value of one’s investment fluctuates extensively. There are times when the market stagnates in a period of little or no growth and subsequently lower values for stocks. This is referred to as a bear market. On the other hand a bull market refers to a period when stock values are on the increase. There is need to evaluate one’s risk tolerance as well as making stocks a part of well designed investment plan. This paper seeks to assess the financial indicators of a technology company in justification of picking its stock listed.
There is a wide spectrum of benefits that come with owning stocks whether purchased collectively or individually. Beside their historical value appreciation, stocks can yield income from dividends. Owning stocks has been proven as one of ways to deal with inflation since their returns consistently exceed the inflation rate. It follows hence that when the inflation rises, most corporations transfer their higher costs to consumers thus implying that their profitability as well as the resulting stock prices is seldom affected by inflation. In addition, there is tax benefits associated to owning stocks. It is important to note that capital gains are not taxed until one sells. The capital gains tax rates are often lower than the ordinary income tax rates.
A Recap of Stocks Investments
Most businesses avoid the tendency of holding too much cash that is redundant, in most cases a portion of their profits are invested in assets that can be converted into cash easily and within a short time, this are readily marketable securities that can be liquidated within a short notice when cash is required. Such securities include government securities, debentures, bonds and stock that are marketable thus easy liquidation within a moment in case cash is needed. Stock in well performing companies is a viable way of investing excess cash, this means that a business acquires an equity interest in another business, thus it signifies a position of ownership in a business, stock provide regular income in form of dividends. These securities are highly liquid and can be converted into cash easily by selling on securities market. Bonds are financial instruments used by corporations and governments to borrow money from institution and individuals to fund their operations (Shangquan, 2000). Subsequently, a company holding the bond is a creditor to the issuing company for a period of time and thus is entitled to payment of the debt and some interest which translates to some extra income.
Most investors will agree that the higher the returns are in a certain investment the higher the risks involved. The relationship between risk and returns cannot be overlooked. Safe investments often carry lower risks but on the other hand they have lower returns. They are different level of risks associated with common stock as well as with corporate bonds. while on one hand corporate bonds have lower risk compared to common stock, they offer lowest return among the two, common stock generally have higher risk but higher potential returns on investment (Sandilands, n.d.) .
In corporate bonds the associated risk depends on the performance and financial stability of the company, thus in case of bankruptcy it will be unable to repay the bond value. Common stocks offer higher returns by way of dividends. On the other hand one may also trade the stocks in a stock market at a higher price than the purchasing one (Shangquan, 2000). The risk includes loss of projected profits. If the share price drops below the buying price one may suffer financial loss.
Diversification is an investment concept widely used by investors and portfolio managers to reduce portfolio risk. When an investor owns diversified investments, the risk is reduced when poor performers are compensated by better performing investments. Effective diversification is simply not having a range of different investments, but rather it is selecting a mix of investments that given a set of conditions they will not react in the same manner this implies that they are investments that often carry low correlation (Shangquan, 2000) . Correlation is considered to be a statistical measure of the extent to which two investments tend to perform the same in particular market conditions.
Well balanced portfolio consists of different classes of assets and variety of investments falling under each class of asset. For instance, different investments in different securities often fall or rise in value seasonally. By distributing your money across a range of investments which may include stocks, bonds and short-term investments, you spread investment dollars among the three investment classes (Shangquan, 2000). Consequently, this will smooth your portfolio performance.
Types of Stocks
There are many types of stocks that one may chose to invest in. Stocks are bought and sold on one or more of the several stock markets such as the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) , and Nasdaq. Stocks are said to be listed when they are sold on an exchange. On of the categories of stocks are the growth stocks. This type of stocks have good projections for fast growth as opposed to the economy or stock market and they generally have average or above average risk. Most investors buy growth stocks due to their good reputation of earnings growth as well as prospect that they will continue to generate capital gains over the long run.
Blue Chip stocks generally involve industry-leading corporations with top-shelf financial credentials. This type of stocks tend to pay good, steadily rising dividends, while generating some growth, offering reliability and safety as well as having low to moderate risk. Income stocks pay a much larger portion of their earnings in the form of quarterly dividends. This category of stocks involves more mature, slower growth companies. The dividends they pay to investors are thus generally risky to own as compared to growth stocks. While the price of income stocks do not grow rapidly, the dividends safeguards beneath the share price. It should be noted that even when the market falls in general, the income stocks will not usually be affected majorly since the investors will still receive their dividends.
Cyclical stocks are another category and are so called following their fortunes tending to fall and rise subject to the economy at large. This implies that they prosper when the business cycle is on the upsurge and they suffer when the business cycle is in recession. Another type of stocks is the defensive stocks. These stocks are theoretically insulated from the business cycle and consequently have lower risk owing to the fact that customers purchase their products and services in bad times as well as good times. Companies that sell foods and drugs as well as utility companies fit in this category. Other categories include speculative stocks and value stocks.
Rationale for Picking Stock in the Technology Industry
A company is said to be competitive especially due to the constant demand for new and innovative products in the market. Intense rivalry among competitors can lead to big loses for an organization especially if organizations decide to engage in price wars. An array of impressive technological advances has increasingly made global business easier and effective. These developments coupled with efficient airline transportation have served to make the business world become gradually smaller. However, there is still a persistence of competitive forces that does not seem to change. Awareness of the pertinent competitive forces can aid a company in venturing out a position in its respective industry that is less susceptible to attack. This is helpful in determining how structurally attractive an industry is and seeks to illuminate on the company’s relative position within the industry in question. It is vital to note that the ultimate profit potential of an industry is subject to the collective strength of the industry forces. Every industry has structural underpinnings in terms of a set of fundamental economic and technical characteristics that result in the competitive forces. The Porter Five Forces Model is instrumental in comprehending and weighing the structure of the business environment of an industry, as well as assessing the threats of competition to a given company. The model breaks an industry into logical parts, analyses them and puts them back together in a bid to provide an understanding of the structure of an industry business environment as well as the competitive threats into an industry.
Porter’s Competitive Model accentuates how the competitive structure in an industry is affected by five fundamental forces. The forces are; Suppliers bargaining power, threat of potential new entrants, bargaining power of buyers, threat of substitute products and services, Intra-industry rivalry. The degree of competitive rivalry of an industry forms the core of the model with the other four forces branching from it. The supplier power is encapsulated in their ability to offer products that are unique or products that are differentiated (Lima, 2006). The supplier ought to provide benefits through geographical proximity to the consumers, and warrants a long time working relationship. In addition, building up switching costs is vital in enhancing the supplier’s bargaining power.
On the other hand, a buyer’s bargaining power is subject to their ability to gain volume discounts and special terms of service. Multiple alternative sources and availability of standard and undifferentiated products and services is a culminating in the bargaining power of the buyer. A new entrant can be considered as startup or an existing company that has not prior competed with the Strategic Business Unit in its geographic market (Porter, 1985). In addition, an existing company can also pose as a new entrant threat if it shifts its business marketing and growth strategy in a manner that begins to compete with the SBU. Substitute products and services encapsulate the alternative to doing business with the SBU. However, formulation of substitute products is dependent on the willingness of the buyers to substitute, the relative price of the new substitutes and the level of switching cost.
Critical Success Factors for the Industry
The technology industry is highly competitive and can be quite profitable if a company is able to attract and maintain a high market share. For a company to succeed in the technology industry there are several critical factors that should be considered including capital, research and development, qualified human resource, well networked supply chain and favorable economic conditions. A technology company requires enormous initial capital investment to purchase equipment and lease buildings/ land where the firm is to be set up. Technology related hardware and software is expensive and should be paid for promptly. A technology company should ensure that they invest in a well equipped research and development department to produce innovative and original technological products. This investment would require a huge capital outlay and very talented; preferably experienced manpower.
It is the manpower that is hired by a company that makes use of the resources that the company has. A technology company needs the hired employees to efficiently utilize the available tools to produce high quality products that are original and will meet the demand of consumers in the market. An organized supply chain is critical in ensuring that raw materials and finished products reach their destination within set timelines. A technology company should have constant communication with members of their distribution team so as to ensure that they are aware of stock levels. Once involved members reach re-order levels, they should fill the necessary paper work to ensure that they have the products that they need to maintain the supply chain. A stable economy is necessary for a technology based company to be able to develop and maintain profitable income. A fluctuating currency should be avoided in starting up or re-investing in a technology based company.
Stock Prices and Ratio Analysis
Financial statements offer a description of cash inflows as well as outflows for a firm subject to three classes of activities namely; operating activities, investing activities and financing activities. The operating activities generally involve the transactions in the typical business operations of the firm. The investing activities includes the cash flows that result from purchases and sales of securities, property plant and equipment, while financing activities shows the cash flows that ensue from transactions with owners and lenders which are funds received from lenders, contributions of capital owners such as sale of stock, payments of dividends, and payments made to lenders (Florentina-Simona, 2010). Financial and cash flow statements serve as a reticulate of the actual as well as anticipated ingoing and outgoing of cash in an enterprise over a specified period. It evaluates the amount, predictability, and timing of cash inflows and cash outflows and is instrumental in forming the foundation for business planning and budgeting (Hamman, 1994). They allow the provision of information that serves as a tool of evaluating the changes in the net assets of a firm, its financial structure with the inclusion of solvency and liquidity, and its capability to affect the timing and amounts of cash flows in a bid to adopt to the changing business environment and opportunities (Florentina-Simona, 2010).
When buying stocks, investors are interested in financial statements to assess the current earnings as well as to predict future earnings. The financial statements have a considerable influence on the price at which the stock is bought and sold. A ratio is considered to be a quotient of one magnitude divided by another of the same kind. It offers the relation of one amount to another. As regards financial statements, absolute values are usually difficult to conceive and commit to memory. Consequently, amounts in financial statements are often more meaningful when compared to other amounts.
One of the significant ratios of the financial statements is the current ratio. Current ratio is defined as the current assets divided by the current liabilities. This ratio offers an indicator of the ability to pay short-term debt. It is universally agreed upon that this ratio should be greater than 1. Debt-Equity ratio is another significant ratio which provides the measure for the risk assumed in a given business. It should be noted that as the debt capital increases relative to the equity capital, the greater the risk. A high debt-equity ratio implies that when a corporation issues bonds, it will have to pay a much higher interest rate. In the event of stock being issued, investors will require a higher rate of return and may try to attain this higher rate by seeking to buy at a much lower price per share. Another key performance indicator is the operating ratio. This is the ratio of total expenses and sales. This ratio shows the percentage of sales that ought to be used in paying the expenses. The ratio is not considerably valuable on its own and it makes more sense when compared to past operating ratios whereby a possible trend may be detected. In addition, a company can compare its operating ratio to that of other companies in the industry.
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