THE ROLE OF A FINANCIAL MANAGER

Any company, be it a small or medium size to the large corporations such as IBM, Google, Microsoft, Amazon, etc. needs money to operate their business. In order to generate revenue, they must first spend their capital/equity (money) on inventory and supplies, equipment and facilities, employee wages and salaries. With that being said, finance is undoubtedly critical to the success of all companies. Although it may not be as visible as marketing or production, however, the art of managing a company’s finances is just as much a key to the firm’s sustainability.

Basically, financial activities of a company is one of the most important and complex activities. And, in order to take care of these activities, a financial manager is the one who is in charge of performing all the requisite financing activities. At the heart of every financially successful organization, for instance, you will surely find a financial manager – a professional who plays a vital role in steering the financial ship towards organizational profitability and growth.

Although the role of a financial manager has long been one of the key positions at any organizations operating with significant turnover, however, for those who have been working in the financial field or for those who possess a strong grasp of numbers and good analytical and communication skills may be the ideal fit for the position.

Furthermore, the typical financial managers have a complex and challenging job. They analyze financial data prepared by accountants, monitor their company’s financial status, and prepare and implement financial plans. One day, they may be developing a better way to automate cash collections and at other times, they may be analyzing a proposed acquisition. This is simply one of the main responsibilities of being a financial manager. Since there are other critical functions that a financial manager performs, below here are some of the multifaceted roles that are embedded in the financial manager’s duties or responsibilities.

 

1. TRANSFORMING A COMPANY’S REAL ASSETS INTO FINANCIAL ASSETS

One of the core responsibilities of a financial manager is to ensure that the company has enough funds to finance its expansion and meet its obligations. In order to do this, the company issues securities (equity and debt), and the financial manager sells them to financial investors at the highest possible price. In today’s capital market economy, for instance, the role of a financial manager is less a buyer of funds with an objective to minimize cost and more a seller of financial securities. In other words, a financial manager must have the ability to maximize the value of these financial assets while selling them to the various categories of investors.

 

2. FINANCIAL PLANNING AND ALLOCATION OF FUNDS

Financial managers are technically the architects of a company’s financial future. They work closely with top management to develop long-term financial goals and strategies, which includes assessing the company’s current financial position, forecasting future trends, and devising plans to achieve financial objectives. By carefully analyzing data and economic indicators, financial managers help organizations to make informed decisions about investments, expansion, and risk management.

Aside from being a strategic financial planner, one of the primary duties of a financial manager is to allocate funds. Simply put, they allocate resources efficiently in order to ensure financial resources are utilized to the fullest. This involves setting the spending limits for various departments, monitoring expenses, and adjusting when necessary. Needless to say, the effective budgeting that a financial manager executes will help companies control costs, maximize profits, and maintain financial stability.

 

3. MAXIMIZING A COMPANY’S VALUE

The main goal of a financial manager is to maximize the value of the company to its owners. For a publicly owned corporation, for example, it is measured by the share price of its stock whereas for a private company, the value is gauged by the price at which it could be sold. To maximize the company’s value, a financial manager has to consider both short and long term consequences of his company’s actions.

Perhaps, maximizing profitability is one approach; yet, it should not be the only one determining aspect. This is because in some cases, such an intuitive approach favors making short term gains over achieving long term goals. As a quick illustration, questioning what would happen if a company in a highly technical and competitive industry had done no research and development? In the short run, profits would be high because research and development is very expensive. However, if it is in the long run, the company might lose its ability to compete because of its lack of new creativities and innovations.

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DIFFERENT TYPES OF COMPANY STOCKS

Over the years, stocks have proved their worth and deserve a prominent place in any long-term investment plan, such as a retirement account. Since the year of 1926, stocks have beaten the performance of any other major asset class by a wide margin that has a return nearly 10% per year on average.

Due to the fact that stocks by their nature are volatile, their value rises and falls to invest in them requires great cautions, thus, they should ideally be held to meet medium- and long-term goals. In other words, money invested in stocks should not be the money that you might need in three to five years. Nonetheless, stocks tend to deliver handsome returns in the long run, but volatile markets may not cooperate with your short-term cash needs.

 

1. GROWTH STOCKS

Growth stocks are the shares of companies with the potential to consistently generate above-average revenues and profit growth. These companies tend to reinvest most or all of their earnings in their businesses and pay out little or none of their profits to shareholders in the form of dividends. Owing to the fact that growth companies expand faster than the overall economy, hence, you can occasionally find these companies in mature industries. After all, keep in mind that even fast-growing companies are not necessarily good investments if their shares appear to be overvalued.

 

2. CYCLICAL STOCKS

Cyclical stocks are the shares of companies whose sales and earnings are highly sensitive to the ups and downs of the economy. When the economy is performing well, for instance, cyclical companies tend to shine. A contracting economy typically hammers the sales and profits of these companies and hurts their stocks. Whatever it is, cyclical industries include manufacturers of steel, automobiles and chemicals, airlines and homebuilders.

3. DEFENSIVE STOCKS

Defensive stocks describe the shares of companies whose sales of goods and services tend to hold up well even during the economic downturn. Some of the examples of industries that are substantially isolated from the business cycle are utilities, government contractors and producers of basic consumer products such as food, beverages and pharmaceuticals.

 

4. INCOME STOCKS

Income stocks typically pay out a relatively high ratio of their earnings in the form of dividends. The companies that issue them tend to be mature and have limited chances for reinvesting their profits into more attractive opportunities, for example, the utilities providers. In short, stocks that pay large dividends are usually less volatile because investors regularly receive cash dividends regardless of the market cycles.

5. SMALL-COMPANY STOCKS

Small company stocks have generated better returns over time than stocks of large companies. Although these companies tend to grow faster than their larger brethren, however, there is a trade-off - "small company stocks are much more volatile than the shares of big companies". Perhaps, there are a number of ways of defining what constitutes a small company. One common example or definition is that a small company is usually the one with a stock-market capitalization of $1 billion or less (if you have no clue what market capitalization is about, it is basically a company’s stock price multiplied by the number of shares outstanding).

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FDI – FOREIGN DIRECT INVESTMENT

Theoretically, the FDI which stands for "Foreign Direct Investment" refers to an investment in the acquisition of foreign assets with the intent to control and manage them. In fact, such companies can make an FDI in several ways, including purchasing the assets of a foreign company; investing in the company, new property, plants, equipment; or participating in a joint venture with a foreign company which typically involves an investment of capital.

Normally, FDI is primarily a long-term strategy where companies usually expect to benefit from it through an access to local markets and resources, often in exchange for expertise, technical know-how, and capital. Subsequently, a country’s FDI can be both inward and outward where the inward FDI refers to investments coming into the country, and the outward FDI are the investments made by companies from that country into foreign companies in other countries. Thus, the difference between inward and outward investments made is called the net FDI inflow, which can be either positive or negative.

Firstly, there are two main categories of international investment – portfolio investment and foreign direct investment. Portfolio investment refers to the investment in a company’s stocks, bonds, or assets, but not for the purpose of controlling or directing the firm’s operations or management. Typically, investors in this category are looking for a financial rate of return as well as diversifying investment risk through multiple markets.

As for the FDI which stands for "Foreign Direct Investment" in other definitions, it refers to an investment made from a party in one country into a business or corporation in another country with the intention of establishing a long lasting interest. This is what generally differentiates FDI from foreign portfolio investments where investors passively hold securities from a foreign country, and a foreign direct investment in contrast can be done by obtaining a long lasting interest through the expansion of one’s business into a foreign country.

Secondly, there are two forms of FDI in the realm of international business, namely are horizontal and vertical FDI. The horizontal FDI occurs when a company is trying to establish a new market such as a retailer, for example, that builds a store in a new country to sell to the local market. Whereas the Vertical FDI refers to when a company invests internationally to provide input into its core operations, which is usually in its home country.

To illustrate this further, a company may invest in production facilities in another country. When a company brings the goods or components back to its home country (e.g. acting as a supplier), this is known as the backward vertical FDI. However, when a company sells the goods into the local or regional market (e.g. acting as a distributor), this is referred to as forward vertical FDI. In any cases, the largest global companies often engage themselves in both backward and forward vertical FDI depending on their industry.

Thirdly, many companies engage in the backward vertical FDI. The auto, oil, and infrastructure which include industries related to enhancing the infrastructure of a country such as energy, communications, and transportation are good examples of the backward vertical FDI.

Companies from these industries invest in production or plant facilities in a country in order to supply raw materials, parts, or finished products to their home country. In recent years, these same industries have also started to carry out forward FDI by supplying raw materials, parts of components, or finished products to newly emerging local or regional markets.

Meanwhile, there are different kinds of FDI – two of which the "Greenfield and Brownfield" are increasingly applicable to global companies. The Greenfield FDI occurs when multinational corporations enter into developing countries to build new factories or stores. These new facilities, in addition, are built from scratch which is usually in an area where no previous facilities existed.

As the name originates from the idea of building a facility on a green field, such as farmland or a forested area, companies build new facilities which can best meet their needs as well as create new long-term jobs in the foreign country by hiring new employees. Bottom line, many foreign countries tend to offer prospective companies tax breaks, subsidies, and other incentives to set up the so-called Greenfield investments.

On the other hand, the Brownfield FDI takes place when a company or government entity purchases or leases existing production facilities to launch a new production activity. One application of this strategy is where a commercial site used for an "unclean" business purpose, such as a steel mill or oil refinery to be cleaned up and used for a less polluting purpose, or a commercial office space and a residential area.

Usually, the Brownfield investment is less expensive and can be implemented faster, yet, a company may have to deal with many challenges including existing employees, outdated equipment, entrenched processes, and cultural differences.

As we know, many governments encourage FDI in their countries as a way to create jobs, expand domestic technical expertise, and increase their overall economic standards. Such countries as Hong Kong and Singapore long time ago realized that both global trade and FDI would help them grow exponentially and improve their citizens’ standard of living. As a result, Hong Kong (prior to its return to China), was one of the easiest places to set up a new company where the guidelines were clearly available and businesses could set up a new office within days.

This is also similar to Singapore albeit the country was a bit more discriminatory on the size and type of business, however, its government offered foreign companies a clear streamlined process for setting up a new firm.

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GLOBAL FINANCIAL INSTITUTION – INTERNATIONAL MONETARY FUND (IMF)

Broadly speaking, the International Monetary Fund (IMF) is an organization which consists of 188 countries working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. Besides, the IMF provides policy advice and financing to its members in economic difficulties and also works with developing nations to help them achieve macroeconomic stability.

Helping a nation that can benefit from globalization while avoiding potential downsides such as massive movements of capital and abrupt shifts in comparative advantage, including labor, trade and tax policies are the important tasks for the IMF. Hence, the IMF supports its membership by providing:

1. Policy advice to governments and central banks based on analysis of economic trends and cross-country experiences.

2. Research, statistics, forecasts, and analysis based on tracking of global, regional, and individual economies and markets.

3. Loans to help countries overcome economic difficulties and fight poverty, mostly in developing countries.

4. Technical assistance and training to help countries improve the management of their economies.

Furthermore, one of the main goals of the IMF as a global financial institution is to ensure the stability of the international monetary and financial system by working together to help resolve crises with its member countries to promote growth and alleviate poverty. As the institution has three main tasks at its disposal to carry out its mandate which are surveillance, lending, technical assistance and training, these functions are underpinned by its research and statistics.

Within the realm of surveillance, for example, the IMF promotes economic stability and global growth by encouraging countries to adopt sound economic and financial policies. In order to do this, the institution regularly monitors global, regional, and national economic developments. As it also seeks to assess the impact of the policies of individual countries on other economies, the process of monitoring and discussing countries’ economic and financial policies is known as bilateral surveillance.

On a regular basis (usually, once every year), the IMF conducts in depth appraisals of each member country’s economic situation by discussing with the country’s authorities and the policies that are most conducive to a stable and prosperous economy; drawing on experience across its membership. At this stage, the member countries may agree to publish the IMF’s assessment of their economies along with the vast majority of countries opting to do so.

Meanwhile, when it comes to addressing how the IMF performs its mandate as a global financing provider, the institution essentially renders its member countries the breathing room that they need to correct their balance of payments problems. A policy program supported by financing, technically speaking, is designed by the national authorities in close cooperation with the IMF.

Although continued financial support is conditional on the effective implementation of this program, however, the IMF lending instruments were improved further to provide flexible crisis prevention tools to a broad range of its members with sound fundamentals, policies, and institutional policy frameworks. Whatever it is, the IMF in the most recent years has not only doubled its lending access limits, but also has boosted its financing support to the world’s poorer countries, with the loans provided at a concessional interest rate.

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GENERAL OVERVIEW OF CORPORATE FINANCE

From startups to multinational conglomerates, corporate finance is literally a critical element in guiding companies towards attaining their financial goals, optimizing resources, and maximizing shareholder value. As it involves the planning and financing of investments made by a company as well as the distribution or reinvestment of the income generated, the primary goal of corporate finance is to maximize shareholder value while striking a balance between risks and profitability, which entails both the long and short term financial planning while implementing various strategies, capital investment, and tax considerations.

First of all, when discussing about the field of corporate finance, it is essentially a branch or a part of financial management concerning with how corporations or companies address funding sources, capital structuring, investment decisions, and accounting. It is a broad subject comprised of many topics including capital structure, capital financing, risk management, capital budgeting, and the time value of money.

Because the ultimate purpose of corporate finance is to maximize the value of a business through planning and implementation of resources while balancing risks and profitability, it also incorporates the tools and analysis utilized to prioritize and distribute financial resources. Hence, the financial management of a corporation or a company involves two functions, namely are:

1. Resource Acquisition: This function involves generating funds from internal and external sources at the lowest possible cost to the corporation. The two main categories of resources, in this case, are equity and liabilities. Equity refers to proceeds (profits) from the sale of stocks, retained earnings, and returns from investments. Whereas liabilities refer to the commitments from which an entity derives value including bank loans, other debts, product warranties, accounts payables, etc.

2. Resource Allocation: This function refers to investing funds with the goal of increasing shareholders’ wealth over time. The two main categories of investments, in this stage, are current assets and fixed assets. Current assets encompass cash, inventory, and accounts receivables, while fixed assets on the other hand are buildings, real estate, and machinery.

Second of all, corporate finance is crucial because it enables businesses to manage their financial risks, for example, by hedging against stock market or interest rate fluctuations. Due to the fact that some companies can control their exposure to currency risks, corporate finance therefore provides the necessary tools to enable them to make sound financial decisions for growth and success in the long run.

Regardless of the size or the type of business operation, each company seeks to streamline its corporate financing for optimal wealth distribution and return generation, which is pivotal for ensuring a company's long-term financial health and sustainability.

Meanwhile, corporate finance helps companies to maximize their shareholder value by increasing profitability and share price. As it helps them to identify and evaluate growth opportunities by analyzing the financial feasibility of new projects as well as assessing the impact of those projects on their financial positions, corporate finance as a result enables companies to also gain a competitive advantage through a string of financial decisions, such as investing in new technologies, mutual funds, real estate, or acquiring and merging with other business entities, which allow them to outperform over their competitors.

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LEARNING HOW TO READ A COMPANY’S FINANCIAL STATEMENTS

Before you decide whether or not if you should invest in stock market, here are a few questions that would help you make a better decision and push you to think very carefully.

- How much cash does the company already have?

- How much revenue has the company made since it was started?

- How much revenue does the company expect to make in the future?

- Does the company have any debts?

Then, once you have done asking yourself with the above questions, the next step for you to start is by looking at the company’s financial statements. Learning how to read Financial Statements is similar to learning a new language. If you want to order a better dish in a Spanish restaurant, you will probably need to speak Spanish to read the course of menu. This is similar with a company’s business.

If you want to find a good stock to invest in, you will need to learn how to speak the language of finance and read their financial statements. Just like learning any new languages other than your mother tongue. It is difficult at first, yet, the more you practice the more fluent you will become.

Broadly speaking, all companies need to keep track of their finance which means that they are keeping track of all the money coming in and going out, as well as other transactions that do not necessarily involve the exchange of money. At the end of each month, quarterly (three months), and year, a company will prepare financial statements which literally are the summary of all its financial transactions in that given period.

In the case of a company that is publicly traded where its shares are sold on a stock market, for instance, it is required that the company prepare and file quarterly and annual financial statements so that the government and the public can see how the company is doing.

Actually, there are a lot of parties who will be keen to have a look at the financial statements of a company. First, the company’s management and board of directors will use the financial statements to track performance. The financial statements typically show how the company has done in the past and will help management to make better decisions about the future. Second, Lenders or the so-called creditors such as banks that have provided loans to the company may also want to see its financial statements.

Some loans may have certain requirements, such as the company’s debt-to-equity ratio "cannot be more than either 0.3 or 0.4" in order to receive that loan, or the lender may just want to see how much cash the company has in order to estimate how likely it is the company will be able to pay back the loan and interest in a timely manner.

Here’s a quick illustration of a company’s debt-to-equity ratio, and how to calculate it is by "dividing a company's total liabilities with its shareholders’ equity".

On the other hand, investors are very interested in seeing the financial statements. They are making decisions about whether to buy or sell stock in the company and thus they need to know how the company is doing to help inform their decisions. When it comes to a company’s financial statements, there are three types that you need to learn how to read them before you decide to invest or buy its shares.

Firstly, it is a balance sheet. The balance sheet basically shows a snapshot of the company’s assets (its resources that it expects to create value in the future), liabilities (the loans and other obligations due to others), and owners’ equity (also known as shareholders’ equity or stockholders’ equity – the stake that the owners or investors like yourself have in the business).

Secondly, it is an income statement. The income statement practically demonstrates how much revenue the company generated over the year, how much it cost to sell its main products, how much it cost to pay its employees over the year, and how much it owed in interest and taxes for the year. On a very basic level, if the company makes more revenue than it spends in costs, it is a profitable business. However, if the company’s costs are greater than its revenues, then it is not a profitable business.

Thirdly, it is a statement of cash flows. The statement of cash flows technically illustrates how much cash came into the business and how much cash went out of the business. It is important to note here that when we use the term cash in the financial world, we mean not only the currency bills like you normally think of such as dollars or euros, but also checks, electronic transfers, as well as the balance in the bank account.

In fact, most businesses will do a lot of their transactions through electronic means (e.g. mobile banking, wire transfers, etc.); yet, they are still considered as the amount of cash which flows in and flows out.

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THE IMPACT OF POLITICAL AND LEGAL FACTORS ON INTERNATIONAL TRADE

As the governing body that have long intervened in international trade through a variety of mechanisms, some of the reasons why governments need to intervene in international trade are simply due to a combination of political, economic, social, and cultural reasons. Politically, a country’s government may seek to protect jobs or specific industries. And perhaps, some industries may be considered essential for national security purposes, such as defense, telecommunications, and infrastructure. A simple example would be a government may be concerned about who owns the ports within its country.

When it comes to addressing national security purposes, some governments may not want advanced technological information to be sold to unfriendly foreign interests which can impact both the import and exports of a country as a whole. As governments may influence trade to reward a country for political support on global matters, they on the other hand are also motivated by economic factors to intervene in the international trade. With that being said, they may want to protect young industries or to preserve access to local consumer markets for domestic firms.

Furthermore, governments have several key policy areas that can be used to create rules and regulations to control and manage international trade. Many governments continue to intervene in this particular area is owing to the fact that there has been a major shift towards free trade among nations. Because of this, those rules and regulations imposed are as follows:

 

1. TARIFFS

- Tariffs are taxes imposed on the imported products. There are two kinds of tariffs exist, one is specific tariffs which are levied as a fixed charge, and the other one is ad valorem tariffs which are calculated as a percentage of the value. Many governments, unfortunately, still charge ad valorem tariffs as a way to regulate imports and raise revenues for their coffers (money box/treasury).

 

2. SUBSIDIES

- A subsidy is a form of government payment to a producer. The basic types of subsidies include tax breaks or low-interest loans for which both of them are very common. Subsidies, in addition, can also be cash grants and government-equity participation, which are less common because they require a direct use of government resources.

 

3. IMPORT QUOTAS AND VOLUNTARY EXPORT RESTRAINTS (VER)

- Import quotas and voluntary export restraints (VER) are two strategies to limit the amount of imports into a country. The importing government directs import quotas while VER are imposed at the discretion of the exporting nation in conjunction with the importing one.

4. CURRENCY CONTROLS AND ANTI-DUMPING RULES

- Governments may limit the convertibility of one currency (usually its own) into others in attempts to limit the imports. While some governments will manage the exchange rate at a high level to create an import disincentive, they in contrast establish rules and regulations against any form of dumping practices, which is none other than when a company sells its product below market price often in order to win market share and weaken its competitors.

 

5. LOCAL CONTENT REQUIREMENTS AND FREE-TRADE ZONE

- Many countries continue to require that a certain percentage of a product or an item be manufactured or assembled locally. Some countries, in fact, specify that a local firm must be used as the domestic partner to conduct business. In conjunction with free-trade zone policy, many countries designate certain geographic areas in attempts to promote trade with other countries where they are free from tariffs, taxes, have less procedures or restrictions, and so forth.

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INTERNATIONAL MONETARY SYSTEM – THE GOLD EXCHANGE STANDARD

Historically, some of the remaining silver standard countries began to peg their silver coin units to the gold standards of the United Kingdom or the USA towards the end of 19th century. The British India in 1898, for example, pegged the silver rupee to the pound sterling at a fixed rate of 1s 4d, while the Straits Settlements in 1906 adopted a gold exchange standard against the pound sterling with the silver Straits dollar being fixed at 2s 4d.

Similarly, the Philippines also pegged the silver peso to the U.S. dollar at 50 cents where their move to hedge their currency was assisted by the passage of the Philippines Coinage Act by the United States Congress in March 1903. When adopting the gold exchange standard, many European nations changed the name of their currency from Daler (Sweden and Denmark) or Gulden (Austria-Hungary) to Crown, since the former names were traditionally associated with silver coins and the latter with gold coins.

Perhaps, the success of the gold exchange standard at the time practically depended on a parallel development that emerged out of the mechanisms that the industrializing countries used to manage the gold standard. As this monetary system differed from the gold standard in that international reserve which consists of both gold and convertible currencies, it made the said development to function with less gold.

Moreover, the mechanisms for settlement of foreign exchange holdings had evolved throughout the Europe with the development of financial markets and central banks. A government (in this case, the treasury or central bank) bought and sold foreign exchange in transactions with its own private sector; becoming the creditor by drawing down or building up its own holdings of foreign exchange.

Because of the fact that those convertible currencies tend to be invested in interest-bearing financial assets, the gold exchange standard which adopted the above mechanism for the settlement of foreign exchange holdings allowed for growth over an increase of gold production.

Last but not least, following the breakdown of the Bretton Woods system, the international monetary system reverted to a more decentralized market-based model where major countries such as United Kingdom, USA, France, Germany, Japan floated their exchange rates, made their currencies convertible, and gradually liberalized capital flows.

What’s more, several emerging countries in recent years apart from those dominant players also had adopted similar policies after experiencing the difficulties of managing pegged exchange rate regimes with increasingly open capital accounts.

An exchange-rate regime in the history of global finance, theoretically speaking, is defined as the way of an authority manages its currency in relation to other currencies and the foreign exchange market. The basic types of policies implemented in the pegged exchange-rate regimes are firstly, a floating exchange rate where the market dictates movements in the exchange rate; secondly, a fixed exchange rate where a central bank keeps the rate from deviating too far from a target value which ties the currency to another currency.

Because of the obstacles of dealing with pegged exchange rate regimes, the decision or the move to apply a more decentralized market-based model has increased government’s control of domestic monetary policies and inflation, accelerated the development of domestic financial sectors and ultimately, boosted the overall performance of economic growth in a nation.

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UNDERSTANDING THE STOCK MARKET'S TERMINOLOGY: MARKET CAPITALIZATION AND PRICE-TO-EARNINGS (P/E) RATIO

Basically, a company’s worth its total value in the stock market is called "Market Capitalization" and it is represented by its stock price. To put it in a simple term, Market Cap (Market Capitalization) is equivalent to the stock price multiplied by the number of shares outstanding or being traded.

For example, a stock with a $5 stock price and 10 million shares outstanding/being traded is worth $50 million ($5 x 10 million). If we take this one step further, we can see that if a company that has a $10 stock price and one million shares outstanding (the market cap = $10 million), then the company is worth less than the one with a $5 stock price and 10 million shares outstanding (market cap = $50 million).

Thus, the stock price is a relative and proportional value of a company’s worth and only represents percentage changes in market cap at any given point in time. However, any percentage changes in a stock price will result in an equal percentage change in a company’s value. This is the reason why investors are so concerned with stock prices and any changes that may occur even if it is just a $0.10 drop in a $5 stock can result in a $100,000 loss for shareholders with one million shares.

Aside from market capitalization, one way to determine the value of a company’s business is with the Price-to-Earnings Ratio or the so-called "P/E" Ratio. The price-earnings ratio (P/E) can be calculated as "Market Value per Share (Stock Price) / Earnings per Share". For example, let’s say that a company is currently trading at $43 a share and its earnings over the last 12 months were $1.95 per share. The P/E ratio for the stock could then be calculated as $43/$1.95 (Stock Price / Earnings per Share) or about 22x (22 times).

In essence, the price-earnings ratio indicates how many years an investor has to wait at the current earnings to get all their money back. If the P/E ratio is 22x, it will take you 22 years for the company to earn how much you bought the stock for $43. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to the ones with a lower P/E. And a low P/E can indicate either a company may currently be undervalued or the company’s profits are expected to decline.

Perhaps, there are some rules of thumb when you think of the P/E (Price-to-Earnings) Ratio as the price you pay for a stock:

1. The average P/E over the past decade is 15x. An average company should be worth about 15x.

2. The typical great companies with very high returns and consistent earnings growth tend to trade about 20-25x P/E, while bad companies or the ones whose earnings are unpredictable and make low returns usually trade at below 10x P/E.

3. A company should trade at about the P/E as its earnings are expected to grow in the future. For example, companies with growing profits 30% per year may be justified to trade at 30x P/E while the ones with not growing may trade at 5-10x P/E.

Overall, below here is a quick chart to measure what P/E Ratio should be so that you will have a better understanding of the above rules of thumb which has already been explained.

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THE SEVEN GOLDEN RULES OF SUCCESSFUL INVESTING

Being successful at anything requires following a set of rules. Good rules are the accumulation of decades of wisdom summed up into the few components that really matter. Successful football players, given as an example, win because they avoid penalties and because of the way they undergo a series of rigorous training.

This is similar to academic learners. Successful students get A’s because of the way they study. The point is that investing in the stock market is no different except that when you succeed in investing, you make a lot of money.

 

RULE NUMBER 1 – THINK LONG TERM

Trying to time the stock market or risking it all to double your money in a year is at best speculating which is similar to the worst gambling. You may as well just take your money to Vegas and lose it there. However, those who are able to successfully navigate the stock market are not speculators or gamblers, but they are investors. Needless to say, they know they can beat the market because they think differently, they think smarter, and they think in a longer-term period.

 

RULE NUMBER 2 – GOOD COMPANIES MAKE GOOD INVESTMENTS

People need to understand and keep in their mind that investing is not like placing a bet on whether the Cowboys will cover the spread against the Packers in the big game. Investing is not trying to get the quarterly press release a microsecond before the other person. It is not even about trying to predict which stock that you think will go up the most. Fundamental Investing is all about buying a tangible piece of a business, or a share of that business. What’s more, your investment portfolio (the collection of all the different shares you own) is only as good as sum of the companies in that portfolio.

If you buy shares of high quality companies at reasonable prices, you will end up with a high quality portfolio with less risk. And good companies are the ones which have a unique advantage that others may not be able to imitate. They are simply the ones which generate high returns on capital, as they do not need to borrow a lot because their business is self-financing.

 

RULE NUMBER 3 – BUY WITH A MARGIN OF SAFETY

When it comes to investing, a margin of safety is formed when one buys an investment at less than its value while using conservative assumptions. The idea of a margin of safety is that you want to buy a business at a price that is low enough with consideration that your assessment could be completely wrong and therefore you would not lose that much.

RULE NUMBER 4 – DO YOUR OWN HOMEWORK AND KNOW WHAT YOU OWN

There is no substitute for your own work. You wish to buy a stock because CNBC recommends it, or because your uncle suggests it or perhaps the stock chart on your laptop screen looks good enough to convince you. Well, the truth is that all of these are a sure way to lose your money. Successful investors, in case if you are wondering, know exactly what they own. They buy stocks of companies with products they believe in.

Not only that, but successful investors go the extra mile to analyze the financials of the companies’ stocks they own in order to make sure they are not missing anything. Remember, most of the extraordinary gains made in the stock market come after a stock is punished, or after it has already risen a lot but you are not going to have the conviction to stick with it unless you really know exactly the companies’ shares that you put your eyes on.

 

RULE NUMBER 5 – STAY CALM AND BE RATIONAL

The typical buyer’s decision is usually and heavily influenced by those around him, which is to buy when others are buying, and to sell when others are selling. Unfortunately, this is a recipe that is bound to backfire. The best investors are the ones who can fight this urge and remain calm through a storm on the sidelines of a market bubble.

RULE NUMBER 6 – DO NOT PUT ALL YOUR EGGS IN ONE BASKET, BUT YOU DO NOT NEED TO HAVE TOO MANY BASKETS EITHER

Diversification is one of the most critical business strategies for your portfolio so that if one stock blows up, it will not sink the entire ship. As much as you think that you will not make a mistake, you will do just fine. Even the masters do and that is why you are highly advised to not put all your eggs in one basket. When it comes to having diversification, research suggests that 90% of diversification benefits can be obtained in most markets with a portfolio of just over 20 stocks.

In other words, the more you diversify beyond that, the less you know about each investment you make. After all, your first and second best ideas are always better than your 100^th best idea so while diversifying is crucial, make your best ideas count!

RULE NUMBER 7 – NEVER STOP LEARNING!

Perhaps the most important rule is to learn more and then keep learning. The fun thing about investing is that the markets are always different and companies are constantly changing. Hence, never stop learning about businesses, never stop learning from other great investors, and never stop learning from your own mistakes. Humility and an eagerness to learn are two traits found in all of the great investors. Even the world’s greatest investor "Warren Buffett" credits his partner Charlie Munger by teaching him that it is better to buy a great company at a fair price than a fair company at a great price.

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