Bonus Shares Are Just a Market Gimmick

Bonus Issue is issue of free shares by the company to its existing shareholders. And since we love 'free' things, we love bonus issues. But beware - they are just a big hype. You gain NOTHING from it.

Financially speaking, bonus shares are issued by converting a part of the free reserves (i.e. the reserves & surplus accumulated by the company over the years, mainly out of the profits retained in the past) into share capital. The reserves are reduced and the share capital is increased equivalent to the same amount.

Suppose a company, having a share capital of Rs.1 billion and reserves of Rs.5 billion, issues bonus share in the ratio of 1:1. Then, its share capital will increase to Rs.2 billion and reserves will reduce to Rs.4 billion. So there is no change in the company's net worth, which remains the same at Rs.6 billion.

Say you are holding 100 shares in the company. And if the Current Market Price is say Rs.200, your investment value works out to Rs.20,000. After the bonus issue, your share-holding increases to 200. But does it mean that your investment value increases to Rs.40,000? No, that's not the case. Since the share-holding has doubled, the EPS will fall by 50%. And assuming that the PE ratio remains the same, mathematically the share price also falls by 50% to Rs.100. Thus, your investment remains the same at Rs.20,000. Hence, there is no change in your investment value.

Therefore, essentially speaking, the shareholder is not getting anything free. In fact he is not getting anything at all - free or otherwise.

The only gains from bonus issues could be increase in trading & liquidity.

Psychologically, a stock of Rs.100/share appears cheaper than a stock of Rs.200. Therefore, more people are willing to buy such a stock. Secondly, the number of shares has doubled, which increase the stock's liquidity. Because of this increased demand & liquidity, the stock may not fall exactly to Rs.100, but may trade at around Rs.110-120. Thus, because of the sentiment, your investment value may improve a bit to say around Rs.22,000-24,000.

But, there is risk too.

People are used to receiving certain dividend. Now, with doubled share-holding, company will have to shell out double the amount as dividend if it aims to maintain its dividend percentage record. The question arises - does the company generate enough profits to meet this increased dividend outflow? If not, the company will have to reduce its dividend percentage. This could have negative impact on the sentiment. Hence the whole purpose of improving the sentiment may be defeated.

The company and the investor must keep this point in mind, before considering the bonus issue.

The same holds true for stock splits too.

Stock split is merely splitting the par value of the share and increasing the number of shares. For example, say a company had issued 100,000 shares at Rs.10, 3 years ago. It now splits the share to a par value of Rs.5 and increases the number of shares to 200,000. Therefore, the company's capital i.e. Rs.1,000,000 does not change at all by the stock split. Again, since the number of shares has doubled, the EPS will fall by 50% and the share price would also mathematically drop by 50%. So again no benefit to the shareholder.

But again, because, the price reduces to affordable levels and number of shares increase, the liquidity and trading improves. As such, the price may quote somewhat higher than the exact half.

For example, some time back the price of a particular company's stock was quoting at Rs.10,000. Not many people would buy a share at that price. So the company split its shares and also issued bonus shares. This increased the number of shares and brought down its stock price to a more 'affordable' price of about Rs.2000.

Concluding, both the Bonus Issue and Stock Split do not do anything to add any 'real value' to the stock. It is only the improved liquidity (due to more number of shares) and trading (due to more affordable prices) that can give some kick to the stock.

Note: Warren Buffett, legendary investor and the world's 2nd richest man for many years now, does not believe in these gimmicks. He has, therefore, never gone for bonus or stock splits in his company Berkshire Hathaway; even though a single share of the company is today traded at around US$ 130,000 (and hence out of reach of an ordinary investor). His value investing methods are no secret. But they require lot of discipline and patience, which unfortunately most of us lack.

If You Like QE3 But The Stock Market Makes You Nervous - Buy Gold!

QE2 in 2010 and 'Operation Twist' in 2011 recovered the stock market from double-digit corrections that were underway at the time, and rescued investors from their extreme bearish sentiment each time.

QE3 is underway and many are convinced that's all that matters, that a repeat of stock market gains is a sure thing.

You need to realize that conditions are much different this time.

For instance, rather than being down double-digits this time with fears high that it is heading down further into a bear market, the stock market was already near four-year highs, and investor sentiment was at high levels of bullishness and confidence when the surprise of QE3 was announced last week.

Perhaps more significant, in 2010 and 2011 corporate earnings were growing impressively. Profit margins were benefiting from the improved productivity brought about by large employee lay-offs, plant closings, and tax loss carry-forwards from the recession, while corporations with global operations benefited even more from their ties to Brazil, China, India, etc., where economies remained strong and the main concerns were rising inflation.

But this time, those normal driving forces for stocks are completely reversed. The economies of important U.S. trading partners like China, India, Japan, Brazil, and the entire 17-nation euro-zone, have slowed dramatically this year, the euro-zone already in a recession.

And corporate earnings are nose-diving. In the U.S. S&P 500 earnings grew at a huge 45% pace in 2010 as they recovered from the losses suffered in the Great Recession. That unsustainable pace slowed to a still robust 15% earnings growth in 2011.

But this year earnings grew only 0.8% in the 2nd quarter, and the consensus forecast is for negative growth in the current quarter, a decline in earnings growth for the first time since the recession ended. Adding to the deteriorating situation, corporations are warning of even slower sales and earnings going forward, citing slowdowns globally that are beyond the ability of the U.S. Fed to fix.

Global bellwethers Intel, FedEx, and UPS, joined the warnings parade in recent days.

Warnings from major transportation companies, like FedEx (FDX), UPS (UPS), and Norfolk Southern Railroad (NSC), are particularly worrisome, since the DJ Transportation Avg has been in a negative divergence with the rest of the market all year, even before these warnings. In spite of the stock market rally since the June low that has the S&P 500 now up 16% for the year, the Transportation Avg has been hitting lower highs on its attempts to rally and is down 8% from its January high. The Transports often lead the economy and the rest of the market since they see early warnings when shipments of raw materials to manufacturers, and of finished goods to end users, decline sharply.

I seriously doubt that the laws of business cycles have gone away, and I still believe that fundamentals matter.

So with previous global economic strength crumbling, a sharp downside reversal in corporate earnings underway all year, the negative divergence of the bellwether Transports, and the stock market already excitedly rallied to four-year highs, there are reasons to question further bullish expectations for the stock market from QE3 this time.

However, since the Fed's goal for QE3 is also to devalue the dollar again (in an effort to boost U.S. exports, and to create inflation) if it is to at least succeed with those goals QE3 should light a fire under gold. And it has been doing that.

We are on a buy signal on gold, and holding a 20% position in the SPDR Gold Trust etf, symbol GLD. But while gold has already rallied 15% from its June low, equaling the rally in the S&P 500, at least gold is rallying from an oversold condition after declining 18.5% from its 2011 record high to its June low. And its rally does not yet have it back to its high of last year, let alone to four-year highs like the S&P 500.

So if you expect continuing positive reactions in markets to QE3, gold might be a wiser choice than the stock market.

The world's largest gold bullion etf is the SPDR Gold Trust, symbol GLD. Canadian investors can choose from six gold bullion etf's that trade in Canadian dollars on the Toronto Stock Exchange. The largest and most active is the iShares Canada Gold Bullion Fund, symbol CGL-T.

Want to Make More Money in the Market?

I often hear traders tell me how they lose: they increase their expectations from, say 8% to 15% as the trade starts heading their way. They analyze trades and see a preponderance in higher returns, some well over 50% some days. "Why can't I have some of that action?", they ask.

Seems like a logical question. But the reality is that very few traders actually take massive run ups with a huge gain on the one day. If you bought in at the low of the day or sold at the high, you likely struck it lucky. If you got both the low and the high of the day, congratulations on being one very fortunate trader! Don't count on it happening again. Therefore, do not think you are good; you simply got lucky. Big difference.

The danger in getting lucky is that traders tend to think it can easily be replicated. Trying it again proves futile and they end up losing. It's important to recognize the difference between intelligent, well calculated trading and getting lucky.

The secret to making more money is to take a small piece of the action in the direction of the move. By taking smaller chunks along the way, you spread out the risk and exponentially increase your chances for long term wealth. It is much easier to reach 8% than a 15% gain. You may also score 10 times for a 5% profit than once shooting for a 50% target. In trying to obtain those huge returns, you run the risk of the stock turning against you.

Maintain that respectable but reasonable percentage in all your trades. If you trade trends, in all likelihood, the trend has already been established and there may not even be much left in the trade.

Everyone would like to make more money. Fair enough. The best way is to keep your percentages the same - maybe even lower them - but trade more contracts. If you make 8% on $1,000, that's $80. A gain of 8% on $10,000 is $800. But if you're trading $10,000 and are satisfied with earning $500 that day, just aim for 5%. It's much easier and faster to reach. Earning $500 a day is $125,000 a year if you trade once a day. That's well over twice the average wage earner in the United States.

Want more money? Trade more contracts.

Are Declining Oil Prices Predicting A Stock Market Decline?

When the economy slowed in the summer of 2010 and the Fed launched QE2, commodity prices took off like a SpaceX rocket. The price of crude oil reversed to the upside along with the stock market, surging up 64%, from $70 a barrel to $114 a barrel eight months later in April, 2011.

When the economy began to slow again in the spring of 2011, the stock market declined again and oil prices fell back to $75 a barrel by October. The Fed then launched 'operation twist', again adding liquidity to the financial system, and the price of oil reversed to the upside, along with the stock market, oil reaching $109 a barrel six months later in March of this year.

This year as the economy slowed yet again, oil plunged back to a low of $75 a barrel in June. This time, as hopes grew that the Fed would come to the rescue again, neither oil nor the stock market waited, but began rallying again purely on the hopes for Fed action. The price of crude oil reached $100.40 a barrel two weeks ago.

When the Fed did indeed announce its QE3 program, it was widely expected that commodity prices, including oil prices, would surge higher as they did after QE2 and 'operation twist'.

But it didn't happen, at least not yet.

Instead, over the last two weeks the CRB Index of Commodity Prices has declined 5.5%, and oil has plunged 11%, from $100.40 a barrel two weeks ago to $89 a barrel this week.

It has traders scratching their heads.

Is it that the Fed's action was already factored into oil prices this time in the rally on hope from the June low? Or maybe that global economies are in such slides that the Fed action (and that of the European Central Bank) is too little too late to prevent a global recession?

Meanwhile, is the plunge in the price of oil an ominous sign for the stock market? I ask since the price of oil seems to track very closely with the stock market, as well as with economic slowdowns and recoveries.

In any event, this week's economic reports seem to answer the question of what the Fed saw coming when it decided to provide an aggressive QE3 stimulus effort in spite of signs of improvement in the housing industry.

The week's reports include that the Chicago Fed's National Business Index, calculated from 85 individual economic reports, plunged further in August. Its three-month moving average, considered a recession indicator, fell from -0.26 in July to -0.47 in August. That was its 6th straight negative reading. And 2nd quarter GDP growth was unexpectedly revised down to just 1.3% from the previously reported dismal 1.7%. And Durable Goods Orders plunged 13.2% in August. Providing a more recent picture, the Chicago PMI Index fell below the 50 level that marks expansion and contraction in September, coming in at 49.7, its lowest level in three years.

Combined with the ominous decline in oil prices, indicating QE3 may not have the same positive impact as QE2 and operation twist, this week's additional dismal economic reports are providing a warning to investors that October may be a difficult month this year.

Those inverse etf's against the market, PSQ, DOG, SH, and RWM are looking attractive again.

Was It An Anti-Obama Mini-Stock Market Crash, Individual Stocks Down 1 to 2% Across The Board

Everyone was somewhat on hold when it came to stock trading the week before the Presidential Election in 2012. Then everyone also speculated what might happen if Governor Mitt Romney's campaign was able to unseat President Barack Obama. Some thought as I did, that if that happened we'd see a 1000 point rally on the DOW. Still, most expected Obama to win, and even Jim Cramer said he expected Obama to win, but also that it didn't really matter because the 2013 financial cliff and day of reckoning was coming either way - regardless of who was elected. Okay so, let's talk.

In hindsight, which of course is always 20/20, President Barack Obama did win his reelection, of course, getting reelected is always the easy part going into a lame-duck term. Most stock traders figured that there might be a little pull-back if Obama was reelected, not much and they expected if it did, it would recover quickly, as most of that was already priced in as he was again; expected to win. Well, what happened shocked a few, but not me.

The day after the election on November 7, 2012 the stock market had a huge sell off, 314 points on the DOW. Basically some of the health care stocks took a beating due to the take-over of the health care industry through the Affordable Health Care Act (Obama Care), but that wasn't all, nearly all the major stocks were down by 1 to 2% straight across the board in all sectors.

This to me shows a no-confidence vote by investors of the concept of another four years of what our economy had just gone through. As resilient the US economy is, if we get a repeat of four more years of this, things won't be looking too good once we emerge on the other side of that long dark tunnel, and who knows there may be a cliff on the end of that track?

As an economic analyst for a think tank, which happens to operate online, I've been quite concerned with the Obama Administrations sometimes cryptic "class warfare" political rhetoric and attack on the job creators. Why? Well, because I've always been one of them, and completely understand how free-markets work, why they work, and when they work best. So, of course, I wasn't the least bit surprised at Wall Street's response to this election. And, I am very worried about the drastic cuts needed now after the Obama Administration has added another $5 Trillion to the US debt. Please consider all this and think on it.