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Friday, November 18, 2011

The affect of labor force participation rate on corporate revenue

According to the Office of Economic Cooperation and Development (OECD), the labor participation rate is the ratio of the work force to working age population. Bureau of Labor Statistics Data shows this rate is at the same level it was between 1978-1984. Workforce participation is important because it affects GDP and consumer income that is in turn a driver of domestic corporate revenue. The labor force participation rate is further explained in the following video:

Labor Force Participation Rate
Source: BLS.gov, US-PD
To illustrate the above further,  The Smithsonian claims the percent of population over 65 will increase from 13% to 20% by 2050 meaning higher entitlement spending such as social security and medicare, and lower tax receipts at current levels and labor participation rates. 
In terms of corporate revenue from domestic sources, its seems reasonable to claim flat or lower revenues based on domestic spending not attached to government spending. That is to say spending not tied to increasingly expensive government programs will decline based on a greater proportion of the population living on reduced retirement incomes. 

The Labor Force Participation rate is near a 40 year low
The National Academy of Social Insurance states 40% of retirees income comes from Social Security. Since social security income is only a fraction of pre-retirement income, the other 60% would have to make up the difference, which it probably doesn't on average because annuity income from pensions and retirement plans generally has to be budgeted with limited new income from sources other than capital gains and dividends refilling the coffers.
Inflationary pressures that cause the cost of living to rise at a faster rate than incomes can further erode the spending power of Americans in the forthcoming decades. For example, in 2009 and 2010 no Cost of Living Increases or COLA adjustments were issued per the Social Security Administration, yet inflation increased in both the years per the BLS meaning consumer income spending power declined.

Monday, November 14, 2011

How to interpret bond yield curves

Yield curves are the percent return on investment offered by financial instruments such as bonds. Bond yield curves are important indicators of economic activity, risk, monetary policy and market conditions. Consequently, bond yield curves are useful in financial analysis. For example,  bond rating and yield indicate the quality of the bonds, and the angle at which the yield curve slopes indicates how risky longer-term bond issues are perceived to be. 

Understanding what bond yield curves mean can help investors with assessing risk and in arriving at investment decisions such as which bonds, if any to invest in. Before delving into some of the particulars of yield curves, watching the video below allows for acclimation with the financial concept:

 

Duration


The length of time until a bond's face amount becomes due to the buyer is called the duration. Generally, with longer durations, the yield of a bond goes up because the opportunity cost and investment risk rises with time. It is for this reason that yield curves tend to curve upward, however the slope of these curves can either be low or high depending on the issuer's credit rating. For example, the U.S Treasury Bond yield curves below are from the Federal Deposit Insurance Corporation (FDIC) and show a higher yield for 30 year bonds than they do for 6 month bonds.  More up to date bond yield curves can be viewed at the U.S. Department of the Treasury.

U.S. Treasury Security Yield Curves
 Source: FDIC US-PD

Classification


The kind of bond also affects the bond yield curve. As evident in the above bond yield curve graphs, conventional bond yield curves are placed higher than the Treasury Inflation Protected Securities or TIPS. This is because investors are willing to pay in the form of lower yield for the inflation protection of security that is not offered by conventional bonds according to the Wall Street Journal. Moreover,  when the demand for TIPS is higher, then the yield will be lower. The reason the yield isn't higher regardless of demand is because the inflation protection is not incorporated into the yield, but rather the principal balance according to Treasury Direct.

Issuer


Bond yield curves also differ by bond issuer. For example, a country with a high credit rating is more likely to have lower bond yields, and a flatter bond yield curve due to the low-risk associated with those bonds. However, if an economy is performing badly, the affect on bond yields tends to be toward higher yields and more vertical curvature. This is evident in recent rises to Italian and Spanish bond yields after being downgraded by Standard and Poor's per Reuters. In other words, with lower-risk bond issues, price rises with demand, but the yield curve then moves down. 

Risk


Market risk also affects bond yields. To illustrate, consider an especially highly rated bond; these are thought to be a financial safe haven or low-risk investments for large institutional investors, sovereign wealth funds and individual investors seeking to lower investment risk via diversification into bonds. If other investments seem too volatile for investors, they may invest a larger amount into bonds because of their safety. The affect of this increased investing on the bond yield curve will be  a downward movement of the whole curve where the longer-term issues still curve up, but at lower yields due to increased demand.

Policy


Bond yield curves can also reflect monetary policy. A good example of this is the Federal Reserve Bank's bond buying programs. Quantitative easing as it is also known adds money to the financial system because the central bank purchases more bonds. This causes the Federal Reserve's assets to increase, and also puts downward pressure on the bond yield curve. Another example of this is the Federal Reserve Banks' 'Maturing Extension Program and Reinvestment Policy' or selling of short-term Treasury Securities and buying of long-term ones. This causes the yield curve to flatten at the back end and become more horizontal which subsequently demonstrates the influence of monetary policy on the bond yield curve.

Wednesday, November 9, 2011

How to use the Dupont Identity to analyze business performance

The Dupont identity is a financial analysis tool used to assess the performance of corporations. According to FCS Commercial Financial Group, an advantage of the Dupont identity is it allows more in depth assessment than a single profitability ratio. This is because the formula evaluates corporate profit in terms of assets, equity leverage and actual sales figures rather than sales forecasts. When calculating the Dupont Identity, two equations are used; one is used to evaluate return on assets, and is a sub-component of the second that ultimately determines business profitability. Before elaborating the details about Dupont Identity, the video below offers a good starting point by broadly explaining the concepts of Dupont Identity and Dupont analaysis:


Components of Dupont Identity financial analysis


The three component parts of the Dupont Identity per the FCS Commercial Financial Group include return on equity, total asset turnover and the equity multiplier. These are three financial ratios that are also individually used in financial analysis. The first of these ratios determines profit margin or the percentage earnings of total revenue. The second ratio demonstrates how well a company's assets are being used in terms of generating revenue. The equity multiplier shows how much assets a company has in terms of equity capital.

1. Profit Margin: Profit/Sales
2. Total asset turnover : Sales/Assets
3. Equity multiplier: Assets/Equity

Equation(s)

The first of the two equations determines a businesses return on assets or ROA by multiplying profit margin by total asset turnover.

1. Return on Assests= Profit margin x total asset turnover

The second equation of the Dupont identity determines return on equity (ROE) by mulitplying ROA by equity leverage.

2. “Extended” DuPont Identity= Profit margin x total asset turnover x equity multiplier

Example:

A Securities and Exchange Commission corporate filing by Walmart Stores, Inc. had a July 31, 2011 quarterly profit of $3.801 billion on sales of $109.366 billion with total assets valued at $193.656 billion and equity of $67.941 billion. With these numbers the component parts of the Dupont formula can be calculated.

1. Profit margin= profit/sales= $3.801 billion/$109.366 billion =3.475%
2. Total asset turnover= sales/assets= $109.366 billion/$193.656= 56.47% (1.77 x sales)
3. Equity multiplier= assets/equity= $193.656 billion/$67.941= 2.85
   
Since Total Asset Turnover is expressed as a multiple of sales rather than the result of division, multiplying 1x2= 6.151%. Therefore, the result of the DuPont equation is which is 6.151% x the equity multiplier of 2.85 = 17.529%

The higher the extended Dupont identity is, the better a corporation is performing. This method of calculating corporate profitability enables analysts to more accurately determine the cause(s). For example, if the total asset turnover ratio is high, but profit margin and the equity multiplier are low, then it indicates strong use of assets and capital but high operational costs. 

In the case of Walmart, a strong aspect of the businesses performance seems to be derived from its total asset turnover and high equity leveraging than profit margin. This means the company makes good use of investor capital and sells a high percentage of product, but with minimal profit on each individual sale.

Tuesday, November 1, 2011

Financial instruments and accounts that provide protection from creditors

Creditors are limited by laws that protect consumers even if those consumers are late on their bills or are sued for liability compensation. Examples of these laws are state statutes of limitations, and federal credit protection laws such as the Consumer Credit Protection Act.

Despite consumer protection from creditors, these laws do not necessarily protect individuals from liens or seizing of assets by the Internal Revenue Service (IRS) or from specific court rulings.  Having said that, several types of financial instruments and accounts protect consumers from creditors allowing an opportunity to keep retirement savings safe from difficult financial situations. Another term closely linked to creditor protection is asset protection planning. This concept, and its relevance to creditor protection is discussed below.


Financial instruments that offer creditor protection

 

Homesteads 


Homesteads are a type of property rather than a financial instrument, but they can also provide financial safety from creditors. Moreover, in some cases the homestead exemption provides asset protection for land 160 acres or less in size. Not all states allow the homestead exemption, so be sure to verify applicable laws before buying property for this purpose.

Insurance


Attorneys at Law Unrah, Turner, Burke and Frees appeal to cost effective insurance solutions to asset protection. Namely, auto, and homeowners insurance are able to protect assets from liability lawsuits for less than asset protection insurance and in terms of creditor claims, term life insurance also provides more cost effective financial security. However, it is probably a good idea to keep in mind life insurance financial protection is limited. For example, although Title 11 of the U.S. Code does protect assets from creditors, the focus is beneficiaries or dependents and not owners.

Trusts


Trusts are a type of legal entity used in estate planning and are often considered financial instruments used to protect assets. Cornell University Law School  describes Trusts as right to property via a fiduciary relationship i.e. not ownership but retention of rights of ownership. Several types of trusts exist, and an irrevocable asset protection trust combined with a limited liability corporation provides enhanced asset protection. Several kinds of Trusts can be used for protection according to the Law Office of Janet Brewer. Moreover, of those discussed are Qualified personal residence trusts, irrevocable life insurance trusts and inter-vivos qualified terminable interest property trusts.

IRAs


Individual Retirement Accounts or IRAs are another financial instrument that protect consumers from creditors. However, according to the New York Times,  in the event of bankruptcy, funds in an IRA are only protected up to one million dollars with the exception of rollovers from corporate retirement plans. The New York Times also refers to difference in state law exemption amounts for non-bankruptcy lawsuit protection. In other words, how much monetary protection provided by an IRA varies between states for creditor claims not associated with a bankruptcy filing. 

Pensions


Defined contribution plans such as 401(k)s and 403(b)s are protected by the Employee Retirement Income Security Act (ERISA). However, these types of accounts are not necessarily protected against Qualified Domestic Relations Orders (QDROs) which are judicial claims against retirement assets during events such as divorce proceedings. Moreover, according to the Wall Street Journal, a kind of 401(k) called the Solo 401(k) is not protected from creditors in every states.