invest Archives | Page 121 of 180

Aug

2023

What Is Book Value Per Share (BVPS)?

By Matthew Warholak | Growing Wealth, invest, Investing | Comments Off

One of the most popular and trusted forms of fundamental analysis is Book Value Per Share (BVPS), or a company’s “book value.” Book value per share is an accounting metric that calculates the per-share value of a company’s equity.

The book value per share of an undervalued stock is higher than its current market price, so book value per share can help investors appraise a stock price.

Knowing what book value per share is, how to calculate it, and how it differs from other calculations, can add yet another tool to an investor’s tool chest.

What Is Book Value Per Share?

Book Value per Share (BVPS) is the ratio of a company’s equity available to common shareholders to the number of outstanding company shares. This ratio calculates the minimum value of a company’s equity and determines a firm’s book value, or Net Asset Value (NAV), on a per-share basis. In other words, it defines the accounting value (i.e. book value) of a share of a company’s publicly-traded stock.

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Book Value Per Share vs Market Value Per Share

The Book Value Per Share provides information about how the value of a company’s stock compares to the current Market Value Per Share (MVPS), or current stock price. For example, if the BVPS is greater than the MVPS, the company’s stock market may be undervaluing a company’s stock.

The market value per share is forward-looking, since it’s based on what investors think a company should be worth, while book value per share is an accounting measure that uses historical data.

What Does Book Value Per Share Tell You?

Commonly used by stock investors and analysts, the Book Value Per Share (BVPS) metric looks at a company’s stock price to determine whether it’s undervalued compared to the stock’s current market price. An undervalued stock will have a BVPS higher than its current stock price.

If the company’s BVPS increases, investors may consider the stock more valuable, and the stock’s price may increase. On the other hand, a declining book value per share could indicate that the stock’s price may decline, and some investors might consider that a signal to sell the stock.

Book Value Per Share also theoretically reflects what shareholders would receive in a company liquidation after all its assets were sold and all of its liabilities paid. However, because assets would hypothetically sell at market value instead of historical asset values, this may not be an entirely accurate measurement.

If a company’s share prices dip below its BVPS, the company can potentially be vulnerable to a takeover by a corporate raider who could buy the company and liquidate its assets risk-free. Conversely, a negative book value indicates that a company’s liabilities exceed its assets, making its financial condition “balance sheet insolvent.”

Book Value Per Share solely includes common stockholders’ equity and does not include preferred stockholders’ equity. This is because preferred stockholders are ranked differently than common stockholders in the event the company is liquidated. If a corporate raider intends to liquidate a company’s assets, the preferred stockholders with a higher claim on assets and earnings than common shareholders are paid first and that amount gets deducted from the final shareholders’ equity distributed among common stockholders.

How to Calculate Book Value Per Share

An investor can apply BVPS to a stock by analyzing the company’s balance sheet. Specifically, an investor will need total asset value, cost of acquiring an asset, and accumulated depreciation of corporate assets which helps provide the most accurate BVPS figure.

Whereas some price models and fundamental analyses are complex, calculating book value per share is fairly straightforward. At its core, it’s subtracting a company’s preferred stock from shareholder equity and dividing that sum by the average amount of outstanding shares.

Book Value Per Share = (Shareholders’ Equity – Preferred Equity) / Total Outstanding Common Shares
Shareholders’ Equity = Total equity of all shareholders.
Total Outstanding Common Shares = Company’s stock currently held by all shareholders, including blocks held by institutional investors and restricted shares owned by preferred stockholders. This number may fluctuate wildly over time.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Example of Book Value Per Share

Company X has $10 million of shareholder’s equity, of which $1 million are preferred stocks and an average of 3 million shares outstanding. With this information, the BVPS would be calculated as follows:

BVPS = ($10,000,000 – $1,000,000) / 3,000,000
BVPS = $9,000,000 / 3,000,000
BVPS = $3.00

How to Increase Book Value Per Share

A company can increase its book value per share in two ways.

Repurchase Common Stocks

A common way of increasing BVPS is for companies to buy back common stocks from shareholders. This reduces the stock’s outstanding shares and decreases the amount by which the total stockholders’ equity is divided. For example, in the above example, Company X could repurchase 500,000 shares to reduce its outstanding shares from 3,000,000 to 2,500,000.

The above scenario would be revised as follows:

BVPS = ($10,000,000 – $1,000,000) / 2,500,000
BVPS = $9,000,000 / 2,000,000
BVPS = $4.50

By repurchasing 1,000,000 common shares from the company’s shareholders, the BVPS increased from $3.00 to $4.50.

Increase Assets and Reduce Liabilities

Rather than buying more of its own stock, a company can use profits to accumulate additional assets or reduce its current liabilities. For example, a company can use profits to either purchase more company assets, pay off debts, or both. These methods would increase the common equity available to shareholders, and hence, raise the BVPS.

The Takeaway

There are many methods that investors can use to evaluate the value of a company. By leveraging useful and insightful formulas such as a company’s Book Value Per Share, investors can determine a company’s value relative to its current market price. While it has limitations, the BVPS can identify companies that are undervalued (or overvalued) according to core fundamental principles, and it’s a relatively straightforward calculation that even beginner investors can use.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

Aug

2023

What Is Gross Spread?

By Samuel Becker | Growing Wealth, invest, Investing | Comments Off

The term “gross spread” refers to an important element of the initial public offering (IPO) process: Gross spread is the money underwriters earn for their role in taking a company public.

When a company IPOs, or “goes public,” it releases its shares onto a public stock exchange, an undertaking that demands a tremendous amount of work behind the scenes. That work involves bankers, analysts, underwriters, and numerous others. All of that work must be compensated, which is where the gross spread — also called the underwriting spread — comes into play.

How Gross Spread Works

The gross spread refers to the cut of the money that is paid to the underwriters for their role in taking a company public. In effect, it’s sort of like a commission paid to the IPO underwriting team. But the underwriting spread isn’t a flat fee, but a spread in the sense that it represents a share price differential.

Underwriters

Underwriters are common players in many facets of the financial industry. It’s common to find underwriters working on mortgages, as well as insurance policies.

When it comes to IPOs, underwriters or underwriting firms work with a private company to take them public, acting as risk-assessors, effectively, in exchange for the underwriters spread. Their job is to evaluate risk and charge a price for doing so.

Recommended: What Is the IPO Process?

The Role of Underwriters in the IPO Process

These IPO underwriters generally work for an investment bank and shepherd the company through the IPO process, ensuring that the company covers all of its regulatory bases.

The underwriters also reach out to a swath of investors to gauge interest in a company’s forthcoming IPO, and use the feedback they receive to set an IPO price — this is a key part of the process of determining the valuation of an IPO.

In order to generate compensation for all this work, the underwriters typically buy an entire IPO issue and resell the shares, keeping the profits for themselves. So, the underwriters set the IPO price, buy the shares, and — assuming the shares increase in value once they become publicly available — the underwriters generate a profit from reselling them, the same way you would selling the shares of an ordinary stock that had risen in value.

For companies that are going public, the benefit is that they’re essentially guaranteed to raise money from the IPO by selling the shares to the underwriters. The underwriters then sell the shares to buyers they have lined up at a higher price in order to turn a profit. That difference in price (and profit) is the gross spread.

For the mathematically minded, the gross spread — basically the IPO underwriting fee — would be equal to the sale price of the shares sold by the underwriter, minus the price of the shares it paid for the shares.

💡Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

Gross Spread & Underwriting Costs

The gross spread, for most IPOs, can range between 2% and 8% of the IPO’s offering price — it depends on the specifics of the IPO. There can be many variables that ultimately dictate what the gross spread ends up being.

The gross spread also comprises a few different components, which are divided up by members of the underwriter group or firm: The management fee, underwriting fee, and concession. The underwriters typically split the gross spread, overall, as such: 20% for the management fee, 20% for the underwriting fee, and 60% for the concession. More on each below:

Management fee

The management fee, or manager’s fee, is the amount paid to the leader or manager of the investment bank providing underwriting services. This fee essentially amounts to a commission for managing and facilitating the entire process. It’s also sometimes called a “structuring fee.”

Underwriting fee

The IPO underwriting fee is similar to the management fee in that it is collected by and paid to the underwriters for performing their services. Again, this is more or less a commission that is taken as a percentage of the overall gross spread and divided up by the underwriting teams.

Concession

The concession, or selling concession, is generally the compensation underwriters get for managing the IPO process for a company. So, in this sense, the concession is a part of the gross spread during the IPO process and is, effectively, the profits earned by selling shares when the process is complete. It’s divided up between the underwriters proportionately depending on the number of shares the underwriter sells.

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Examples of Gross Spread

Here’s an example of how gross spread may look in the real world:

Company X is planning to IPO, and its shares are valued at $30 each. The underwriters working with Company X on its IPO purchase the full slate of shares prior to the IPO, and then go off and sell the shares at $32 each to investors and the general public.

In this case, the gross spread would be equal to the difference between what the underwriters paid Company X for the shares, and what they then sold the shares for to the public — $32 – $30 = $2.

Or, to express it as a ratio, the gross spread is 6.7%. More on the ratio calculation below.

Gross Spread Ratio

As mentioned, the gross spread can be expressed or calculated as a ratio. Using the figures above, we’d be looking to figure out what percentage $2 is (the gross spread) of $30 (the share price sold to the underwriters).

So, to calculate the ratio, you’d simply divide the gross spread by the share price — $2 divided by $30. The calculation would look like this:

$2 ÷ $30 = 0.0666

The figure we get is approximately 6.7%. Also note that the higher the ratio, the more money the underwriters (or investment bank serving as the underwriter) receives at the end of the process.

IPO Investing With SoFi

Though the gross spread, or underwriters spread, is not a well-known aspect of the IPO process, it’s relatively straightforward. Underwriters, who shepherd a company through the IPO process, ultimately buy the initial shares from the company at one price, and sell them to the public at the IPO at a higher price. The spread between the two is considered the gross spread, or the compensation the underwriting team earns for all their work.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What is meant by the underwriting spread?

The underwriting spread is another term for the gross spread. Underwriters pay issuers, or an issuing company, for a company’s shares prior to the IPO. The underwriting firm then turns around and sells shares to investors. The difference (expressed as a dollar amount) that the underwriter pays the issuer and that it receives back from selling the shares during an IPO is the underwriting spread.

What are gross proceeds in an IPO?

Gross proceeds, in relation to an IPO, refers to the total aggregate amount of money raised during the public offering. This is all of the money raised by investors during the IPO.

What is a typical underwriting spread?

As underwriting spreads are usually expressed as dollar amounts, the typical underwriting spread can vary depending on several variables in the IPO process — including share price, share volume, etc. But in general, it can amount to between 3.5% and 7% of gross proceeds during an IPO.

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SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Aug

2023

What Are Non-Transparent ETFs?

By Matthew Zeitlin | Growing Wealth, invest, Investing, Terminology | Comments Off

Unlike ordinary exchange-traded funds (ETFs), which disclose their underlying assets daily, non-transparent ETFs are only required to reveal their holdings on a quarterly or monthly cadence. This ability to conceal their assets can help active non-transparent ETF managers to cloak their strategies for longer periods, with the aim of maximizing performance.

To understand some of the advantages these funds may offer investors, it helps to compare them with standard ETFs.

Why Would You Invest in Non-Transparent ETFs?

For nearly 30 years, exchange-traded funds (ETFs) have been a mainstay for big institutional investors as well as individuals, thanks to their transparency, tax efficiency, and low cost. Today, the ETF industry in the U.S. has billions, if not trillions, under management.

Traditionally, investors have found ETFs an attractive option because of their liquidity, which has made ETFs more transparent than mutual funds. Unlike mutual funds, you can trade ETF shares throughout the day on an exchange, similar to stocks. And the way shares are created and redeemed gives investors more visibility into the funds’ underlying assets, compared with mutual funds. This ‘transparency’ has been true of both actively managed ETFs as well as passive ETFs, which track an index such as the S&P 500.

But the fundamental transparency of the ETF “wrapper” or fund structure has been a thorn in the side of some active ETF managers, who may prefer less visibility around their holdings for strategic reasons. Hence the appeal of non-transparent ETFs to active managers.

Active non-transparent ETFs — also called ANT ETFs — aren’t required to reveal their assets daily, as noted above; rather they report a snapshot of what they hold on a monthly or quarterly basis, similar to a mutual fund. In some cases they report the assets they hold, but not how much they hold.

Recommended: ETFs vs. Index Funds: What’s the Difference?

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

How Passive vs. Active Strategies Can Impact Transparency

If you think about it, the evolution of active non-transparent ETFs makes sense in the larger context of the ETF universe, where passively managed ETFs comprise more than 90% of that market.

Passively managed ETFs offer some of the lowest ETF fees in today’s market, which is one reason they’re typically cheaper to own than mutual funds. The overall tax efficiency of index ETFs also helps to lower investing costs, and has contributed to their overall popularity with investors.

ETFs, of course, are also valued for their role in adding diversification to investors’ portfolios, with many ETFs invested in specific sectors (e.g. electric vehicles, pharmaceuticals) or securities (e.g. U.S. Treasuries, corporate bonds).

No matter whether an ETF is invested in a broader equity market or a niche sector, passive ETFs are designed to mirror or track the stocks in a certain index. Thus the transparency of these funds is part of how they work.

That’s not true of active ETFs, which rely on the oversight of a fund manager to choose the underlying assets (just like an active mutual fund). But because ordinary ETFs require a daily disclosure of the fund’s holdings, this can hamper an active manager’s ability to execute their investment strategies.

When a fund’s assets are disclosed on a daily basis, the market can bid up the price for their holdings. And while in the short term this might be good (the assets could go up), in the long term it could disrupt the fund manager’s strategies. And, if other investors try to anticipate the trades that active managers might make, sometimes called front running, that could cause asset prices to fluctuate and potentially impact the ETF’s performance.

The Use of Proxies in Non-Transparent ETFs

How might a non-transparent ETF solve this problem?

The way ETFs keep their price in line with their assets is that the sponsor of the ETF trades throughout the day with an “authorized participant.” These authorized participants will create and redeem “baskets” of securities, i.e. the stocks or bonds that the ETF holds, and then trade them to the ETF for shares of the fund, which allows the ETF to stay in line with the price of its underlying stocks.

This process obviously requires a great degree of transparency across the board. So, how does a non-transparent ETF obscure its holdings? The answer is, by the use of “proxies”: These are baskets of stock that are similar to but not identical to the underlying holdings of the ETF.

Thus, non-transparent ETFs are able to occupy a happy middle ground in the ETF world: they enable fund managers to conceal their strategies while keeping the liquidity of pricing that is core to trading ETFs overall.

The History of Non-Transparent ETFs

For years, the ETF industry was composed mostly of index ETFs, which helps to explain why the universe of ETFs is primarily passive. But over time, some investment companies began seeking regulatory approval for non-transparent ETFs, also sometimes called semi-transparent ETFs, in order to pursue more active strategies. The approval for these funds, and the technology underlying the non-transparent strategy, began rolling out in late 2019, and ANT ETFs have seen steady inflows since then.

Though non-transparent ETFs are still a relatively small part of the overall ETF market, this sector is gaining traction and is now approaching $2 billion AUM. This reflects a similar trend among active ETFs, which have also seen more inflows this year.

💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.

The Takeaway

Non-transparent ETFs may be a relative newcomer in the multi-trillion-dollar world of ETFs, but they offer an attractive new opportunity for investors who are interested in active investment styles — but still want the cost efficiency and liquidity of an ETF. Non-transparent ETFs also give active fund managers the ability to cloak their strategies, which may aid potential outcomes.

As with all ETFs, they may have a place in an investor’s portfolio. But it’s generally best that investors do some research or consult with a financial professional before investing.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

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SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

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Aug

2023

Investing in Growth Funds

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

A growth fund or growth stock mutual fund is invested primarily in growth stocks and focused on capital appreciation, or in other words: profit.

Just as growth investing is a certain investing style, a growth fund is a specific type of mutual fund or exchange-traded fund (ETF) that reflects this more aggressive investment style. Growth funds primarily include shares of growth stocks, but can also include bonds or other investments designed specifically with higher returns in mind.

Unlike some value stock funds, growth funds rarely pay dividends. Instead, investors make money on the appreciation of the underlying stocks. Since growth mutual funds are considered riskier investments — with a higher risk of loss along with a higher potential for gains — holding these funds for the longer term may help mitigate the short-term impact of price volatility.

Before you decide whether growth funds would suit your strategy, it may help to learn more about how they work, as well as some of the pros and cons of these funds.

What Is Growth Investing?

Growth investing is a strategy that focuses on increasing an investor’s capital or earnings. For this reason, growth investors may invest in younger or smaller companies which are said to be in a growth phase, and whose earnings are expected to increase at an above-average rate compared to their industry sector or the overall market.

Growth stocks aren’t always new companies, though. Larger, more established companies can also fall into this category, assuming they are poised for expansion. Big companies could be in a growth phase due any number of factors, e.g., technological advances, a shift in strategy, a movement into new markets, acquisitions, and so on.

How much growth can you expect to get from good growth stock mutual funds? As with any mutual fund, the performance of these funds depends on their underlying assets and, in the case of actively managed funds, their portfolio managers’ strategies.

There are also growth index funds, which are passively managed. A growth index fund is a growth stock mutual fund that tracks the performance of a particular stock index that’s focused on growth (e.g., the CRSP Large Growth Index or CRSP Small Cap Growth Index).

To give you an example of how growth funds compare to the domestic equity market as a whole, the U.S. stock market had an average return of 14.83% from 2012 to 2021, according to the most recent data. For context, here is the performance of five growth mutual funds and ETFs over the last 10 years.

Fund Name	Total Net Assets	10-year avg. annual return
Growth Fund of America (AGTHX) from American Funds, as of 7/21/23	$231.7 billion	12.23%
iShares Core S&P U.S. Growth ETF (IUSG) , as of 7/21/23	$13.91 billion	14.05%
Vanguard Mega Cap Growth ETF (MGK) , as of 7/21/23	$13.99 billion	15.29%
SPDR Portfolio S&P 500 Growth ETF (SPYG) , as of 7/21/23	$17.7 billion	14.39%
Vanguard Small-Cap Growth Index Fund (VSGAX) , as of 7/21/23	$30.5 billion	11.95%

Remember that growth investing can be volatile since companies typically take some risks in order to expand. Also, some growth companies can get a lot of media or investor attention, which can contribute to price swings as investors buy and sell shares with the hope of seeing a profit.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

Examples of Growth Stocks

Market capitalization — which indicates the number of outstanding shares a company has multiplied by its price per share — is not a specific hallmark or characteristic of growth stocks. Growth stocks can be large-cap corporations, mid-cap, or smaller companies. That said, most growth funds generally tilt toward larger companies.

Large-cap companies can scale their manufacturing to produce more products at cheaper prices, which increases their potential. Plus, big companies tend to reinvest the money they make into research and development, acquisitions, or expansion.

Information technology companies are often the largest holdings in U.S. growth mutual funds, but these funds may also hold healthcare and consumer discretionary stocks as well.

Smaller companies also have a lot of growth potential, as noted above — and some small-cap companies may be in the initial startup phase, which can sometimes generate outsize growth. And many mid-cap companies have been around longer and may have the ability to adapt to new market needs.

Benefits of Investing in Growth Mutual Funds

There are a few good reasons to consider growth stock mutual funds, and portfolio diversification is at the top of the list. It would be expensive for most individual investors to achieve the level of diversification offered by a pooled investment like a growth mutual fund. Investing in a single fund gives investors exposure to a wide range of stocks in different sectors.

Growth funds may also have long-term potential. For instance, growth stocks are more likely to see returns during an economic boom cycle, when many companies are growing and thriving.

While investors may not be able to count on dividend income from a growth mutual fund, they may still be able to sell the fund for more than what they paid for it. Whether that’s attractive to you can depend on your overall investment objectives, time horizon and risk tolerance.

Downside of Growth Mutual Funds

Like any other investment, there are potential drawbacks to keep in mind with growth stocks and their growth fund counterparts.

While growth stocks can potentially increase in value more quickly than other stocks, this also makes them a potentially risky and more volatile investment. A good growth stock mutual fund might return 18% one year and 6% the next. That kind of volatility isn’t for everyone.

In order for a growth stock to keep growing, the company must continue to earn money. This is challenging for any company to maintain over a long period of time. If there’s a recession, if a company has an unforeseen loss, or can’t continue to grow, the value of the stock will go down.

To manage this risk, investors may choose to hold growth stocks and growth mutual funds for the five to 10 years, so that they can ride out market fluctuations and potentially be more likely to make a profit.

It’s also important to keep in mind that some growth stocks could become overvalued by the market, which might impact a growth fund’s performance. In this scenario, an investor might buy shares in a growth fund, hoping for solid returns. But if one or more of the underlying companies in those funds ends up being overvalued, the stock’s performance might fall below investor expectations.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Evaluating a Company’s Potential for Growth

Assessing a company’s potential for growth, either in the near or long term, is not an exact science. But it’s important to consider how likely a company is to grow when determining whether it’s a good fit for a growth portfolio. This typically involves looking at several key metrics, including:

• Return on Equity (ROE). Return on equity is used to measure company performance. It’s calculated by dividing net income by shareholder equity over a set time period.

• Earnings Per Share (EPS). Earnings per share represents a company’s total profit divided by its total number of outstanding shares. EPS is used to measure a company’s profitability.

• Price to Earnings to Growth (PEG). The price to earnings to growth ratio represents the price to earnings (P/E) ratio of a stock divided by the growth rate of its earnings over a set time period. Growth funds tend to have a higher P/E ratio (price to earnings ratio), which is the cost of a company’s stock relative to its earnings-per-share (EPS) than other funds. This can make them more expensive, but their potential for growth might make the extra cost worth it.

When using these and other metrics to measure a company’s growth potential, it’s important to understand how to interpret them. For example, a company that has a higher earnings per share is generally viewed as being more profitable. Likewise, a high price to earnings ratio is considered to be an indicator of continued growth.

But investors should also consider how sustainable the outlook for profitability and growth truly is, given the context of a company’s revenue, debt, and cash flows.

Buying Growth Mutual Funds

When choosing which growth stocks or growth funds to invest in, there are several factors investors may choose to consider. These include:

• Historical performance

• Stocks and other securities held in the fund

• Cost and potential earnings

Growth funds can often — but not always — be identified by the word growth in their name. Some investors might choose to put their money in blended funds, which combine growth stocks with less risky holdings. These funds allow investors to benefit from some of the upsides of growth funds without quite as much risk.

Certain growth funds are exchange-traded funds, or ETFs. Like any ETF, these funds can be traded during the day like stocks.

It’s important for investors to understand the risks before investing in any stock or fund, and to build a diversified portfolio of assets in order to mitigate risk. With a diversified portfolio, investors hold both riskier assets and safer assets, in an effort to reap the benefits of growth without losing too much along the way. It’s also vital to remember that past performance is not a guaranteed indicator of how well a stock or growth fund will perform in the future.

Investing for Growth or Value?

Growth investing and value investing are couched as different styles of investing, yet they share a similar profit-driven focus — just a different means of getting there. With growth investing, the overarching goal is to invest in companies that have solid potential for growth. With value investing, the goal instead is to find companies that have been undervalued by the market — and hopefully see them increase in value.

A value investor may seek out companies that they believe are bargains based on current market price. They then invest in these companies, either by purchasing individual shares or through value mutual funds, and hold onto those investments over time. The end goal is to eventually sell their shares for a profit down the line.

In addition to eventual capital appreciation, value stocks can also pay dividends to investors. Value stocks are typically more likely to be established companies rather than newer ones. The most important thing to know with value investing vs. growth investing is how to avoid a value trap. This is a company that appears to be undervalued, but actually has a correct valuation. The trap comes into play when an investor buys in, expecting the stock’s price to rise over time, only to be disappointed by a price that stays the same or worse, declines.

Determining When to Invest in Growth Mutual Funds

Dollar cost averaging is a way to invest small amounts of money consistently over time, rather than attempting to time the market, which helps investors to limit their risk exposure. However, if there is a stock market correction, it can be a good time to pick up some extra assets while they’re at particularly low prices.

Growth stocks tend to do well during bull markets, so while they may not see significant gains during a recession, they can still be an option to consider for long-term investments to pick up before the next economic boom.

The Takeaway

Growth stocks have a primary goal of capital appreciation. These stocks are expected to grow more quickly than other stocks in the market, and because of this, growth mutual funds are considered riskier investments than other mutual funds with a high risk of loss along with a higher potential for gain.

Growth funds holdings tend to have a higher P/E ratio (price to earnings ratio), which can make them more expensive investments, but their quick growth may make the extra cost worth it.

These types of funds are more likely to see returns during an economic boom cycle, vs a recession. During a recession or economic downturn, companies may not have the cash or earnings to be able to invest in growth, and the value of the stocks the fund could go down.

Investors who know the basics of growth mutual funds may be interested in adding some of these assets, or other types of mutual funds and ETFs, to their investment portfolio.

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Aug

2023

A Brief Overview of the Sarbanes-Oxley Act (SOX)

By Ashley Kilroy | Financial Independence, Growing Wealth, invest, Investing | Comments Off

In the wake of several corporate scandals in the early 2000s, the Sarbanes-Oxley Act was passed in 2002 in order to protect investors, shareholders, and employees from companies misrepresenting their financial records or otherwise engaging in deceitful practices.

Read on to better understand the provisions in the Sarbanes-Oxley Act (SOX) and how the protections that it provides to investors.

What Is the Sarbanes-Oxley Act?

To safeguard investors from corporate fraud, Congress passed the Sarbanes-Oxley Act (SOA) of 2002 . The act aimed to improve corporate financial records, making them more robust, reliable, and precise.

When the law passed, then-President George W. Bush said it was “the most-reaching reforms of American business practices since the time of Franklin Delano Roosevelt.”

Names for Congressional sponsors Sen. Paul Sarbanes and Rep. Michael Oxley, the Sarbanes-Oxley Act came in response to a rash of corporate scandals in the early 2000s, including those involving Enron Corporation, WorldCom, Global Crossing, Tyco International, and Adelphia Communications.

In addition to tightening up corporate responsibility and financial reporting regulations, the Sarbanes-Oxley Act formed the Public Company Accounting Oversight Board (PCAOB), which oversees auditing standards and ensures that companies comply with the new law.

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What Prompted the Passage of the Sarbanes-Oxley Act?

In the 2000s, companies such as Enron Corporation, WorldCom, and Global Crossing among several firms caught up in accounting and financial reporting scandals. As investor confidence fell in the wake of the scandal, Congress passed the Sarbanes-Oxley regulations to prevent further fraudulent financial reporting, minimize future scandals, and protect investors.

What’s Included in the Sarbanes-Oxley (SOX) Act?

Although the SOX Act is extensive, there are a few crucial components, including:

Section 302

This section requires senior corporate officers, such as the CEO and CFO, of public companies to file reports with the Security and Exchange Commission (SEC). All companies publicly traded in the U.S. must create a system for their financial reports.

This system should include a traceable, verifiable pathway for the reports’ source data. None of this source data can be tampered with in any way. Additionally, the method and technology which retrieves that data must be reported on as well. If it’s changed, the company has to document the particulars of that change.

Section 404

This section directs the company to disclose the internal protocols in place for financial reporting to the public. The company must discuss shortcomings and efficacy in these evaluations.

Sections 802 and 906

Both sections impose penalties for mishandling documents. That means companies need to have a financial reporting system with preserved, traceable data and clear documentation on how it’s handled.

Section 802 pertains to altering or destroying documents with the intent to affect a legal investigation, which can lead to a prison sentence of up to 20 years. It also enforces proper auditing maintenance requirements. Section 906 forbids certifying misleading or fraudulent reports, which can incur fines up to $5 million and upwards of 20 years imprisonment.

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The Sarbanes-Oxley Act: Penalties

A non-compliant company and its executives could face severe penalties for violating the Sarbanes-Oxley Act. As mentioned in Sections 802 and 906, there are legal ramifications, including fines and prison sentences. For example, 802 imposes a penalty on any individual who knowingly does not preserve financial and audit records. This failure can result in up to 10 years in prison; however, other violations can lead to millions of dollars in fines and up to 20 years imprisonment.

Earlier Legislation

Before the Sarbanes-Oxley Act was in place, there were other laws governing the securities industry, most of which had been put in place during or after the financial crisis that led to the Great Depression.

The Securities Act (1933)

This law required more transparency around securities sold on public exchanges, and banned insider trading.

The Glass-Steagall Act (1933)

Also known as The Banking Act, this legislation forced banks to split up their investment banking and commercial banking operations. It also established the Federal Deposit Insurance Corp.

The Securities Exchange Act (1934)

This act created the SEC, which regulates the securities industry and holds disciplinary powers over publicly traded companies that violate the law, along with associated individuals.

The Trust Indenture Act (1934)

This act created formal agreement standards that bond issuers must uphold in every sale to the public.

The Investment Company Act Act (1934)

This act requires that companies that invest and trade securities must regularly disclose their financial condition and investment policies to investors.

The Investment Advisers Act (1940)

This act requires that investment advisers must register with the SEC and adhere with its regulations.

The Securities Acts Amendments (1975)

These amendments prohibited brokers from self-dealing, aimed to minimize conflicts of interest, and required additional disclosures by institutional investors.

The Takeaway

Regulators have many tools they can use to discourage financial institutions and advisers from unethical activities, and to penalize those who fail to comply with the rules. That said, it’s important for all investors to do their due diligence and research any company with which they want to invest or adviser with whom they want to work.

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Photo credit: iStock/vadimguzhva

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A Brief Overview of the Sarbanes-Oxley Act (SOX)

What Is the Sarbanes-Oxley Act?

What Prompted the Passage of the Sarbanes-Oxley Act?

What’s Included in the Sarbanes-Oxley (SOX) Act?

Section 302

Section 404

Sections 802 and 906

The Sarbanes-Oxley Act: Penalties

Earlier Legislation

The Securities Act (1933)

The Glass-Steagall Act (1933)

The Securities Exchange Act (1934)

The Trust Indenture Act (1934)

The Investment Company Act Act (1934)

The Investment Advisers Act (1940)

The Securities Acts Amendments (1975)

The Takeaway

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