Free «Corporate Finance » Essay Paper
Investment decisions are very complex and they have to be undertaken with very much consideration. This is because, it calls for a massive of cash to used. There must be formulated proper methods to determine in which portfolio is the viable investment option exists. The method of determination adopted by the individuals and the companies are the ones that will give perfect results. This paper defines and discusses some of the option methods that may be used to determine the best investment option among the existing ones. The paper provides guidance on the interpretation of the investment ratios (Chorafas, 2006).
A dividend yield- this is calculated by dividing the annual dividends per the share number of the shares of the company with the price per share. Defined as that ratio which shows by which extent the companies pays the dividends entitled by the shareholders in each year. This criterion shows how much money one is getting in every shilling invested in the shares of a company. Many investors opt to invest their cash in the companies with high dividends yield in their shares.
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Price earning ratio- one can get the markets hoard valuations of companies and the actual generate income by this companies by comparing the earnings per share and prices of different companies using this ratio. It is then defined as, the tool for calculation of equity value of an entity calculated by dividing the value market price per share of the company, by the yearly gains per the shares (Berk, 2007 ).
The other indicator of company’s valuation is the dividend cover, which is the rate of the company’s net income compared to the dues paid to the shareholders in form of dividends. The ratio is calculated by dividing the earnings per share with the amount of dividend entitled to that share. This rate shows how much the earnings cover out the dividends paid out (Chorafas, 2006). The rate that is higher than 2 is considered to be safe while any rate that is below 1.5 is presumed to be risky.
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Market capitalization may also be considered as the total value of the company that is issued to the public. The amount of capitalization rate is derived by multiplying the number of the issued shares by the price per every share. This criterion may assist the owners of the businesses and the potential investors to determine the value of the company in which they are operating or about to invest their money in. high values of this feature shows the high net worth of the company and very suitable for investors. The high amount of market capitalization does necessarily mean that the company is the best. It may turn out that the company has high value but reward too little in cases of dividends. The investors must therefore consider using other indicators like P/E, dividend yield, dividend cover etc in making their conclusions.
Diversification of portfolio is the way that investors opt to invest capital in a number of investments in order to minimize their risks. Averagely, many investment portfolios give back massive income compared to one source, since others may be high while others are low. In the jims advisory case, an investor may base an argument basing with the price earning per share of one company and the other. Instead of investing in the one with the higher, he/she may invest in both of them and get average returns where the one with the high boosts the one with low. Hence, the investor minimizes the risk of loosing much in investments. This fractuations in the gains of operations of the company is the one referred to as unsystematic risk.
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The type of information provided by the price earnings ratio, the dividend cover and the dividends yield assists Jim in determining what portfolios to invest in. in the case of the price-earning ratio, he has to calculate the P/E of the options companies he has and considering to invest in. by calculating this, he is able to see the ones with the highest ratios. The ones with these high ratios are the ones that are the viable ones to invest in. in coming up with the conclusion after getting the better options he is to check for the risk of the portfolios and make decisions on whether to invest in one, or to diversify his investments. For the dividend yield, he has to check closely the amount of dividends issued by the companies he in intends to invest in, this will be done by looking at the price each shareholder is paid in return of his/her investments. Doing these for every company and comparing them makes him to predict the amount of yields he will be deriving from the investments. The high yielding company’s portfolios should be the ones given higher priority. Again predicting on the cash flows it is upon him to decide whether to invest in numerous companies or not. As per the dividend, cover issue, Jim has to look carefully to the incomes of the different companies of his choice and compare them with those of the other companies. After deriving these incomes with the other companies, invest in ones with the highest.
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The market capitalization is relevant in the portfolio investment decision since no one will admit to invest in an institution with low amount of holding. Hence, Jim as rational investor and who wants the best returns ever, must invest in the company or companies with a relative higher capital in order to be guaranteed of existence.
The goodness and badness of a particular portfolio is the one that drives potential investors in it. Despite the four named methods of determining the viable portfolio, the investor can use other methods like the earning per share in determining the best one to invest in. In addition, the kinds of risk carried by the portfolios determine to a greater degree the investments to be done. Portfolios with high risks are omitted.
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Risk averse is the criterion where investors opt to put their investments in a low returning interest that is certain rather than investing in the high interest portfolio where there is uncertainty. Risk seeking is the act where the investors check on the areas with high returns and not considering the risks in them. They do not fear risks (Berk, 2007).
In the way Jim chooses hi portfolios, he is a risk-seeking individual. He is for the idea of investing in the high returns investments without considering the risks carried by them. Being this way calls for him to diversify in the investments and in order to cover for the risks that may accrue.
Jim may consider selling the portfolios that have low returns and the ones that seems to decrease in value in the future time. This may be known by the income cash flows of the companies. On the other hand, he may have the option of holding the shares of the companies with increased incomes and their dividend covers seems to be promising. With checking on the price earning per share the ones with the highest are the ones to be held.