Risky Business (Part 3)

What else can MF Global teach us about risk?

Investment returns are based, not on optimism, but on arithmetic. Whether it’s growth investing, value investing, or bond investing, return on investment is a matter of math. It may seem like a “dark art,” but calculating investment return is actually fairly straightforward: take the company’s expected revenues, subtract its operating costs, and you have the operating margin. Take out interest expenses, depreciation and taxes, divide by the number of shares outstanding, and you get earnings-per-share.

Now, different businesses have different characteristics: how fast they’re growing, how regulated they are, what the competition is like. These factors play into what management will do with the cash. Usually, some of that cash comes back to shareholders as a dividend, and some gets reinvested into the business.

With bonds, your upside is limited. You should have strong evidence that whoever issues the bond will have the cash necessary to pay the bond off when it matures. When MF Global bought peripheral European debt, management expected that surely the rest of Europe would not allow their partners to default. On a mark-to-market basis, though, those bond prices crashed as investors worried about the Euro.

MF Global was levered over 25 times. When your equity is that thin, a little price fluctuation can wipe you out. Investors need to acquiesce before the inexorable power of math: the greater your leverage, the less risk you can afford.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net
By | 2014-09-09T17:30:56+00:00 November 4th, 2011|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

Leave A Comment