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| Key
Economic and Financial Terms |
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| Economic
Terms |
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GDP
or Gross Domestic Product is a country’s overall output
(of goods and services). the figures most closely watched are
the change in GDP, compared with a previous period in real terms
(ie taking inflation into account). Since measuring service
output (ie work done by ad agencies, consultancies, accountants
etc) is so difficult, overall economic output figures normally
come out for a quarter of a year at a time. they are, however,
constantly revised.
People looking for more up-to-date information often turn to
figures for manufacturing and industrial output, which DO come
out monthly. Unfortunately, these figures are also always later
revised heavily, and they are far from the full picture as the
major economies now earn a vast part of their income from services.
Some countries give more prominence to figures for Gross National
Product or GNP. GNP takes into account international flows to
and from a country’s citizens and companies. If the flow of
interest payments and dividends coming into a country is bigger
than the flow of profits taken out of the country by foreign
owned companies, then GNP will be bigger than GDP.
Net National Income (the same as Net National Product), takes
off an estimate for capital consumption or depreciation as machinery
naturally falls apart over time.
For United States GNP/GDP statistics we need to be particularly
careful. the Americans like to make things seem dramatic! A
quarterly rise of 1.4 per cent would be reported as just that
in the UK, but in the US this is compounded to an annual rate
so they’d talk about growth of 5.7 per cent, calculated like
this:
100* { [(1.014)*(1.014)*(1.014)*(1.014)] - 1} = 5.7 per cent
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Inflation
the rate of increase of prices.
Remember above all "prices" and "inflation" are not synonyms.
Prices (over a month) can rise while inflation (normally looked
at over a year) falls.
Price indices may be seasonally adjusted or unadjusted.
In the United States, consumer prices are seasonally adjusted....it
therefore makes more sense to look simply at monthly changes.
But in the UK, the retail price index is unadjusted, hence we
normally report the year-on-year change.
eg for a complete explanation: "Official figures in Britain
show a sharp drop in the annual rate of inflation. Prices rose
by 3.2 per cent in the year to December, after an increase in
prices of 3.8 per cent in the 12 months to November."
or rather more quickly: "Britain's annual inflation rate has
fallen from 3.8 to 3.2 per cent." (NB prices may still have
RISEN from November to December, although by less than they
went up between November and December last year) |
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Trade
Balance
Trade figures are often reported in daily newspapers in
a very confusing way. Many take “Trade Balance” to mean simply
the trade in physical goods crossing national boundaries. But
this is only part of the picture.
the full picture is the “Current Account” trade balance, which
takes into account “invisibles” as well as the “visible” trade
in physical goods. Invisibles - as the name suggests - incorporate
flows of money into and out of a country, where nothing physical
flows the other way. the invisible balance will be positive
if dividends and other earnings coming into a country (eg from
foreign tourists) outweigh similar flows going the other way.
To summarise,
Visible trade + Invisible trade (tourism+other services) = Current
Account balance
This total is still not the whole picture though. the current
account deals in flows of cash (ie dividends/interest).....the
capital account (which is very difficult to measure and therefore
normally reported with little prominence) is about holdings
of assets.
Current Account + Capital Account + balancing item = 0
This equation describes the Balance of Payments. (the balancing
item is just the residual error, reflecting the difficulty in
collecting accurate data.)
the Balance of Payments ALWAYS balances. It is therefore incorrect
to say that the Balance of Payments has gone up or down (or
is in surplus or deficit). However, if a big deficit in the
current account balance is only being matched by a capital account
surplus thanks to emergency lending from the International Monetary
Fund, a running down of government reserves, or by attracting
“hot money” into a country’s financial assets (using high interest
rates), then it would be fair to say that a country has a “Balance
of Payments problem”. |
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| Financial
Terms |
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Dividend
Yield This is the percentage annual return
you would get from investing in a particular share now.
Tables in newspapers normally show the “historic” dividend yield,
taking the past year’s total dividend payments per share divided
by the current share price. This is because only the historic
dividend payments are actually known. Investors, though, often
estimate the coming year's dividends, and so talk about the
“prospective” dividend yield.
Over time, even if a company is only doing moderately well,
you would expect the cash dividend payout to increase (if only
thanks to inflation). the capital value of the shares should
also go up over time, reflecting the rising dividend payment,
so the ratio of the two (the dividend yield) might - in theory
- be constant over the course of time.
In practice, the dividend yield will vary. Currently (March
1998), dividend yields in Britain are at the lowest since the
First World War.
the average dividend yield for the London market was 2.77 on
26th March - even lower than the trough of 2.85 reached before
share price crashes in 1972 and 1987. In the 1970s, the yield
averaged six per cent.
Some argue that the current low yields are unsustainable, and
therefore share prices will crash. Others say that shares are
still attractive despite the apparently low dividend yield,
because there are big hidden returns.
Governments have recently tried to encourage companies to “invest
more” by taxing company dividends relatively harshly. Companies
have tended to respond - not by retaining more of their earnings
to invest - but instead by paying out their money to shareholders
in more sophisticated ways.
One way of effectively paying money back to shareholders is
for a company to buy back some of its own shares. This means
the total number of shares in circulation will fall, so increasing
the possible pay out to each of the remaining shareholders.
the bankers Credit Suisse expect £15 billion of share buybacks
in the UK in 1998, about half the total dividend payout. Most
analysts therefore now view the dividend yield as a pretty hopeless
way of assessing how highly shares are valued historically.
Instead they look at the “earnings yield” (see below). |
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| Ex-dividend
A share price ex-dividend indicates that any
buyer won’t receive the latest dividend. the dividend will have
been paid - but to the share’s previous owner. Ex-dividend prices
will therefore tend to be lower than the price the share commanded
just before a dividend is due. |
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| H-Shares
the Hong Kong listings of Chinese state enterprises.
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Profits
can be expressed in many different ways. Very broadly company
accounts will show,
Total value of sales (or turnover)
minus Costs incurred (including pay and rent)
equals Operating Profit
minus Interest payable on company debts
equals Pre-tax profits
minusTax
equals After-tax profits
divided by number of shares in issue
equals (Net) earnings per share. |
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Price/Earnings
ratio or P/E ratio measures the share price
divided by the net earnings (or profit after tax) per share.
By definition that’s the same thing as a company’s capitalisation
divided by its net profits. When the number gets very high,
this indicates that investors are taking an optimistic view
of a company’s prospects.
As with the dividend yield, the only concrete figures that can
be worked out involve dividing the current market capitalisation
by last year’s recorded profits. This is an “historic” P/E.
On the other hand, many analysts use their future earnings forecasts
to generate “prospective” P/E ratios.
the P/E number can vary a lot over time and between companies.
For example on March 26th on the London stock market, the Shell
Oil company was trading on a P/E of 24. British Airways is on
a P/E of 31. However, the unfashionable engineering group, BTR,
is on a P/E of only 11.
Just as some think that the low dividend yield suggests that
the markets are about to crash, so the same doommongers believe
the high average P/E ratio is also a signal of trouble ahead.
the P/E ratio on the broad-based United States share index,
the S&P 500, is now at 27 - it’s highest since records began.
these are “historic” P/Es, though, and since “prospective” P/Es
will generally incorporate future earnings growth, the prospective
P/Es will be a little lower.
the P/E ratio is often expressed the other way up, as the earnings
yield. Instead of the capitalisation divided by the net
profits, the earnings yield is the net profits divided by the
capitalisation (or the net profit per share divided by the price).
A P/E of 27 corresponds to an earnings yield of 3.7.
the earnings yield does remove some of the distortions generated
by only looking at the dividend yield (see above). But it still
ignores “relative” returns. Investors will always look at the
relative returns from putting their cash into different assets.
One would expect shares to offer a lower yield than government
bonds because if you buy shares you also stand to benefit from
the increase in the capital value of your investment. Most government
bonds (like bank and post office savings accounts) simply pay
back the capital sum that was lent by the investor in the first
place. If inflation is high and there is real economic growth,
the investor can lose out in a big way by being invested in
fixed income bonds.
the return that bond issuers have needed to offer in recent
years has fallen dramatically thanks to low inflation. Ten-year
UK Government bonds now yield six per cent - yields of twice
that have been available in recent decades.
Hence, if bond yields have come down from 12 per cent to six
per cent, many would argue that this fully justifies the drop
in share earnings yields from say 8 per cent to 3.7 per cent.
This would imply that shares aren’t overvalued at all.
From the investors' point of view, in looking at the actual
return over the next year from putting new cash into either
shares or bonds, the gain in the capital value of the shares
also has to be taken into account. the example below is purely
an illustration showing the trend, and the figures aren’t accurate.
But for example, things could have changed thus from the days
of high inflation and moderate growth to the UK and US experience
of recent years which has been a time of low inflation and higher
growth:
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OLD
DAYS |
NOW |
| Share
earnings yield |
8 % |
4 % |
| Inflation |
5 % |
2 ½ % |
| Real
Growth |
2 % |
2 ¼ % |
| TOTAL
RETURN |
15
% |
8 ¾ % |
| compared
with bond yield of |
12 % |
5 ¾ % |
In both cases the “risk premium” is 3 per cent for the total
return from shares over bonds, so justifying the drop in the
share earnings yield to 4 percent. Hence, some say share prices
could yet rise further.
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| Red
Chips Hong Kong based companies controlled
by the Chinese govt or Chinese enterprises/interests. |
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