Beware on Margin Calls

[rrt3rookie]

A little warning on margin calls. Some of you may already be aware of this, but I was not.

In one scenario, I was desparately fighting off margin calls late in the game. At this point I had sold off all the stock in my other companies, so all I could do was to have the company buy back stock. The margin call pops up at the beginning of a month. During the month I was able to get my account back into the black. However the end of the month was the end of the quarter and expenses came out, sent the stock price down, and sent my margin account back into the red. The broker immediately sold off all my shares because once you start selling your shares, the price goes down which means you have to sell more, which sends the price down,etc.

SO even though I had gotten my margin account back into the black, it does not turn off the margin call so when it checks at the end of the month, there is still an open margin call.

[OilCan]

SO even though I had gotten my margin account back into the black, it does not turn off the margin call so when it checks at the end of the month, there is still an open margin call.

Actually, it does 'turn off' the margin call when you square your account with the broker. What often happens is that a company's share price continues to fall so that when the next month rolls around, and you think you are square with the broker, you are not - your stocks have decreased in value again with the new month. You are back into negative purchasing power and your broker sells stocks to square the account.

Stocks fall in price for two main reasons: a recession is underway or company profits are turning sour. Once a company's stocks are in decline, it takes some quick action to stop the decline - or at least hold prices stable. You can buy back company stock (short term solution), pay off some bonds (short term again), and/or check all your trains for profitability and re-route the loser trains (best solution). Don't retire any trains or sell any industry during a margin call, this will hasten your company's stock decline.

The best preventive plan is to keep your personal debt less than 1/3rd of your stock value, never more than 1/2 of your stock value or the dreaded margin call will show up.

I really don't like margin calls - they mess up your quest for wealth for many, many years.

[aspenfallen]

I really wish I had read this thread sooner... I was working on a scenario and after my 5th attempt, finally got it right. Then, on year 13 of 25, I got greedy and bought a bunch of stock. Now, the stock prices are slowly lowering and I can't get the broker to stop calling... I keep restarting from my save point, but no luck! No matter what I do, I always get all of my stock sold off and, since I'm -$400k in the hole, won't be able to win the scenario that requires a huge PNW, UGH! Guess I'll have to play the scenario for a 6th time...

[Stoker]

Once a company's stocks are in decline, it takes some quick action to stop the decline - or at least hold prices stable. You can buy back company stock (short term solution), pay off some bonds (short term again), and/or check all your trains for profitability and re-route the loser trains (best solution).

Some of this advice is correct in some situations, but the part about paying off a bond making your company's book value go up - especially in the short term, is completely wrong. Do the math. Let's use some simple numbers here so it is easy to see. If you have a company with $1,000,000 in assets and have a bond out for $500,000, your Company Book Value (which stock value is primarily based upon) will be $500,000. If you save up $500,000 in cash, at that point the CBV will be $1,000,000. If you take that $500,000 and pay off the bond, you pay $510,000 (there is a $10k early-payment penalty), so your CBV will DECREASE to $990,000, and the stock price will drop slightly, not go up. If, on the other hand you invest that $500,000 in anything that makes a profit, your CBV (and stock price) will increase according to the amount of profit realized.

[RulerofRails]

Stock prices go through swings due to the economic cycle and consequent effects on the economy. Buying stock on margin SHOULD be done with caution. I say that even though I do it all the time. This is similar to real life, the more we are willing to lose the more we MAY gain. However, the game's odds are in our favor, with experience we can predict the future earnings of our company pretty well especially with the stabilizing effect on profits we get by owning industries.

Like I said, I buy on margin all the time. I do that at times when I am sure the company is going to make more money the next year. In the first 5 years or so of a normal game I can usually get a really good increase in profits year on year. Each year before June I buy up stock as much stock as I can but leave a little margin (enough to buy one or two more shares). Then after June I buy until I can no more. I check at the beginning of each new month to see if the price is high enough to buy some more. In December I don't always buy, depends if I have more income coming and if the share will split. I don't want a margin call when the price "readjusts" at the start of the next year.

I feel like I am in a race, share price is increasing fast and I want to buy as much as possible with my margin before I am in too much debt. If I can get 50% ownership of a healthy company with less than 2M of debt I am pleased. That will take care of most scenario's PNW goals. A trick I use when starting a company with 100k of personal cash is to only use 900k of other investor's money. Then I buy a share on margin straight away giving me 15% ownership.

Disclaimer: Use this for ideas only. I don't want to preach to the choir. There are many ways to play this game and especially the stock market. Find a style that works for you. This is what I do in most scenarios. In a handful of scenarios I know of, revenues are too low or there is an event that causes a market crash (Panama is a good example) where this "method" will back-fire and I have to restart and be really cunning about how I invest.

[Stoker]

Most players seem to lack any coherent strategy when it comes to stock buying. Buying up shares with only the idea of increasing wealth is generally a losing proposition, and this results in excessive margin buying and then of course margin calls when the economy slows. Options as to what you can do varies from scenario to scenario, but the most common strategy is to gain at least 51% of your primary company, and then get 51% control of a competing company. At that point you can do several things. You can hop over to the second company and use it's assets to help your primary company (double up track, create industries that will benefit it by increasing haulage potential, etc). Then of course is the option to loot the second company and stick as much of that company's cash in your pocket as you can, and then sell off your shares. The most common goal is to merge with the target company, but in general it behooves a player to engage in one or both of the previous options before you do so.

[Lama]

I did extensive testing on what influences stock price, and came up with the following (some of which was already discussed above, of course).

There are two measures of interest:

1) book value per share (BVPS)
This is the value of the company (all assets minus all debt), divided by the number of shares outstanding.
Example: A company is worth $1,000,000 and has 20,000 shares. Each share is worth $50.

2) share price
This depends on the BVPS, but is modified by a factor "f" that depends on many variables.
Example: Say the BVPS is $100, but the share price is just $80. In this case, the factor "f" would be 0.8.
Example: If the BVPS is $100, and the share price is $120, the factor "f" would be 1.2.

Either way, the BVPS remains the fixed "x" of our equation, whereas the share price is the variable "y".
A factor "f" modifies "x" to result in "y". The factor "f", in turn, changes with conditions in-game.

So what determines the factor "f"?

a) economic state
The higher the economic state, the greater "f".
All else being equal, during depression and recession, "f" will tend to be <1. During expansion and boom, it will tend to be >1.

b) dividend payments
The higher the dividend paid, and the longer you go without lowering the dividend, the greater "f".
This is by far the biggest influence you can exert on the share price (see test results at the bottom).

c) stock trading
Every sale of your stock lowers, and every purchases of it increases "f". The more active the market, the greater the effect. That's why the mass sell-off in a margin call sends the share price into free fall.
This effect is pronounced, but wears off over time. It wears off the more quickly, the less the volume of trade in the stock.


Implications

The bottom line is of course that you need to have a profitable company to raise stock prices. The more profitable your company, the greater the stock price.

First, profit increases the "x" in the equation, your CBV (and hence the BVPS).

Second, extra cash spent on dividends improves the "f". Of course, dividends also boost your player cash, directly.

Extra cash spent on stock buy-backs does not increase the "x". Consider, for example, the above company with $1m CBV and 20k shares of stock. BVPS is $50. If that company buys back 1,000 shares, you now have 19k shares of stock outstanding. CBV will be $950,000 (we spent $50k on the buy-back). BVPS will now be $950k/19k=$50. No change.
However, in the very short term, buy-backs may save you from a margin call, because every purchase of your stock in the market (by you, by another player, or by the company itself) temporarily raises the factor "f". This effect wears out quickly, though.


Testing the effect of dividends on factor "f"
I started a company that I fully owned, with $1,000,000 in cash and 20,000 shares of stock. This company never built any tracks, but received $100k per month, by event. The economic state was fixed to "normal".

In a first test run (a), I paid no dividend. In subsequent runs I increased dividends to 50c/share (b), $2.05 (c), and $3.12 (d).

At the end of the year, these were the results:
___BVPS__SharePrice__"f"
(a)_$111____$66______0.595
(b)_$111____$67______0.604
(c)_$109____$68______0.624
(d)_$108____$69______0.639

Also note the effect of the different strategies on my personal net worth. The table shows my cash (I), the value of the stock I owned (II), and my net worth (III) at the end of the year.
______I_________II_______III
(a)__$9,297__$128,000__$137,297
(b)_$19,436__$130,000__$149,436
(c)_$50,864__$132,000__$182,864
(d)_$72,496__$134,000__$206,496


Summary

In a game where PNW is the goal, do not pay dividends until you have bought a good chunk of your own stock (33% or more). Dilute stock at first by issuing more, to keep prices low. Buy stock when the economy is low. Once you own 33%, crank up the dividends gradually, buy stock on margin unless the economy is above normal, and have the company buy back stock when you have money to spare after dividend payments. After you own 50%, max out the dividend whenever possible. Build cash reserves in player and company accounts to buy stock when the economy tanks.

[RulerofRails]

Lama, I love your concise formatting and testing!

I agree with all you said, but I think that having a company with a constant annual profit caused you to overlook the effect of profits on share price. I would say that this is actually the biggest factor influencing the "f" you gave in your example.

I have noticed a general rule that the total value of shares outstanding (market cap) is around 10 times annual profits. (I use this to calculate what I need for PNW goals, for example: 100M PNW, I need at least 10M annual profits with 100% player ownership.) The other factors in your post then have their effect on this taking share price within a 7-13x (my estimate) annual profit range. I haven't paid enough attention to know if this figure holds true when I have a really large company with high CBV but little earnings to show for it. Checking one of my large saves now, but my company has thousands of industries and my average laptop takes 20 mins plus to load it!

This is a complex relationship. When I have 100,000+ company shares in say the 8th year of a game, the share price is really sluggish (stable) no matter how fast I earn money until I pass the previous year's profit. There also seems to be a stronger increase in the second part of the year, I don't know how this is calculated (I think it is a safeguard to prevent too great fluctuations, profits becoming increasingly "locked in" during the second half of the year) but it increases the growth I see in the second half of the year. Conversely, booking a decreased profit (year on year) will make the share price really weak the next year. It will continue to fall throughout the first part of the year even if the company makes good money during that period.

I also notice that shares with a higher face value say $98 respond much better to any change in "f" than say $43 shares, maybe this is explained by the greater market depth (more shares after a split). I still think it is something more though. Probably due to the complex formula for share price.

If you find that this is another factor, too, feel free to incorporate things into your post and I will remove most of this one. You have done most of the hard work to do the best analysis of share price in the game I have seen. It would be a good one to link beginners to. Also I am interested as to your views on the overhead charge. If you hadn't noticed, some of us here got into a discussion of it in this thread: viewtopic.php?f=23&t=3294&start=15#p35652. We were off-topic there so maybe start a new thread for that. Thanks.

Edit: checked my file. Large company with $3.17 Billion CBV ($2B cash). Boom times. Share price $61. CBV per share $100. 31,488,000 shares outstanding. No dividend for past 5 years. Last years profit $123M. Expect more in the current year as boom times came round within the last year and company is industry rich ($150M industry profits last year). I am getting a market cap 15.6x annual profit. I have a hunch that the game wont let the share price of a consistently profitable company go below 50% in Normal economic conditions. This is what I have in this game assuming that one economic level rise increases share price 10%?

[RayofSunshine]

Boy, all these threads are a "lot to swallow". I guess that I play very conservative when it comes to PNW with aims at the stock market. I said conservative, as I will only buy stock to 1/2 that of the "purchasing power". I will increase my "buying" once into the "booming" economy, but still leave some margin of safety, as that "booming" can switch to "Prosperity", and that "purchasing power" drops.

Now in the case of "bonds", I did notice that while a player has a number of usually high interest rates, as they were issued in the start of the game, that it will "reduce" the percentage of the economy going into "booming". If a player doesn't have any "outstanding" bonds, that the percentage increases his chance for the economy to go into a "booming" economy earlier. Well, it just seems that way.

One member said to max out the bonds at the beginning of the game, and that way a player has "lots of revenue" to have necessary finances in the play. That is fine, if a player has a good economy itself to help advance his agenda I have yet to try that avenue of approach.

It all "boils down to" how comfortable a player initiates his playing. But it also comes to the point of having fun.

[Stoker]

@ ROS: Regarding Bonds. What it boils down to is whether you are in business to make money or save money. If you are in business to make money, the more capital you have to apply the more money you will make. What I see over and over in these threads is people wanting to run a business like they do their personal finances. It is not the same thing. For one's personal finances, a loan of any sort is a liability, and for business finances a loan represents earning potential. More earning potential = more profits. It is that simple. If you would rather save 10% a year and have no income instead of paying 10% per year to make 10% on top of that there is no reason to show up at your business. It is this exact mentality of wanting to "save money" instead of making money that makes monetary goals in RT3 so hard for so many people.


Also: I do not think the amount of bonds you have out has any bearing on when and if the game engine will change the economy. AFAIK this is a purely random function, unless there are events written by the scenario scripter.

[RulerofRails]

I will increase my "buying" once into the "booming" economy, but still leave some margin of safety, as that "booming" can switch to "Prosperity", and that "purchasing power" drops.

Why do you do that? In Boom times you pay top dollar for shares. (I don't buy then unless it's the first couple of game years and I am in frantic stock grabbing mode due to real evidence of a substantial increase in year on year profits.) What goes up must come down. If you are right near the end of a scenario, of course, it doesn't matter.

Following a certain formula of debt to purchasing power doesn't make much sense. You need a better reason to buy and that reason should mainly be that your company is growing and will continue to do so. I normally limit my margin buying to a sensible debt figure. I hate going above 10M debt even in games where I need to buyout AIs, but normally 5M is my upper limit. The interest kills if you go too high for long periods.

The main reason I max out bonds is to buy industries. Check what gain you are actually making on some of your industries. If you buy only cheap industries or build them at good locations you should get 25% ROI. In rare cases I have been able to take out one bond at 16%, but normally I get my first bonds at an average of around 12% interest. 25%-12% is 13%. So a 500k bond is making me around 65k every year. When I have 20 bonds that is $1.3M profit (minus overhead) every year. That is a nice little stipend to finance my railroad. Try it, financial freedom is fun!

[Stoker]

After reading through Lama's post about stock price evaluation completely I am impressed with the level of thought and testing that went into it, but in the end he ended up not even considering one of the primary influences on stock price: Profit, particularly profit per share and profit compared to book value, (Return On Investment) . It is like saying that the energy in mass can be expressed as E=m and forgetting to include the speed of light squared. This is a lot like Oilcan's handbook that is incredibly well planned and executed, looks fantastic, is concise and informative, but in the end does not give correct advice concerning most of the financial aspects of RT3. I am not trying to be overly critical or dissuade attempts at providing advice for RT3 players, but wrong information is useless or even detrimental to the RT3 player no matter how good the intention and completely irrespective of how well it is presented.

[RayofSunshine]

Well RulerofRails, I will have to try and switch my method of purchasing stock. Usually when the economy is in the "beneficial" time of Recession or Depression for the best time, I usually am just trying to "stay alive". But your suggest does warrant an attempt to change my tactics. Guess having been born and lived thru the 30s Depression, I have a tendency to hold unto revenue until times are of a better economy.

And Stoker, with the above being said, I believe that persons who have had to struggle find it easier to "spend" during better economy rather than that of a "lesser" time of finances. In other words, buying bonds are only used out of necessity. However, your suggest does warrant some thought, and I will have to try using it. My thoughts along the line of bonds is that of the "interest" which requires payment, and a person can get bogged down. That is why today, a large percentage of persons are "bankrupt" as they over spent their incomes. e.g. Look at the National Debt of the U.S. and you will see my point. But don't look at the Stock Market, as that is being bolstered by the U.S.Treasury.

[Blackhawk]

While I might not play as conservative as you Ray, I don't think I play as aggressive as Stoker either. But as Stoker said, we have to keep in mind this is a business rather than personal finances. So if as a business I can take out that 5% bond and use it to buy an industry that would give me a 10-15+ % return it makes sense. The higher interest bonds obviously have to be limited though. If you take out a 10% bond and only make a 10% return that doesn't further your goals in the scenario it's probably not worth it. I noticed you played Oilcan's Red River Valley map and had 1m in bonds. Imagine how much harder that map would be without having had that 1m in debt. But also imagine if you had taken out a few more bonds in that game when they were at 3% interest how much faster you could have expanded. At one point I was up to 4m in debt in low interest bonds in that scenario.

A personal finance situation that is similar would be taking out a school loan you could have an interest rate around 1-2% (back before the govt stepped it and mandated the interest rates). Rather than pay that debt back immediately it makes more sense to invest in the stock market in a company paying 4% in dividends. But I agree with you in that most of this country has become too debt happy and after this housing debt bubble, we'll see the next generation crippled by student debt and enslaved to the banks by the debt they will never be able to pay off while working at minimum wage at the local grocery store.

[Stoker]

Any investment made by a company, whether in RT3 or real life must have a positive rate of return on investment.

[Lama]

Profit, particularly profit per share and profit compared to book value, (Return On Investment) . It is like saying that the energy in mass can be expressed as E=m and forgetting to include the speed of light squared.

RulerofRails and Stoker, you seem to make basically the same, eminently valid point: that profit (whether in absolute terms or as RoI) influences stock price. Whether it is the one thing that anchors the baseline of "f", while dividends etc. are merely modifying factors, whether it is equally as important as dividends, or whether it is exponentially more so, seems to be conjecture, however, unless one did some empirical testing. I am itching to do that, but have too much on my plate currently.

[low_grade]

I've been pushing dividends up and up in my recent game, from $1 to $1.50 to $2 to $2.50, over 5 years of play, where the economy went from Boom to Prosperity to Normal to Recession, and while my profits continued to increase by about 20%, and my 5 year stock return is also about 20%. To me, going from $1 Dividends to $2.50 is a big difference, which doesn't seem reflected in stock value here. Just one case of anecdotal evidence to consider.

[Wolverine@MSU]

Any investment made by a company, whether in RT3 or real life must have a positive rate of return on investment.

Not necessarily. This is clearly what's behind credit default swaps: You take out an insurance policy on an investment, manipulate things so the investment goes bad, and collect on the insurance, while hanging the poor saps who bought into it out to dry!

[Stoker]

Any investment made by a company, whether in RT3 or real life must have a positive rate of return on investment.

Not necessarily. This is clearly what's behind credit default swaps: You take out an insurance policy on an investment, manipulate things so the investment goes bad, and collect on the insurance, while hanging the poor saps who bought into it out to dry!

You contradicted yourself. Taking out an insurance policy, manipulating things so the investment goes bad, and then collecting on the insurance is a positive rate of return on the money they invested. What you are saying is that because an expense was incurred that there is no return on investment. The fact that trickery and fraud is involved in CDS's and that on the surface the initial investment was lost is irrelevant to whether there is a positive rate of return on the money they invested to make this happen. Money was invested by the Corporation,Expenses were incurred (the lost initial investment), and then a Profit was reaped. When looking at the bottom line, the money expended to enact this cycle of fraud is no different than any other expense- like fuel and tires.

[aspenfallen]

Whoa this post ended up with so much stuff I think is over my head yet. Or maybe it's just the Friday-night rum kicking in. Either way, I'll have to try reading this one agin in the morning, haha!!