Stock Sales Summer 2015

We have been watching the markets and trends and there are some stocks that we will cull prior to the next round of investing.

Coca-Cola Femsa (KOF) – this is basically the Mexican and Latin American Coca-Cola distributor.  Per their last earnings release:

“As beverage transactions continued to outpace volumes across our operations- reinforcing our daily consumer engagement – we are encouraged by our operators’ positive performance in the midst of a challenging environment, marked by weak consumer trends in Brazil, a slowly recovering consumer landscape in Mexico, and currency volatility across our markets. On a comparable basis, we delivered high single-digit consolidated revenue growth and double-digit operating income growth during the quarter.”

What they mean by “comparable basis” is that the currencies of Mexico, Brazil and other countries such as Argentina have collapsed and they are still making a lot of sales but the sales are worth less when they are converted into the US dollar or some other index as they were in prior periods.

So what do we do?  Do we hold on and wait for the dollar to fall and / or their currencies to rise?  The company seems well run (they have growing transactions) and Coca-Cola is never going away, and these countries have a rising middle class and growing populations (unlike most of the world) to consume more goods in the future.

Royal Dutch Shell (RDS.B) – Shell has been pummeled by the commodity price slump.  They are also based in the UK / Europe so they face an additional currency overhang when translated into US dollars.  They also were “acquirers” of a natural gas company in the midst of these events which means they paid a premium price in a time of decline.  The most worrisome element, however, is that they continue their high risk plan of drilling for ice in the volatile and difficult arctic, at a time of reduced oil prices (which makes high cost investments like deep water drilling even riskier).  They also have a relatively higher chance of environmental catastrophe which will be very difficult to clean up given the paucity of local resources and the ferocious environment in the far north.  They are a sell.  If we want to “buy low” in the oil or natural gas business there are better candidates.

Trans Alta (TAC) – Trans Alta is a Canadian power generator.  They have strong exposure to coal and also the Canadian commodity boom / bust which consumes much of their electricity.  They pay a strong dividend (for now) but it has been reduced as the company struggles.  Future dividend cuts would impact the company even further.  Given the combination of the poorer Canadian economy and currency, the dire forecast for coal, and the commodity bust, this is a sell.

Wynn (WYNN) – Wynn is a gaming operator with operations in Macau, the only area of China where their gambling-mad citizens are allowed to play.  There are also many other more subtle elements to this infatuation with gambling including an ability to move currency out of the country, which is otherwise difficult to do.  Recently the new Chinese premier (dictator?) has cracked down on certain types of ostentatious corruption (generally among those who are not politically allied with him, since “corruption” is embedded into all aspects of their command economy) which has hurt gambling.  But Wynn is a shrewd operator and he is expanding capacity and likely this too, shall pass.  It is hard to sit while revenues and profits decline, however.

Exxon (XOM), Statoil (STO), and Devon (DVN) – these energy giants (Exxon is the biggest, but Statoil is unique since it is from Norway, and Devon is smaller but well run) have all been hurt badly by the reduction in oil and natural gas prices.  For now, unlike Shell above, I think it makes sense to stick with them.

Seaspan (SSW) – Seaspan owns container ships that travel between China and overseas destinations and has been investing in a new, fuel efficient fleet.  Seaspan has a very high dividend (8%) which they have been able to sustain so far.  On the one hand they seem to be a good operator but overall Chinese exports are faltering and if there is a general fall in the market they likely will still be able to rent out their newer, fuel efficient craft but the rate that they would receive would be correspondingly lower.  This one is on the edge.

Westpac Banking (WBK), Canadian Imperial Bank (CIB), Toronto-Dominion Bank (TD) – the first bank is Australian and the latter two are Canadian.  These banks are generally well run but all have been hit by the depreciation of their currencies vs. the US dollar, and the fact that they are exposed to real-estate “bubbles” in the Australian and Canadian markets.  As the commodity markets fall, the entire country can be hit with reduced services, demand and an overall high level of debt.  These are on watch.

Trends in Stocks

Investing in stocks is always hard.  You are looking at data about the past but you are betting on an individual stock in the future.  In addition, there has been huge correlation among stocks and markets and the impact of currencies and central bankers (often inter-twined) has given various world markets boom and bust qualities.

In the US, there are two markets, the NASDAQ and NYSE.  NASDAQ has traditionally been more technology focused, meaning that when these stocks go up, the NASDAQ soars.   Here is a quote on “the only six stocks that matter” about the NASDAQ from the Wall Street Journal:

Six firms— Amazon.com Inc.,Google Inc.,Apple Inc.,FacebookInc.,Netflix Inc. and Gilead Sciences Inc.—now account for more than half of the $664 billion in value added this year to the NasdaqComposite Index, according to data compiled by brokerage firm JonesTrading.

Thus the bottom line is that if you don’t have these stocks in your portfolio, the overall index may be rising (and our benchmark for performance), but your own returns will be worse.  We do have some of Amazon and Facebook in portfolio 2, but not much of it overall.

Outside the USA, foreign markets have been hurt by the rising US dollar, which makes their market values lower for us here in the USA (where the dollar is our currency).  This hurts stock investments in Europe (the Euro), Canada (the Loonie), and Australia (the Australian dollar) if you are denominated in US dollars (which we are).   The dollar is up significantly vs. almost every other currency in the world with the exception of the Chinese Yuan.

The Chinese market went crazy this year, in what appears to be a major bubble, that recently started crashing and was accompanied by strong intervention from the central authorities, who went after short sellers and even stopped stocks from trading for various reasons.   At one point almost the entire Chinese stock market by valuation (over 80%) was not trading.  The rationale is that if stocks are heading down, and you can stop trading, then this gives the market participants time to stop panicking.  This type of intervention stops the market from functioning efficiently, however, and will have many other unforeseen impacts down the road.

Mergers and acquisitions (M&A) activity also soared in 2015, which is a sign of bullishness and also likely a sign of a market peak.  A Wall Street Journal article recently summed it up:

Companies are merging at a pace unseen in nearly a decade. Halfway through the year, about $2.15 trillion in M&A deals or offers have been announced globally, according to Dealogic. That puts 2015 on pace to challenge the biggest year on record, 2007, when companies inked deals worth $4.3 trillion… In industries ranging from health care to technology to media, chief executives are rushing to make acquisitions, often either in anticipation of takeover moves by rivals or in response to them.

When acquisitions occur, you as a stock market investor typically want to be the “acquired” company, not the “acquirer”.  The “acquired” company receives a premium price to their current market value but the burden of “earning” that higher price falls on to the acquired company, and typically M&A does not pay off long term for most companies (as opposed to internal or “organic” growth).  While there have been many acquisitions, most notably in the health care / insurance / pharma industry which is consolidating under Obamacare, our portfolios had few of these acquired companies in the mix.

Finally, you had a decimation of the commodity indexes.  Commodities such as oil, some foodstuffs, natural gas, iron ore, copper, gold, etc… have seen their prices collapse, which in turn damages the stocks of mining companies, oil companies, and many other participants in the commodity value chain.  Per Bloomberg:

Almost all commodity markets have taken a severe beating lately. The aggregate Bloomberg Commodities Index is down 61 percent from its 2008 peak and 46 percent from the 2011 post-crisis high

These are severe reductions.  They impact entire economies particularly the Arab countries (which make all their export income in oil), Russia (many commodities), Australia and Canada.  There are large “secondary” impacts as well – reduced commodity prices hurt service demand in Canada and Australia and put their housing boom at risk.

So what does this mean for us and our portfolios?  We’ve been hurt by the commodity bust, the rise of the US dollar (on our foreign stocks), and we’ve missed some of the booming stocks because they were narrowly concentrated in a few names and some of the largest M&A was in sectors where we had few investments.

We are now going to look at some of the stocks and cull some prior to our next round of purchases which will occur in August – September as the beneficiaries of the various portfolios head off to school for the year, and will tie new purchases (of the cash) with additional investments that will be made soon.

Calculating Basis on a Stock Split

One of the more interesting side benefits of writing this blog and running the trust funds is that I take apart my brokerage statements in detail.  Recently, eBay split into two stocks as they spun out PayPal into a separate company.  Portfolio One owns 50 shares of eBay, which became 50 shares of eBay and 50 shares of PayPal.

50 eBay shares were purchased in December 2007 at a price of $33.50 a share or a total of $1675.  This is the “cost basis” or “tax basis” of the stock.  Regardless of how many times eBay and PayPal subsequently split or spin off, the total of the basis is $1675 and can’t go higher or lower.

Today, unlike when I started this blog, you can find pretty much anything out on the internet.  So I just typed in “eBay Paypal spin off stock price basis” and found this link.  In the link they said that the split percentage was calculated based on the market price of PayPal and eBay after the stock was launched… which was .5682 as PayPal and .4138 as eBay.  .5682 + .4138 = 1 as it must since the basis must be split between the two stocks.

As a result of this, eBay’s 50 shares must be worth .4138 * $1675 = $693.12 or ($693.12 / 50) $13.86 a share.

PayPal’s 50 shares must be worth .5682 * $1675 = $951.73 or ($951.73 / 50) $19.03 a share.

For fun, I went to my site’s brokerage account where they calculate the cost basis for taxes and they had different numbers.. eBay was $761.86 and PayPal was $927.14.  This totals $1689.

The difference between the $1689 – $1675 = $14.  That’s probably the commission we paid back in 2007 (when we weren’t getting free trades).  That makes sense, then.  Thus my “total” basis is $1689 to split between the two stocks.

I’m not certain what the difference is between the calculation I found on the internet and the brokerage calculation.  They are close enough, though.  This shows the complexity of the process – it would be much worse if I had bought eBay at many other price points over the years, and / or if it had split a bunch of times.

Well… I dug around a bit more and went to eBay’s investor relations site.  They had a document there from their head of tax describing one way to split the basis between the two stocks.  Here is a link to that document.

In that document eBay said the following:

Based on that approach and the assumptions and calculations set forth in Item 16 below, 39.2706% of an eBay stockholder’s aggregate tax basis in his or her shares of eBay common stock immediately prior to the Distribution would be allocated to such stockholder’s shares of eBay common stock and 60.7294% would be allocated to such stockholder’s shares of PayPal common stock received in the Distribution.

So if I plug in the $1689 ($1675 + $14) basis times .392706 I get $663.28 for eBay and $1025.71 for PayPal.  Aargh that doesn’t tie out either.  I think I might send an email to the support section of the brokerage account to ask.  Probably I am spending far more time on this than it is worth but since I am down the rabbit hole…

Stock Selections for Summer 2015

There have been stock sales in some of the portfolios so we will have another round of stock selections.  Here are the choices.

INTERNATIONAL

  1. Vale ADR (VALE) – $7, ($5 – $14 over 52 weeks), $35B market capitalization, 5.5% yield, $35B in debt.  The Brazilian mining giant has been hit hard by the reduction in demand for the commodities that it produces as well as difficulties in Brazil as the economy is stagnant and the currency is falling.  With these factors it is a solid candidate for a rebound in future years if they can continue to focus on efficiency and cost reductions
  2. Alibaba (BABA) – $88, ($77 – $120 over 52 weeks), $220B market capitalization, no dividend, $8B in debt.  Alibaba is a Chinese e-commerce giant.  They are listed directly on the NYSE and not an ADR.  While the Chinese stock market has made a huge advance recently, Alibaba has slowed as the company re-groups and reduces hiring and focuses on execution.  If you already own Yahoo don’t buy Alibaba because Yahoo has ownership of a portion of their stock which is already reflected in Yahoo’s value
  3. Infosys ADR (INFY) – $31, ($25 – $37 over 52 weeks), $35B market capitalization, 1.6% yield, no debt.  The Indian outsourcing and consulting company is poised to grow with India and benefits from the strong dollar since much of its costs are in Indian currency but much of its revenues are received in dollars

US Market

  1. Celgene (CELG) – $115, ($72 – $129 over 52 weeks), $91B market capitalization, no dividend, $7B in debt.     Celgene is a US biotech / drug company with a variety of drugs under patent and a pipeline of many other potential future products
  2. Juniper Networks (JNPR) – $27, ($18 – $27 over 52 weeks), $11B market capitalization, 1.5% yield, $2B in debt. Juniper Networking is a high technology company specializing in fast networking gear.  The company is well run and has beaten analyst profit estimates recently
  3. Dow Chemical (DOW) – $51, ($41 – $54 over 52 weeks), $59B market capitalization, 3.3% yield, $20B in debt.  Dow Chemical provides processed material for manufacturing and agriculture.  The company benefits from lower US natural gas costs which provide advantages since it is a major component of their products.  The company recently fended off an activist investor which reduced their stock price.

Recent Stock Moves

Rise of the China Stock Market

When you are judging the success of your portfolio against benchmarks, which conceptually is a simple exercise, the question soon arises:

1) who are you comparing yourself against?

2) what currency is your benchmark denominated in?

Whether you want to invest there or not, China has had a major rally, and the Chinese Yuan is stable against the US dollar (in the range of 6 Yuan / dollar and 6.4 Yuan / Dollar over the last 3 years) as opposed to other currencies like the Euro and the Japanese Yen which have cratered in dollar terms.

The incredible rise in stocks in Chinese stock prices has mostly gone “under the radar” of US media.  Recently they connected the stocks in Hong Kong with stocks on mainland China and not only have prices risen substantially, the same stock trades for different prices in each location.  Per this WSJ article

Shares of Chinese companies listed in Hong Kong look like a steal compared with shares of the same companies that are listed in Shanghai. Such stocks on average trade at a 32.89% discount in the former British colony, according to the Hang Seng China AH Premium Index.

Typically, under a concept called “arbitrage”, the price of equivalent items in different markets are narrowed when investors take steps to capture the “easy money” of buying that same good cheaper in a different place.  A very simple example is that you can’t have gasoline selling for $4 in one state and $3 in an adjacent state; everyone just crosses the border to buy the cheaper gas until the price differential narrows.  Gaps of a couple of percentage even across exchanges is enough for investors to jump in and take advantage; a 32% differential is extreme.

This rally isn’t due to a perception that the economy in China is getting better; in fact it seems to be getting worse.  The rally has been enhanced by structural moves that allow more investors into the market (largely retail mainland investors) and lets them buy stock on margin, as well.  Per this WSJ article:

Margin lending has more than tripled in the past year to a record 1.7 trillion yuan ($274.6 billion)…The practice isn’t unique to China, where margin debt equals 3.2% of total market capitalization, compared with 2.3% in the U.S. But when compared with the value of stock that is freely traded, making it accessible to ordinary investors, the percentage for China rises because state entities own more than half of the market.  Research by Macquarie Securities Group shows China’s margin-debt ratio at 8.2% of the free float. That easily exceeds the peak of 6% reached in the late 1990s in Taiwan, the second-highest level globally in recent years.

Thus if you didn’t have a proportionate share of your portfolio invested in Chinese stocks, you were a “relative” loser, although there are many reasons to believe that this rally isn’t sustainable.  This goes back to the original question of how benchmarks are defined.

Individual Stock Moves

In one of the portfolios I follow there have been significant and immediate moves in several of our stocks.  These stocks were related to China or the the technology industry.

Linked In (LKND) recently had an earnings call and their stock price plunged by over 20% in one day.  The cause of the drop wasn’t the earnings themselves (they beat expectations), it was their “forward guidance”.  For stocks with a high price / earnings multiple like Linked In, the market needs to have continued rapid growth to justify the high stock price today.  In fact, Linked In currently doesn’t book profits, primarily due to their high amounts of stock based compensation (stock given to executives in lieu of cash).  Linked In’s guidance talked about currency headwinds (meaning that if they brought in the same revenues overseas it would “count less” towards net income because of the rise in the US dollar) and also some one time acquisition costs from recent companies they’ve purchased.

Amazon (AMZN) had their last earnings call where they continued to show no profits on a GAAP basis and yet their stock rose 6.8% due to other factors that analysts apparently found compelling.  Note that a 6.8% gain for a company the size of Amazon is a large increase in market capitalization (over $10 billion) in a single day.

China Life Insurance ADR (LFC) has almost doubled from around $40 / share to $80 / share as part of the overall China rally discussed above.  While a seemingly sound stock this performance gain is not tied to any fundamentals in how the company operates; this growth is tied to the giant overall rally.

Wynn Resorts (WYNN) dropped more than 10% in a single day after earnings were released.  Wynn has a property in Macau (China’s only location with legal gambling) and it has been hit hard with a recent crackdown on high-roller gamblers by China’s communist leaders.  Note that the scale of gambling in China dwarfs Las Vegas by any measure (total market, amount bet per player, etc…) and thus properties in China have been proportionally more lucrative than their US equivalent.  It is not known whether this will be a long term reduction of high rolling gamblers or a short term hit; that depends on inscrutable Chinese government polices.  Left to their own devices, it is highly likely that Chinese would continue to gamble at record rates.  Wynn also has long running board issues and governance issues as well.  At risk is their dividend, which “income investors” price highly in an era of virtually zero yield on debt (without taking on significant risk).

Westpac (ADR) – the Australian bank slightly missed earnings and their stock went down almost 5%, but then recovered a bit and was down 3%.  The CEO said that flat earnings won’t be tolerated in a later interview.  Unlike those companies with little or no GAAP profits (Amazon, LinkedIn), a company like Westpac won’t usually fall as much with a minor earnings miss because it has a lower P/E ratio and incredible future profit growth isn’t already “baked in” to the stock price.

Seeing large moves in single stocks can be viewed as a sign of a bull market in its last stages.  Since we invest for the long term we don’t pull in and out of the market based on short term moves but it is definitely something to consider; stocks with limited earnings and high P/E ratios or tied to giant rallies like is occurring in China today should be on some sort of watch.

Cross posted at Chicago Boyz

The “Kiddie Tax” and When to File

One of the most onerous perceived issues with having a trust fund (UGMA or UTMA) for kids are the US income tax rules.  The government is worried that parents will shift assets into the names of their children in order to minimize tax obligations since the children typically have a lower marginal tax rate.  Several years ago I did a decent write up of the tax situation here which I will summarize and update now.  Remember, this blog is not a professional tax advisory source you need to do your own research and tailor it to your particular situation these are general guidelines only.

One element that is interesting is that the funds don’t even receive a 1099-INT any more.  This form is for interest earned annually; you need to earn $10 in interest income to meet this threshold.  With money market earnings (typically what your brokerage account is hooked up to in order to buy stocks) at near 0.01% (as low as they go) you would need to have $100,000 sitting in cash all year long in order to meet the $10 1099-INT threshold ($100,000 * 0.01%) =  $10.  Sound crazy?  Let’s do that math again… 1% of $100,000 is $1000.  Then 1% of that is $10.  If you had actual interest bearing instruments (CD’s, bonds) obviously you can get in the 2% – 5% range depending on duration and riskiness this is for the short term cash parked in your brokerage account tied to your investing.

For filing requirements – Turbo Tax does a nice job of describing them here (they change year by year so make sure that you are looking at the correct information in future years).  For dependents (someone claimed on another persons’ tax returns, typically kids through the end of college) the minimum filing requirements for “earned income” (wages) is $6200.  Thus you need a pretty good summer job or year round part time job to meet this threshold.

However – for “unearned” income (dividends and capital gains), the filing requirement is only $1000, as they note.  Between $1000 and $2000 you can file section 8814 and add the child to the parents’ tax return, and beyond $2000 in unearned income you are now required to add them to the parents’ tax return under the “kiddie tax” provisions.  This assumes that the college student is paying less than 50% of their own required support, which is another calculation but probably a decent assumption given the high cost of a college education today.  Worst case, you need to either add the child’s unearned income to your return or you need to have them file a separate return that is tied to the parents’ return.  This type of work used to be onerous by hand but with a modern tax program such as Turbo Tax can be done more easily.  Turbo Tax will also tell you if you are better off adding the child to your return or having them file separately; there is a second round of internal calculations it does as you make too much money for certain credits when the unearned income is added to the parents’ return but now we are far beyond the scope of this discussion.

All in all, the likeliest way to avoid this is to net out capital gains with capital losses each year which will usually keep you below the $1000 threshold, until dividends get high enough that it pushes you over the top anyways.  This is called “tax loss harvesting” and I described it here.

With modern tax preparation software and a decent understanding of the brokerage house tax forms these tax complications shouldn’t be enough to deter you from setting up a trust fund (UTMA or UGMA).  For our funds they generally don’t start to get big enough to hit the tax threshold until the beneficiaries are in college and by then they often are starting to work anyways and you need to consider it for those purposes.

Finally, one of my proudest moments as someone who set up these funds is when my nephew called and he was doing his own tax return.  While you think of them as the children they once were they all become adults at some point and begin to take responsibility for their own affairs and this is a proud moment.  Taxes and investing are a part of life and one of the most important purposes of this effort from my perspective is to encourage financial literacy.  I also have been blessed because the beneficiaries all seem to have the sense not to try to take out the money and spend it on frivolous items (which they theoretically could do once they are adults) and this is another positive item, learning to defer gratification and save for the future.

Buying CD’s Through Your Brokerage Account

For many years at this site I have advocated buying CD’s through your brokerage account (Fidelity, Vanguard, E-Trade, Schwab, etc…). If you buy a CD through your own bank you will usually get a far lower rate for what is a completely commoditized product (they are all guaranteed through the FDIC, after all) than what you can get if you shop around in a brokerage.

CD_Yields

This NY Times little data graphic found in their business section makes this point starkly. Let’s look at the differences between the “average” CD that your bank would offer versus what you can get from these other banks offering the highest yields:

– 6 month CD (0.16% average, 1% for highest paying CD)
– 1 year CD (0.27% average, 1.21% for highest paying CD)
– 5 year CD (0.87% average, 2.25% for highest paying CD)

In an era of ZIRP the difference between almost nothing (0.16%) and 1% is very significant. Someday if interest rates rise we may not have to scrape for nickels like this but in today’s environment you need to vigorously watch expenses, risks, and get returns where ever you can (without taking on more risk).

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