On Investing

Investing has changed significantly during the 25 or so years that I have been following both the market and also the tools available for an investor to participate within the market.  The following trends are key:

  • The cost of trading and investing has declined significantly.  Trades used to cost more than $25 and now are essentially free in many cases.  Mutual funds used to have “loads” of 5% or more standard when you made an investment, meaning that $100 invested only went to work for you as $95.  These sorts of up-front costs have almost totally been eliminated
  • ETF’s have (mostly) replaced mutual funds.  ETF’s “trade like stocks”, meaning that you can buy and sell anytime (mutual funds traded once a day, after being priced with that days’ activity) and they don’t have income tax gains and losses unless you actually make a trade (mutual funds often had gains due to changes in the portfolio that you had to pay taxes on even if you were just holding the fund)
  • CD’s and Government Debt are all electronic.  You used to have to go to a bank for various governmental bond products or to buy a CD.  Now you not only can buy all of this online, you can choose from myriad banks instantly rather than settle for whatever your main bank (Chase, Wells Fargo, etc…) offers up to you
  • Interest Rates are Near Zero.  One of the key concepts in investing is “compound interest”, where interest is re-invested and even small, continuous investments held for a long time can end up amounting to large sums (in nominal terms, because inflation often eats away at “real” returns).  However, with interest rates basically near zero, you need to earn dividend income or take on more risk (i.e. “junk bonds”) in order to receive any sort of interest income.  There is no “safe” way to earn income any more
  • Currency Fluctuations Matter.  When the Euro initially came out it was $1.30 for each US dollar, and then it went to 70 cents per dollar, and now it is about $1.10 per dollar.  At one point the dollar fell 30-40% against many currencies world wide (when “commodity” currencies like the Canadian and Australian dollar were surging).   For many years currencies were relatively stable against one another but that era seems to be ending, and thus the change in relationship between the US dollar and their currency can be much greater than the return that is earned on the international investments
  • Active Trading Has Mostly Been Beaten By Passive Trading.  While there are many exceptions, initially the majority of investments were “active”, but over the years many of the “active” managers have substantially under-performed the market, wilst charging investors more in fees (it is cheaper to run a “passive” index).  As a result, there has been a massive shift away from active investors to passive investors like Vanguard
  • Correlation Among Stocks and Investment Classes Is Much Higher.  Correlation means that stocks or asset classes tend to “move up” together or “move down” together.  It is not unusual for me to look at a portfolio of 20 stocks and 19 or 20 of them have all gone up or down on a single day.  This is related to active managers being unable to “beat” the market (see above)
  • The “Risk Premium” for Lower Quality Debt is Small.  The amount of extra interest required for low quality borrowers over the US Treasury benchmark is very small.  Investors are taking on a lot of risk to just earn a few more percentage points of return.  If there is a downturn in the economy (such as what happened only recently in US oil companies), there are likely to be significant declines in junk bond values that wouldn’t justify the modest risk premium you receive for holding these types of assets
  • ETF’s Provide an Easy Way to Participate in Commodity Markets.  It was more difficult to buy and invest in commodities like gold and crude in the past, and it was often limited to relatively sophisticated investors or those willing to hold on to physical commodities like gold (which can be risky since they need to be stored and protected due to high value and inability to trace once stolen).  Today you can easily buy a liquid ETF to participate in the commodity markets for key areas like precious metals (gold and silver) and crude oil / natural gas
  • Fewer Companies are Going Public and the Market is Shrinking (in terms of issuers, not total value) – It is easy for start up companies to access private capital (venture funds) and they tend to “go IPO” at high values, making a further upside (after the initial IPO) more difficult.  The total market is shrinking in terms of listings due to M&A (companies buying other companies) faster than the new IPO’s and many companies are “buying back” shares which also reduces the total value of the public markets
  • Bonds have had a Gigantic Bull Market that is Nearing It’s End – Bond prices move inversely to yield; thus if you held on to a 5% low risk bond (which would have been available everywhere in the early 2000’s), that bond would currently be priced at much more than 100 cents on the dollar today.  Interest rates peaked around 20% near 1980 and now are not far from zero; in this sense bonds are part of an enormous “bubble market” that has not yet peaked.  But given how low rates are (they are even negative), it seems like this bull run is about to come to an end
  • Ensure That You Include Dividends and Total Return.  A common mistake is to look at performance just in terms of stock or asset prices, and avoid including the compounding impact of dividends received, especially since dividends often rise each year.  Dividend income can make up a significant portion (25% and up) of total return, so selecting assets that provide dividend income is critical.  Finally, dividends provide favorable tax rates when compared to interest income

What does all of this mean?  I would sum it up in two ways:

  1. It is easy for individual investors to set up a simple and low cost way to track the market – the “basic plan” that I set up as a simple example can be used by anyone and it does what it says.  Here is a second plan that also includes some hedging of the non-US investment
  2. You will need to save much more (or take on more risk) because interest rates are low – with near zero interest rates, you can’t make much money on low risk interest bearing products (like CD’s, savings accounts, and simple government debt).  If you are earning risk income, you likely are taking on substantial risk of default because there is no “free lunch”.  As a result, you need to put more cash into stocks in order to earn dividends or see real returns, but this also could lead to significant losses if there is a market crash like 2008-9.

I try to promote financial literacy and have helped many friends and some family members when they ask questions.  Ideally we would actually drive financial literacy through school and into the university.  Even those who have a degree in finance or accounting often lack practical advice on personal finance and don’t know how to approach these issues.

One key concept is “net worth”.  Net worth isn’t how much you earn in salary, it is what remains in savings after taxes (or through long term deferral of taxes).  The only “assets” that count are those that you can turn into cash if needed, and they are “net” of the debt (such as on your house).  Most people have a negative or near-zero net worth, which is also linked to the concept that they are essentially a couple of missed paychecks away from very bad outcomes such as having to take out a payday loan or borrow money from relatives.

Another key concept is trying to avoid excessive student debt.  Unlike all other forms of debt (loans on your house, your car, or credit card debt) your student debt cannot be discharged through bankruptcy.  You essentially have no options except to repay your loans, and if you miss payments or fall behind the fees and penalties will greatly increase your balance due.  Student financial literacy is critical because they are making decisions that will impact themselves and their families for the rest of their lives and they must be made thoughtfully and with the end in mind (if you are taking out all of this debt, you must be driven in your career to make money in order to pay it off and get on with building net worth).

Cross posted at Chicago Boyz

It’s Stock Picking Time for 2016!

Every year at the end of the summer we select stocks.  Here are the choices for 2016.

US Companies

Spirit Airlines (SAVE) – $40 (52 week high / low $53 / $33), $2.8B market cap, no dividend, $0.6B debt.  Spirit Airlines is a low cost airline that is challenging the oligopoly domestic carriers.

Gilead Sciences (GILD) – $77 (52 week high / low $113 / $77), $101B market cap, 2.4% dividend, $21B debt.  Gilead Sciences is a pharmaceutical company.

General Electric (GE) – $31 (52 week high / low $33 / $23), $281B market cap, 2.9% dividend, $145B debt.  General Electric is a conglomerate that has exited financial services.

International Companies

Unilever ADR UK (UL) – $48 (52 week high / low $38 / $48), $150B market cap, 2.9% dividend, $13B debt.  Unilever is a British consumer goods company with a strong global presence.  This is the ADR that pays out in British Pounds so that there is no tax withholding.

SAP ADR (SAP) – $89 (52 week high / low $62 / $89), $112B market cap, 1.5% dividend, $8B debt.  SAP is a German software company with a strong global presence.

Elbit Systems ADR (ESLT) – $97 (52 week high / low $72 / $103), $4B market cap, 1.6% dividend, $0.4B debt.  Elbit Systems is an Israeli defense contractor.

Stocks on watch update

Generally waiting and putting these stocks on watch have gone well.  They have mostly increased in price recently.

Novartis (NVS) – did not have a good quarterly earnings release.  Still on watch may sell.

Statoil (STO) – still generally on the rise with the recent increase in oil prices

Linked In (LNKD) – up since lows.  Will see if it stalls

Wynn (WYNN) – up almost 50% off its lows.  Beat q1 earnings.

ConocoPhillips (COP) – up off lows but hurt recently by Canadian shutdown due to wildfires

Coca Cola Femsa (KOF) – generally still on the rise off lows.  OK dividend

Devon (DVN) – up significantly off lows.  Benefiting from recent rise in oil prices

Royal Dutch Shell (RDS.B) – also up on recent oil price rises.  Hit some by closing of Canadian oil sands due to wildfires

Oracle (ORCL) – still doing OK.  Will keep on long term watch due to cloud threat

Juniper (JNPR) – missed their 3/31/16 earnings.  Will watch on 6/30/16.  May be passed up by the cloud environment.  Could be an acquisition target

Current inclination… is to sell Juniper and Novartis.  Will watch.

Comments for Stocks on Watch

In general, earnings season is coming up now (mid to late April) for many of these stocks and we can hear about forward revenue projections and their views on oil prices as well as dividend policy.

Comments for Stocks on watch:

Novartis (NVS) – April 21 we will hear Q1 results and updates on strategy and EPS.

Statoil (STO) – April 27 we will hear Q1 results.  Stock price linked to dividend policy.  Their current dividend is over 7% and sustaining the stocks’ value

Linked In (LNKD) – April 28 Q1 earnings call.  Stock hit hard after forward guidance but still has significant and growing revenues (not a unicorn).

Wynn (WYNN) – Stock still in 90’s… will continue to watch (up from far lows).

ConocoPhillips (COP) – Stock already took hit from 75% dividend cut.  Now they believe they can break even on cash flow perspective at $45 oil which is attainable.  Remains on watch

Coca Cola Femsa (KOF) – Stock in 80’s… will continue to watch.

Devon (DVN) – still watching with oil prices.  Devon has a low dividend so little downside risk now of dividend cuts.

Royal Dutch Shell (RDS.B) – will watch with oil prices and their restructuring.  Still holding on to high dividend for now (almost 8%)

Oracle (ORCL) – still rising with cloud numbers.

Stocks on Watch – March 2016

The strategy of these 8 portfolios has been to purchase individual stocks, and to hold them for the medium term.  These portfolios are not the same as an individual investor who seeks to invest for their long term financial future – they should utilize low-cost ETF’s and brokerage CD’s as is described in the “basic plan” that is linked to here or at the top of the site.  Portfolio 2 (see link on the right side of the page) has now converted to a long term type of model.

The reason we employ this strategy is because 1) I want to teach the principles of investing 2) I want to encourage thrift (savings) with the “match” concept 3) I want the beneficiaries to be actively involved in selections and see the consequence of their selections (stocks go up, stocks go down).  In addition, choosing stocks teaches a lot about capitalism and is a fundamental aspect of everything that happens in the world of business – stocks move up and down due to business fundamentals, their particular industry situation, the impact of commodity prices, the impact of foreign currencies vs. the US dollar, the geopolitical situation, and due to the actions of our central bank (ZIRP).  It is my selected role to attempt to teach about all of these concepts at once through the act of stock selection and portfolio changes.  These stock portfolios are not intended to be their entire net worth – if it was, then I would recommend moving to something more similar to Portfolio 2, above.

Given that we use individual stocks, we need to “watch” these stocks, especially if they fall significantly and stay down in price.  We also look for stocks that might have hit their highs and are on their way down, although we would be more likely to “ride the winners” over the medium term.  Portfolios 2, 7 and 8 don’t have any stocks on watch.

Stocks on watch

Portfolio 1

  • Statoil (STO) – Norwegian oil company, hit by the fall in crude as well as the fall of the local currency vs. the US dollar.  Will hold – seems unlikely they will cut their dividend which supports their current price.  The company will likely raise their debt level which is sustainable.
  • Novartis (NVS) – Swiss drug company, a recent purchase.  We will see how earnings play out at the end of April and how the company presents forward guidance.

Portfolio 3

  • Linked In (LNKD) – Online business networking company that recently gave poor forward guidance and had its stock price cut in half.  We are going to continue to watch Linked In since it seems over sold but if it doesn’t move we will sell it.
  • Wynn (WYNN) – A casino operator with interests in China, hit recently by a crackdown on corruption and gambling in China.  The stock was in the 60’s and came back into the 90’s and is on the upswing.  Will look to see if it get’s into the 100’s and make a decision but don’t want to sell while it is rising.
  • ConocoPhillips (COP) – An oil and gas major, hit by the recent collapse in oil prices.  They reduced their dividend by 75% which impacted their stock price, as well.  We are going to watch the price of oil which drives many of the companies on this list.  It went from the high 20’s up crossing the 40 dollar barrier.  If it gets into the middle 40’s and stays there many of these companies will be in OK shape for holding

Portfolio 4

  • Coca Cola Femsa (KOF) – Central American Coca Cola distributor, hit by the decline in currency value against the US dollar and also turmoil in local countries.  KOF has bounced up from the 60’s and recently crossed $80 / share.  Will watch and see if it retains upward momentum after earnings.
  • Devon Energy (DVN) – US oil company hit by recent collapse in commodity prices.  We are going to watch the price of oil which drives many of the companies on this list.  It went from the high 20’s up crossing the 40 dollar barrier.  If it gets into the middle 40’s and stays there many of these companies will be in OK shape for holding
  • Royal Dutch Shell (RDS.B) – European oil company hit by the recent collapse in commodity prices and the Euro / UK Pound vs. the dollar.  We are going to watch the price of oil which drives many of the companies on this list.  It went from the high 20’s up crossing the 40 dollar barrier.  If it gets into the middle 40’s and stays there many of these companies will be in OK shape for holding
  • Statoil (STO) – Norwegian oil company, hit by the fall in crude as well as the fall of the local currency vs. the US dollar.  Will hold – seems unlikely they will cut their dividend which supports their current price.  The company will likely raise their debt level which is sustainable.
  • Oracle (ORCL) – while this stock has been doing well, Oracle faces severe competition from the cloud and resulting price pressures on their product.  Gross margins are still going up and they are claiming significant cloud earnings.  We will keep watching these trends
  • Linked In (LNKD) – Online business networking company that recently gave poor forward guidance and had its stock price cut in half.  We are going to continue to watch Linked In since it seems over sold but if it doesn’t move we will sell it.
  • Novartis (NVS) – Swiss drug company, a recent purchase.  We will see how earnings play out at the end of April and how the company presents forward guidance.

Portfolio 5

  • Linked In (LNKD) – Online business networking company that recently gave poor forward guidance and had its stock price cut in half.  We are going to continue to watch Linked In since it seems over sold but if it doesn’t move we will sell it.
  • ConocoPhillips (COP) – An oil and gas major, hit by the recent collapse in oil prices.  They reduced their dividend by 75% which impacted their stock price, as well.  We are going to watch the price of oil which drives many of the companies on this list.  It went from the high 20’s up crossing the 40 dollar barrier.  If it gets into the middle 40’s and stays there many of these companies will be in OK shape for holding

Portfolio 6

  • Coca Cola Femsa (KOF) – Central American Coca Cola distributor, hit by the decline in currency value against the US dollar and also turmoil in local countries.  KOF has bounced up from the 60’s and recently crossed $80 / share.  Will watch and see if it retains upward momentum after earnings.
  • Royal Dutch Shell (RDS.B) – European oil company hit by the recent collapse in commodity prices and the Euro / UK Pound vs. the dollar.  We are going to watch the price of oil which drives many of the companies on this list.  It went from the high 20’s up crossing the 40 dollar barrier.  If it gets into the middle 40’s and stays there many of these companies will be in OK shape for holding
  • ConocoPhillips (COP) – An oil and gas major, hit by the recent collapse in oil prices.  They reduced their dividend by 75% which impacted their stock price, as well.  We are going to watch the price of oil which drives many of the companies on this list.  It went from the high 20’s up crossing the 40 dollar barrier.  If it gets into the middle 40’s and stays there many of these companies will be in OK shape for holding

Portfolio Eight Updated March 2016 – Tax Time

Portfolio 8 is half a year old.  The beneficiary contributed $500 and the trustee $1000 for a total of $1500.  The current value is $1341 for a loss of ($159) or negative (10.6%).

Portfolio 8 Updated March 2016

This portfolio consists of Mastercard (MA) and Tata Motors ADR (TTM).  Both stocks are down about 10% for the year so far.  Due to the fact that there are no sales and not much dividends (it has only been 6 months) there were no tax forms sent by the brokerage.

Portfolio Seven Updated March 2016 – Tax Time

Portfolio_7G_Mar_2016

Portfolio Seven is about half a year old.  The beneficiary invested $500 and the trustee $1000 for a total of $1500.  The current value of the portfolio is $1357, for a loss of ($143) or negative (9.5%).  Both Alibaba (BABA) and Mastercard (MA) have come down about 10% since purchased in the fall.

Due to the fact that there is only modest dividend and no sales in this portfolio we were not sent a tax return by the brokerage.