Jason’s Portfolio April 2016

I thought it my be useful for myself and others if I list out the stocks in my portfolio and watch list. I have informal categories for each stock I own based on whether I’m looking to buy, hold, or sell. I’d like to make those categories a bit more formal in this post and going forward.

The “Method”

There are really two things I’m tracking here for each stock in the portfolio.

One is what mode I’m in with regards to the stock; whether I am watching, buying, holding, or selling the stock.

The second item tracked in this list is the value of the stock; if I think the stock is undervalued, fairly valued, or overvalued.

Note that the mode is not a recommendation. It’s just how I am personally approaching the stock. The mode I list is based primarily on how large my position is in the stock. If I say I am “buying” a stock, I could be buying it right now if it’s undervalued or I might be waiting for the price to fall (sometimes as much as 50%) before getting in. Similarly, if I list the mode as sell, it just means that I have too much of that stock and need to find the right time and price to sell.

The Value on the other hand can be considered my opinion of whether a stock is a good buy or not based on the current price. I am not a professional… disclaimer disclaimer… I should really get the correct language to keep people from suing me… but if I say something is undervalued I think the stock price is going to be higher 5 years out and if I say it’s overvalued I think the stock price is going to be unchanged or lower 5 years out.

Here are the categories again.

Mode

  • Watching
  • Buying
  • Holding
  • Selling

Value

  • ? (Need to research more.)
  • Undervalued
  • Fairly valued
  • Overvalued

Ideally I will be buying stocks when I think they are undervalued and selling them when they are overvalued, but whether I am buying or selling depends on some other things.

To skip to the list, you can load the Google Spreadsheet here. Or read below for an explanation of each “mode” and “value” category.

Modes

The “mode” I list for each stock is not a recommendation to buy or sell. It’s simply how I am approaching a stock. If I say I am “buying” a stock, I am really looking to buy. It just means I wish I owned more of this stock. I might be buying the stock at the current price or just as often I will be waiting for a stock to pull back (maybe as much as 50%) before really committing to it.

Similarly, if I say I am “selling” a stock, I may be selling it right now but just as often I am waiting to sell it. This really just means that I have more of this stock than I need and I could sell some to purchase stocks that I think are undervalued. I am almost never selling 100% of my position in a stock.

Here are some more details on each of the above “modes” I might be in with regards to the stocks in my portfolio. At any given time I’m either watching, buying, holding, or selling.

Watching

These are stocks that are on my radar, but I haven’t yet invested in. They might be a company that I am confident in, but need to do more research on to find a fair price to buy the stock at. Or they are a stock that I think is “on sale”, but I need to do more research on to find out if the underlying company is strong.

Buying

These are stocks I am looking to buy more of. Usually I am buying when the stock is also undervalued, but I’ll sometimes open positions in stocks when they are fairly valued with the hopes that they will drop further.

When buying, I try to open a 25-50% position and then buy in 25% chunks for each 10-20% drop in stock price. So if I had $10k to put toward a position, I would open a position with $5k and then buy another $2.5k when the stock price dropped, and another $2.5k if it dropped further. These are rough numbers. The specific numbers will depend on the particular stock and situation. But I’m generally dollar cost averaging into these stocks as the price bottoms out.

Holding

These are stocks that I am invested in and holding. I’m not buying more, either because my position is too large a % of my total portfolio or because the stock is fairly valued or slightly overvalued. I’m not selling either because in general I’m more interested in acquiring as much stock as possible in companies I think are strong vs trying to make “trades”.

Selling

These are stocks that have run up for me and I’m looking to sell. I generally won’t sell stock unless I need the money to purchase something else that is on sale (from my Buy list) or I think the market is heading downward and I want some cash to hunt for opportunities.

Value

How do I determine if a stock is undervalued, fairly valued, or overvalued? In general, I try to guess how much revenue a company is going to be making 5-15 years out and figure out what a fair price would be assuming they get there and then discount that price based on risk factors. I use an analysis similar to what Phil Town does in his book Payback Time. You can see an example of that kind of analysis I did for GOOG here.

The list below will contain just one word, but behind that is typically a lot of research, earnings calls listened to, model spreadsheets, and deep thinking about the technicals and fundamentals of the stock and company. I also try to do some “main street” thinking by considering what the company actually sells, how much they think they are going to sell and at what margins/etc. It’s awesome to see a company like Apple growing at 25% per year, but are there enough people in the world to buy enough iPhones for them to double their revenue again?

Here are some general thoughts about each category of value.

? More Research Needed

If its been to long since the last time I researched a stock, I’ll put a ? in the value column. Maybe the stock price has run up and I’m not sure if it’s still undervalued. Maybe a few earnings reports have come in and my numbers need to be updated to take new numbers and growth rates into account.

Undervalued

These stocks are either mature companies with low PEs or revenue multiples (like Apple) or young companies where (in my opinion) the market is undervaluing the future earnings potential of the company (like Tesla). If a stock is in this category, I generally expect it to grow 2-4x over the next five years.

Unless I already have a large position, I should be looking to buy more of these stocks. If you asked me for a “stock tip”, these would be the stocks I would talk about.

Note however that undervalued doesn’t mean “will not fall in price”. Stock prices can always go lower, especially stocks that have had a good run recently. Stocks that are up 100% over the past year could still be undervalued. You’ll just have to be more careful when buying them (i.e. dollar cost average).

Fairly Valued

These stocks are priced about right based on the models I’m using. I’m generally holding these stocks and letting them run.

Over Valued

These stocks are highly priced (or “frothy”) based on the models I’m using. These are probably “momentum” stocks that the market is taking higher and higher. I’m generally letting my winners run, but if I need cash to purchase more of a stock in the undervalued category, these are the stocks I’m going to sell first.

My Portfolio

These are stocks that are on my watch list or stocks I own some amount of in my retirement account, my wife’s retirement account, or a couple of personal accounts I hold in my children’s names. For each, I’ll say what “mode” I’m in for that stock and how I think it’s “valued”. A “?” in the value column means that I need to update my research based on the current stock price and fundamentals.

I’ll keep an updated spreadsheet of this portfolio in Google Docs publicly here. Or you can see the list from the time of this blog post below.

Company Ticker Mode Value
Activision Blizzard ATVI Hold Fair
Amazon AMZN Buy ?
Apple AAPL Buy Undervalued
Disney DIS Hold ?
Google GOOGL Hold Fair
Hasboro HAS Hold ?
Netflix NFLX Hold Fair
Nintendo NTDOY Buy Undervalued
PayPal PYPL Buy ?
Solar City SCTY Buy Undervalued
Starbucks SBUX Hold ?
Square Enix SQNXF Buy Undervalued
Tesla TSLA Hold Undervalued
Take Two TTWO Hold ?
Twitter TWTR Buy Undervalued
Zynga ZNGA Buy Undervalued

Notice that this is almost 100% technology stocks, which does leave me undiversified by industry. However, technology companies are something I feel I have a lot of domain knowledge over which helps me to pick the winners. We also invest part of each of our accounts in total market and world market index funds.

“Payback Time” Analysis for GOOG

Image representing Google as depicted in Crunc...I still own a few shares of GOOG. It’s felt overpriced recently, but I’m holding onto a minimal amount at all times and trying to add more over time. So I’m hoping the price drops a bunch so I can pick up more cheaply.

Do a search here for GOOG for my previous thoughts (years old), but I basically think that the world will continue to be drowned in data. Google’s goal to organize the world’s information and their expertise at scaling Internet apps puts them in a great position to be a contender in just about any future technology.

Phil Town Payback TimeAnyway, I’ve recently read Phil Town’s new book Payback Time. The title there, like most investing books lately, takes advantage of the recent drop in the stock market to entice readers. However the content and tone of the book isn’t as whiny as you might think, and is generally applicable to investors in all markets.

We were big fans of the first Phil Town book, Rule #1, mostly because it described things in layman’s terms and gave readers a clear method for putting the books theories into practice.

Payback Time works the same way and repeats a lot of the ideas in Rule #1. There are still the 4 M’s (Meaning, Moat, Margin of Safety, and Management) for example, but instead of using technical analysis (in the form of Rule #1’s red/green arrows) Payback Time recommends a form of dollar cost averaging, Town calls “stock piling”.

Of course, Town has a section in the book titled “Why This Isn’t Dollar Cost Averaging” that I’ll try to summarize here. Town says (emphasis his), “DCA means investing a fixed dollar amount at fixed intervals no matter what the price of a given stock.” He then goes on to list the numerous flaws and criticisms of dollar cost averaging.

For further reading, Christian writes why you should consider “Averaging Down“, and here Steve “The Undertrader” describes his stockpiling-like investing style.)

So Town calls stockpiling “DCA with a brain”. You don’t buy any time or on predefined schedules. You buy when the stock price is within your Margin of Safety. And you don’t hold indefinitely. You sell if the stock price goes about your Margin of Safety.

I’ll buy that. And I like this a little better than using “the tools” or “the arrows” or technical analysis to judge a stock because it’s one less thing to calculate. If you are calculating a “sticker price” and MOS price anyway, might as well use them to trade. If you thought of stocks as commodities or discounted dollars, this kind of trading would make even more sense. I value $1 at $1. If the market is pricing it at $0.80, I buy. If the market is calculating it at $1.10, I sell. Sure I could have waited for the price to drop to $0.70 before buying, or $1.20 before selling. I would have made a better trade, but I’m always making a winning trade if I buy when the price is lower than what I value it at (plus my MOS) and sell when the price is higher than I value it at.

So the Payback Time strategy should be a little easier to follow than the technical analysis from Rule #1. Well, to a certain extent. Town introduces another calculation called “the payback time” (maybe that’s the true meaning of the title) to pretty much calculate the MOS from a different angle. And he brings technical analysis back in, talking about support and resistance levels. Here’s a good recent analysis from Hipegg on Google.

Alright, so that out of the way, let me share some of my calculations on Google stock (GOOG). I’m basically running through the Payback Time Spreadsheet found on the Payback Time website. It’s a handy tool.

Here I would want to do a large Google Moat analysis, but I’m lazy. So I’ll say hey, they have a huge margin and virtual monopoly in search. And while there stance is vulnerable (MSFT is gaining ground lately), this moat is fairly stable because (1) it takes a lot of knowledge and investment to serve billions of searches a day quickly and (2) advertisers and publishers benefit from consolidation and drive the market towards one winner.

Charlie Munger and Warren Buffet at Berkshire Hathaway like Google’s moat. Not sure if they are investing. Buffet shies away from tech.

Here I would want to do a large Management analysis, but I’m lazy. I’ll say hey, these guys strive to do no evil. Page and Brin seem like great folks who are in it for the long term. They are standing up to China vs. going for short term profits. They don’t fudge their numbers (other than tweaking the Adsense lever). They don’t mess around with finance gimmicks like splits, etc. They are smart and clearly have a better understanding of the future than the average C-Level exec.

Some numbers:
* 5 year EPS Growth has averaged 34%.
* 3 year OPS (operating cash flow per share) Growth has averaged 17%.
* 5 year Sales Growth has averaged 40%.
* 5 year BVPS (book value per share) Growth has averaged 58%.

Nice all around. You usually want to go as far back as you can on these numbers. We can’t go much further back than 5 years because Google only started trading in 2004. If you wanted to be more conservative, you could use more recent (last 2-3 years) numbers since Google basically went from nothing to a top 10 company in 2 years and since then has grown a little slower.

Some more numbers:
* ROIC (Return on Invested Capital) = 18%
* ROE (Return on Equity) = 18%

Nice again. BTW, you can get some of these numbers in chart and spreadsheet form at YCharts.

Google has no debt!

Now, let’s calculate a sticker price and MOS.

* EPS = 21.97 (according to Yahoo)
* Earnings Growth = 14% (That’s my number. Historically we’re looking at 34%, and analysts are estimating 19% for next year. Should do more “main street” analysis of this considering how large Google is.)
* Future P/E = 24 (that’s about average for Google. 2x earnings would be 28)
* MARR = 15% (This is my “minimal acceptable rate of return, i.e. I want to make at least this much per year)
* MOS% = 25% (Ideally you would want 50%, but that is hard to get with GOOG and I’m pretty confident in them.)

I get MOS numbers then like:
* EPS = 21.97
* EPS in 10 Years = $81.45
* Stock Price in 10 Years = $1,954.74
* Sticker Price Today = $483.18
* MOS Price = 3/4 = $362.39

So according to this, I am a seller above $483.18 and I am a buyer under $362.39.

For completeness, here is the Payback Time Analysis using these numbers. To recoup my investment in 8 years, I’d want to buy GOOG at $331.43. That basically means that if you bought all of GOOG at $331.43, you would earn that back in Revenues (assuming our growth numbers) in 8 years. That would be a good investment if you were buying a franchise, and should be a good investment when buying stock as well.

I hope this was informative. Feel free to pick apart my numbers. In particular, I am always interested in pondering what a company that grows at 14%+ for 10 years would look like in the future. I’ll do that in a future post.

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Commodity Investing – Insurance for your Purchasing Power

I wanted to provide a counterpoint to some recent articles posted on Investorgeeks that have suggested commodities are not a good place to invest.  More specifically, that the commodities boom is a high risk area of investing and potentially a giant bubble.

I have a different opinion.  I personally feel that investing in commodities is the only way to ensure in the coming years that your portfolio is not decimated by hyper inflation.

The Present State of the US Economy

Before we discuss this further, we need to do a quick summary of the present state of the US (world) economy:

1.  Ben Bernanke is printing money as fast as he is able.  As a result, M3 money supply is expanding at close to 20% per year.  Inflation, literally an expansion in the money supply, is running at close to 14% per year, as calculated using a basket of goods with no hedonics and weighting adjustments.  Clearly, we have managed to export some inflation.  However, I believe that is rapidly coming to an end due to the loss of confidence in the US economy and the pummeling the US dollar is taking.

2.  A flight to quality is depressing bond yields, with real yields that are NEGATIVE, even according to the government’s own crooked CPI.  Bond fund managers are calling for bailouts (at the expense of the US taxpayer).  Low yields were supposedly a result of petrodollar recycling and the yen carry trade.  The strengthening yen and diversification away from the USA suggests this binge is now over.

3.  The Fed is now willing to take the rubbish paper sitting on the books of large financial institutions and give them “liquidity” in return.  In effect, the Fed is buying these bonds for their face value, even though they know many are drastically overvalued if not worthless.  The US taxpayer is again left holding the bag.

4.  If we examine the Federal Government, we see overspending that is funded by thin air money creation (the Treasury floats some bonds and the Fed buys them with freshly created money).

5.  The Fed continues to lower the cost of money, slashing rates in attempt to create a positive carry trade for the banks.  Wall Street banks, and now brokerages, can borrow as much as necessary to bail themselves out.  This insidious practice is most detrimental to Mom and Pop investors who are unable to utilize the freshly created money until well after it has passed through the hands of the financial sector.  With the money supply increasing at 20% a year, it is the rare average Joe who is experiencing an increase in salary to compensate for their decreased purchasing power.  In fact, given the weak economy and the layoffs in the real estate and financial sectors with the consumer discretionary sector to follow, it is likely that wages will stagnate until the public wakes up to hyperinflation.

All of these actions are achieving two things:

1.  the death of US dollar; and

2.  a rise in the price of everything tangible (aka commodities).

This is very bad news for the US consumer.  Gold and oil have both appreciated a huge amount when priced in US dollars.  However, to the rest of the world, the price increases are partially offset by currency appreciation and perceived wealth due to inflated housing markets.

In effect, the standard of living of the average US consumer is DECREASING relative to the rest of the world.  For the past century, US consumers have helped themselves to a supersized portion of the world’s goods and services.  This was justified as the US was an industrial powerhouse.  Today, most production has been outsourced, leaving the US to sell services.  Ask yourself this – how many people do you know who are selling services compared to making products?  How many of those making products work for the auto industry?  What value do you think someone in the European Union places on an US accountant, lawyer or real estate agent?  More than a Chinese built toaster?  Less than a South Korean built plasma tv?

The falling dollar and high rate of inflation act as a tax on the US consumer.  As we all know, a tax increase slows the economy – decreasing consumption (Keynesian economics) or savings and investment (Austrian economics), depending on your world view.  We have seen the economy falling off the rails for months now.

While commodity prices have increased, firms have attempted to slow the rise in prices to maintain consumer demand.  As their margins narrow, expect to see a decrease in corporate profits.  We have already seen this with refinery crack spreads and food prices.

As a result, the full inflationary effect of all the “liquidity” trickling down from Wall Street to Main Street has not yet been seen.  All of these factors point to a sorry state for the US economy, and the world economy by extension.  “Stagflation” is here again.

Why Commodities?

Now that we have placed things into perspective, why should you invest in commodities?

Firstly, and most importantly, you cannot create commodities out of thin air.  Unlike the money supply, commodities require an investment of physical effort to create.  Imagine the entire GDP consisted of a single apple and the money supply was $10.  It is easy to work out that the apple would sell for $10.  Now imagine the Fed takes a piece of paper, writes $100 on it and marks it as official legal tender.  An investment bank would now purchase that apple for $100 and sell you a sliver for your $10.  We are at that point right now.  You have a decision to make – which would you rather own?  The apple or the $10?

Now replace “apple” in the last statement with “ounce of silver”.  One ounce of silver last year sold for ~$12.  Today is sells for over $20.  Has the ounce of silver changed?  No.  Has the value of paper money depreciated relative to the silver ounce?  Yes.  If you can purchase 10 loaves of bread with one ounce of silver now, you can bet that in 5 years time, in 10 years time, in 100 years time you are going to be able to purchase about the same quantity for your silver ounce, regardless of its face value in terms of “paper money”.  There will be fluctuations – in good times the value of silver will be lower, in bad times higher, but the inverse is true of almost every asset class.

Secondly, in most cases, “demand” for the commodity results in its destruction.  The apple is eaten.  Copper becomes part of the toaster and plasma tv mentioned above.

Thirdly, a difficulty in stockpiling (imagine how difficult it would be to store copper worth $1M compared to an electronic bank account) hinders manipulation in the commodity itself relative to the financial markets.  Very few individuals own the necessary warehouse space to store large volumes of any commodity, with the exception of the precious metals.  Doing so has costs with no yield.   It is true that markets can be manipulated through futures, but the majority of open positions are closed prior to settlement to avoid taking physical delivery (most futures dealers will do this for you automatically and do not allow physical delivery to occur).  Futures are generally available for every month, ensuring that markets are renewed repeatedly.  Attempts to “corner” the market in assets such as silver and copper have generally been disastrous.  Recently we saw such an attempt in natural gas that resulted in a hedge fund blow up and a depreciated price wiped away relatively quickly.

In short, the increase in copper from less than $1 to greater than $3 per pound is not due to manipulation, but rather supply and demand.

Lastly, the bull market is still young.  While a growing number of people talk about the commodity bull run, many are still invested in financial assets or real estate.  Each commodity normally has only a small number of companies in production.  Physical delivery of precious metals is rare.  A 25 year bear market has taught many individuals to stay clear.

Have you ever stopped to wonder why Cortez was so entranced by Aztec gold or why pieces of eight (silver coins) were a store of wealth for hundreds of years?

What and How to Invest?

In the event you are even slightly concerned about hyperinflation and want to protect your purchasing power, you should take action to ensure that around 5% of your wealth is stored in hard currency.

In short, take physical delivery of gold, silver, platinum or palladium.  As a secondary hedge, purchase some stocks who are early to mid stage producers.  Examples include Chesapeake (natural gas), CNOOC (oil), Pan American (silver) and Yamana (gold).

As another option, you can purchase the oil, natural gas, gold or silver ETFs, or invest in a broader basket of agricultural or industrial commodities.

Futures are risky and the use of leverage can blow up in your face.  However, there is no requirement for you to use the ~10 to 1 leverage.  If you had $10,000 to invest, you could purchase a contract for 100 barrels of oil for delivery in December of 2010, rather than ten contracts for 1,000 barrels.  That way you can hold through a 10 or 20% correction without forced liquidation.  If you want to take some extra risk, wait for a pull back (to say $90 a barrel) and buy two contracts.

Conclusion: Depression?

Lastly, and on a slight tangent, history shows that approximately every 100 years the world witnesses a depression.  This is normally the result of government intervention that pushes a recession over the cliff.  The last depression occurred in the 1930s.  The majority of the people who experienced the depression were so scarred, they hoarded food for the rest of their lives.  They hated debt and purchased precious metals to prepare for the next depression that never came.  Many maintained their own garden to have some control over their food supply.  Their children, the baby boomers, were less risk adverse but still heeded the lessons of their parents.  Their grandchildren, generation X and Y, have only a mild understanding of what a depression is and how bad things could become.

The world will face many challenges over the next decade – peak oil, peak natural gas, peak coal, record low supplies of foodstocks such as wheat and corn despite record production for the last decade, the retirement of many workers with the most experience and knowledge, and a population projected to increase by 50% by the end of the century.  I think it is prudent to prepare for the Black Swan that could be around the corner.

As always, good luck.

Phil

Disclaimer:  The author owns shares in all four stocks mentioned and silver and gold bullion.

This post is for entertainment purposes only. No part of this post should be construed to constitute investment advice. The author is not an investment professional and assumes no responsibility for any investment activities you undertake. Prior to undertaking any financial decisions, you should contact an investment professional.

To Buy or To Sell: That is the Question…

Do you buy or do you sell? Steve says the following:

Here’s the deal, if you felt Apple was a good buy at $130 and it drops to $120, why would you sell? Unless some really bad long term news came out, this is a buy trigger to me. Not only does it lower the cost basis of your original purchase, but it increases your holdings at a price better than you thought was good before.

That is a very dangerous game to play since if the stock drops again you now lost double the amount. And you cannot predict whether a stock will go up or down since it is a general crapshot. Easy come and easy go is quite common in the market.


Bottom line is, if you don’t need the money right now or in the next couple of years, there’s no need to panic when a pull back is coming because it’s really irrelevant in the big picture. The goal, at least in my opinion, is to amass shares of great companies and you need the market to drop to do that. Does Buffett dump Coke when it has a bad quarter? No, he doubles down. He knows he’s picked a great company and it will come back and when it does he’ll have a lot more shares that he bought with profits he got during the up period.

I am guessing by referencing Buffet you are talking about value investing, and buying and holding a stock. First let me repeat double down is a very dangerous game! My algorithmic trading system uses it, but unless you follow the market and watch how stocks are doing you will get your fingers burnt quite badly.

If you think you can double down and then hedge yourself with put’s be careful as I addressed this recently. Two days ago I looked at setting up a hedge with Apple, and calculated that it is too expensive and risky. Right now Apple is hovering at 45% implied volatility and that is absurd! This means to recoup your option premiums the stock has move at least 45%. With Apple being what it is that is a risky premium.

What I want to focus on is that pullbacks, and surprises are quite relevant, and let’s look at the Apple stock. Apple is flying high right now. But it was not always like that. Imagine you bought Apple in 1999, you would have had to wait until 2005 to recoup your profits. Imagine doubling down on Apple as the slide was going down? So for five years you are under water with your long shares. Can you afford to be under for five years? And what if you were leveraged? You could be wiped out. Ooops, many were after the dot com bubble.

To give you an illustration of how dangerous double down due to surprises, Steve Jobs himself did not even believe that Apple would do as well as it is doing now.

As of Friday, 5/25/07, Apple is trading for $112 per share. Therefore the value of the 10,000,000 shares assuming he still owned them all would be $1.12 billion.

However the value of the options would be far greater had he held them until now. The intrinsic value of the deeply in the money ESOs trading at 100 delta would be as follows: (112 – 9.15 x 15,000,000 = 1.54 billion) plus (112 – 21.80 x 40,000,000 = $3.6 billion) for a total of $5.14 billion.

So the exchange of the ESOs for the restricted cost Mr. Jobs over $4 billion. This is the most expensive and worst options trade ever made.

Steve Jobs the ultimate insider of Apple is a trading DUFUS! He is worth over a billion dollars, which is pretty good. But he gave up 4 billion because he wanted the security and safety of stocks. I don’t blame him, and I am not critiquing him. What this tells us is that Steve Jobs himself did not expect this kind of success. And if the CEO of the company did not expect this success how can a stock picker be smarter? Answer is that you can’t, and that successes like Apple often are a crapshot.

This means that timing is 100% relevant! I even think Buffet would not argue with that. Buy and Hold is a bad strategy, and I have data to back up what I say. Consider the following image.

This image is a profit (Y-axis) vs number of trades (X-axis) chart for a particular equity using a Monte Carlo simulation. I call it the tree structure and it is very telling.

  1. If you buy and hold, and the stock goes up, then you will make money.
  2. If you make some trades then probably you will loose money and it would appear that less trades is better.
  3. If you time the market then the chances of you making money in excess of buy and hold is pretty good.
  4. If you do bad trades, and think doing the opposite is the right thing to do, no, you are wrong because a bad trade is a bad trade.
  5. Sometimes a trader cannot hit the broad side of a barn!

This tree structure is consistent for ALL EQUITIES that I have tested against! What this told me is that if the equity is going up a buy and hold will yield a certain amount of money. If you trade a few trades then you will reduce your profitability. But if you increase your trades your profitability increases quite a bit because you are timing the market.

The net result is that a buy and hold will only earn about a third of day trading the same equity. The results vary since some equities go down, some go up, and so on. But there is always a timing to an equity.

For example a buy and hold of the equity modeled by the image would have yielded a 31% return. Respectable, yes. Yet had you day traded a buy side only, meaning no shorts on this equity you would have yielded a return of 90% with NO LEVERAGE.

Conclusion: Daytrading the buy side only of an equity that you believe is a winner yields more profit than a buy and hold strategy. Because you can’t predict the winners, day trading the equity you will at the worst not loose money. Double down works effectively in day trading scenarios because you are keeping a very close eye on your bottom line. Otherwise is a good way to wipe out your account.

Wine Investing

Bill (CEO of WineLog) did a quick little post on Wine Investing over at the WineLog blog and introduced me to a site called WineInvestor.com.

A good site to learn about wine investing is wineinvestor.com. Wine Investor is collecting (in one place) all the types of information I would need to explore investing in wine. The guy that runs Wine Investor is from the financial services field, works with technology, and loves wine. What a killer resume.

Investing in wine could be a great way to diversify your portfolio. Especially if, like me, you already have a passion for wine. WineInvestor calls it an alternative investment, specifically a “collectible”, and suggests about 5% allocation in collectibles in this article on asset allocation and diversification. (Let’s see, that means I need to go shopping for about $1500 in wine. Nice!)

Here are some other great articles from WineInvestor. New posts are added about once a week or so.

Turn 100,000 into 1.6 million in Four Months!

Yes you read it right, I can show you how to make 1.5 million in less than four months. You think it is impossible, right? Think of what you could do with that money. You could pay off your mortgage, take a trip around the world, or buy a brand new Hummer because well you can!

Sounds like a scam right? You are reading the title and first paragraph and realize its April 1! Yet wait it is real!

Head over to Zacks 100K Challenge and a trader called Java J has managed to convert 100,000 into 1.6 million in under four months! The guy is a trading machine! (BTW this is no April Fools joke…)

Amazing!

Why Are You Paying More?

I was reading Jason’s posting and forum entry was thinking…

“Yeah, commissions stink. With the E*Trade account, my net loss was ($629). I paid $441 in commissions.

I have thought numerous times about moving to another broker for commissions, but I’m really happy with how E*Trade has treated me otherwise. As my account size grows, the commission cost will become a smaller part of my gains/losses.”

Why are people paying more than they should? I really don’t understand it. It’s as if people enjoy throwing money out the window. My mother is in the same boat. She traders with Ameritrade, and BlueMax, and these companies are ripping you off.

Let me give an example:

On the etrade website they are saying you can get a savings account with no fees and no minimums for 5.05%. They are saying that they are 6x the nation average. Well, what they are talking about is a rip off!

I trade with Interactive Brokers which I consider a competitive broker. When my money is parked at IB I get interest based on the libor rate, which is a daily interest rate that banks lend to each other without collateral.

Right now the USD libor rate is 5.304%, and IB takes a 0.25% cut when paying interest thus I get 5.054%! In other words I get more interest with IB than eTrade.

Then people seem to get excited about Zecco and its no cost trades. It looks like no cost trades, but I wonder about the spread? Some brokerages that trade in CFD’s take no fees either, but their spreads include a fee.

Though I think I know where Zecco makes it money. They calculate an outrageous margin rate. Normally a margin rate is calculated using the libor, or at least that is what the brokerages pay. In my case my broker charges libor + 0.5%. Considering that the USD interest rate is 5.304%, I am charged 5.804% on my margins. With Zecco charging 10.5 percent, you are paying an additional 4.3% interest. This is money thrown out the window, up in smoke what have you!

And even if you don’t trade on margin if you day trade or do trades over multiple days you probably use margin. The exchanges hold your money for three days, which means during those three days you can’t buy or sell with that money. Normally brokerages will credit your account right away because from the brokerages perspective the transaction is a done deal and all that is left to do is fill out the paperwork.

To understand what I mean by margin even though you have enough cash consider the case where you have 30,000 in your account. If on day 1 you daytrade 15,000, then on day 2 you only have 15,000 available to trade. Even though your account will say 30,000 the 15,000 that has be credited to you is on margin until the cash is cleared. BTW this rule is not brokerage related, but is an exchange thing.

Summarizing it, what I don’t get is why people are throwing their money away when they could use a Professional Broker and save money?

You have to ask yourself are you trading for fun or are you serious about trading? If you are serious, then you need to calculate the interest costs, trade costs, and so-on. At the end of the day all that matters is how much you have in the pocket, not how much you made before expenses!

Mistakes Happen

Last week I made a $13,000 mistake (a tax ruling, not in my favor due to most impressive stupidity on my part). In Warren Buffett terms, that mistake cost me $226,842 ($13,000 compounded at 10% for 30 years – see boys, I do know how to do math).

I won’t sugar coat it. It sucked. Big time.

But I can guarantee that it won’t be my last mistake, nor my biggest (yeah, much to look forward to). Making mistakes is part of investing (or any financial decision for that matter).

I was once given some words of wisdom from an executive (after losing a million dollars, see full story here). He told me that mistakes happen, mistakes will continue to happen and the harder I played, the bigger the mistakes I would make.

And I do see myself moving along the mistake curve. I started with the small financial mistakes like thinking the stuffing envelopes for cash scam was legit. My learning there? Ask, ask, ask for opinions before shelling out hard earned money (in this case, $5, not much but I was dead broke at the time).

I progressed into mistakes like following hot investment fads (dot com, dot gone and ouch afterwards). That learning? Stocks that everyone is buying are usually overpriced (and ready for a correction).

My recent blooper taught me that I should never invest in something for tax savings reasons alone (complete dumbness). I was talking to an investment buddy of mine and he laughed. Seems that mistake is a rite of investing passage.

Do you see the trend here? Mistake, learning, different mistake, different learning, yet another mistake, yet another learning. Mistakes are fine (okay, they aren’t fine, they’re bloody painful) as long as we learn from them. Of course, it would be easier to learn from other people’s mistakes but who is smart enough to do that?

Some of us get stuck on one mistake (like following hot investment fads) and never move forward. As with school, the financial world forces us to sit through investment lessons until we finally learn what we’re meant to learn (or drop out). If I find myself continually losing money, I know that I haven’t learned an important lesson.

Of course, I don’t recommend deliberately making mistakes just so you can learn from them. Believe me, try for perfection and let the mistakes happen naturally. However, when they do happen, only mentally flog yourself for a day or two. Then chock it up as tuition fee, learn your lesson and move on.

Now that I’ve shared some of my idiotic moves with the world, why don’t you share some of yours? What have been some of your biggest, most creative mistakes (including scams fallen for)?

Mutual Funds ARE for Losers!

Kimber made a post about why Mutual Funds Aren’t for Losers, which was a good article and I see her point of view, however, in this case, I thought I would show the other side of Mutual Funds, which, in my opinion, suck to the point where vacuums should be named after them, or maybe they could rename the Chicago Cubs the Chicago Mutual Funds.

First problem is, they are overly diversified, bringing your risk down, but also bringing down your profits. Hugely bringing down your profits. Bringing down your profits to the point where you have to wonder why you bought it in the first place. You’re essentially saying, “I don’t care what I get, as long as I get something. Sometime. Maybe.” According to the Christian Science Monitor:

The average US diversified equity fund grew 6.7 percent in 2005, the third upside year in a row, according to fund-tracker Lipper Inc. “

I’m sorry, but 6.7% returns, on average, just isn’t good, no matter what the freaks on CNBC say and if you consider beating a risk-free CD by a measly 2.2% an ‘upside’, that’s pretty sad.

Secondly, you can’t trade them when the market is open. I know this goes against my strategy of only trading on weekends, however, if the world is ending, I want to know I can get out. You can’t get out with Mutual Funds.

Thirdly, the mutual funds are stuck at a limited percentage each stock can be within their portfolio. Let’s say Amgen finds a cure for cancer tomorrow. Can the mutual fund capitalize on this? Barely. You’ll be screwed watching everyone buy Amgen and seeing it go through the roof while the mutual fund sits with approximately 20% of their assets in the rocket ship and the rest in sinking stocks and you can’t even sell your mutual fund shares until the market closes to get the cash to jump on the bandwagon.

Fourthly, you pay taxes on trades you don’t make. You’re still invested in the fund, yet you pay taxes on the trades! Heck, in a mutual fund you can lose money for the year and still pay taxes because the fund could have had positive trades for some stocks and losses for others. It depends what year they sell the stock. (IE: if they buy a stock in 2000 for $10, it goes to $30 in 2001 when you buy the mutual fund, and then drops to $25 in 2002 and they sell that stock, you pay capital gains on $15, even though your fund lost $5 since you bought into it.) Not a good plan and not a good unexpected bill you have to pay at the end of the year. I’d rather take profits from my stock trades, set aside 25% of the profit for capital gains and know it’s there, or just hold my stock and not pay taxes until I feel like it or, better still, sell my stocks in January and invest my tax money for 16 months before I have to pay the capital gains on the sale. In any of the scenarios, if I’m trading stocks or Exchange Traded Funds, my taxes come out of the profits I’ve made, not out of my cash at hand.

The fifth reason they suck are the fees. Fees here, fees there, tons of hidden fees, added fees and for what? To pay a guy a million dollars a year to not beat the market? A big waste of money.

The sixth reason why they suck is they rarely beat the market. To quote our good friends over at Motley Fool:

“On the whole, the average mutual fund returns approximately 2% less per year to its shareholders than does the stock market in general. ”

and on the Smith Business website, in an article saying how great Mutual Funds are, they quote Motley Fool too:

About three-fourths of all managed mutual funds underperform the stock market’s average return, according to investor-run Web site “The Motley Fool.”

That essentially means, you’re better off buying Diamonds (DIA) or Spyder (SPY) (disclosure, I have SPY and MDY, which is the mid-cap index, as my ‘safe money’ investments), than to buy a mutual fund.

92 Million people currently own mutual funds, but how many people do you know who are invested in mutual funds say anything overly positive about them? Sure, when the market booms, things look swell, but realistically, over time, mutual funds don’t make people extremely wealthy, if they did, we’d have about 92 million millionaires saying how great mutual funds are and that’s simply not the case, not to mention all of the top traders trade stocks, not mutual funds, and I can show you dozens of people I know who have watched their mutual funds sit and do nothing or next to nothing while active traders killed the market consistently. Way back in 2003 I wrote an article over at my Undertrader.com site about dollar cost saving and buying ETF’s instead of mutual funds. If you had purchased Spyder (SPY) on the day of that article you’d be up $28.22 a share or 25.7% in 3 years and if you had bought the Mid-Cap (MDY) that day you’d be up $38.94 or 37.2% in 3 years and that’s without anyone managing anything, just a straight index.

Sure, it’s pretty swell that you can get percentages of shares in Mutual Funds and sure it’s cool that you’re instantly diversified, (which I don’t think is necessarily a good thing), however, an ETF is so much better than Mutual Funds that it’s not even a competition. It’s like Carl Lewis racing Emmanuel Lewis and individual stocks are like Carl Lewis racing Jerry Lewis.

If you only have $25 a month to invest, which is great and I applaud the effort and it’s a great start, I would rather you buy individual stocks from Sharebuilder and pay the $4 fee than to buy a mutual fund. In the long run you’ll learn more, you’ll come to grow and understand at least one specific company and it’s stock, and you’ll be investing on your own instead of letting some millionaire schmuck in a suit do it for you.

Invest in peace…

Following Smart Money (Real Shareholders)

My recent “discussions” with fellow InvestorGeek, Steve, about “baseball cards” as a metaphor for stocks have prompted more thinking on my part. Isn’t that what you wanted, Steve? Actually, I’ve already known that trading stocks is very much like trading baseball cards. I’ve already blogged about the same metaphor many times.

Though Steve and I disagree on whether dividend paying stocks are more than just baseball cards, another point of mutual agreement is that fact that most investors cannot affect any changes with their meager number of voting shares. Whether you own 1,000 or 10,000, or 100,000 shares of a company (even penny stocks), your ownership is no more than a drop in the ocean. But there are investors who do affect positive change through shareholder activism. Notable names include Warren Buffett (Coca-Cola), Carl Icahn (Time Warner), Kirk Kerkorian (General Motors), Ed Lampert (Sears/K-Mart). What if you followed them instead?

Why shouldn’t you leverage their insight and know-how to turning meager companies around? Very often, the news of an activist investor entering the picture can cause a falling position to revive. Case in point with General Motors – if you had bought GM when Kirk Kerkorian announced his interest, you’d have done very well for yourself. How about when Warren Buffett first took a position in unloved Coca-Cola? Or as Ed Lampert is currently trying to turn Sears around? The jury’s still out on the Sears venture, but K-Mart investors caught a break from their falling stock prices.

On the Forbes list of 400 richest Americans, a good subset of these folks made their fortunes by investing. That subset includes Warren Buffett ($46 billion), Carl Icahn ($9.7 billion), and Jim Simons (worth $4 billion). What are some other investors that can be considered “smart money”? Similarly, short investors may be following ShareSleuth to find out which companies Mark Cuban is currently shorting. But how do you take advantage of these legendary investors’ track records?

Following The Legends
Sites like GuruFocus.com make it their mission to follow the trades of many of the notable gurus, investors and fund managers out there. The information on GuruFocus can become a very good starting point for an investor to setup their initial stocks watch-list. If you’re willing to be a swing trader, you might not catch the bottom of the stock, but you might be able to ride the upward momentum!

I also use PubSub.com to keep track of trade movement by some famous investors. Through PubSub, you can get alerts on keywords in SEC/EDGAR filings. When these investors move, they often have to disclose their actions, and if you know what to look for, you stand a chance of staying ahead of the majority of the market.

Are there any other tools out there that I have missed?

Warning!
Blindly following anybody’s stock picks can potentially turn into a recipe for disaster. Smart money stock picks can offer a good starting point, but your own research and due dilligence cannot be replaced. How do you separate the true activist investors from the hedge funds looking to profit from arbitrage?

In the end, these investors are only looking to make profit for themselves. Please be sure you understand the rationale for these activist investors to buy a position in the first place. Check your own risk tolerance to see if you can stand the potential fluctuations like these investors can!