Utility Stock Research

Posted on July 24, 2010 by Carl from Chicago

It is time to start researching stocks for the 2010 trust fund recommendations (I recommend six stocks in total, each fund takes two, unless there are some special sells needed or consolidation).  While doing this, I also look for opportunities for myself on occasion, although the vast majority of my personal investments are in passive ETF’s with low costs and CD’s bought through a brokerage (and real estate). This particular post is discussing US utility stocks.

Yield and Interest Income

Right now there is little yield available.  Interest rates in the US are very low and the “risk premium” received for taking on more risk is not high relative to returns.  At one point the risk premium on lower rated debt was very high (in 2008-9 during the height of the fiscal crisis) but now it is only a couple of points over Treasuries for comparable maturities which isn’t worth it, in my opinion.  Per the latest:

  • 10 year treasuries 3%
  • equivalent corporates 4%
  • High yield 7.4%

Basically they are paying you only 1% more than what you’d get risk free for high quality corporates that still have a risk of default and then 4.4% more (pre-tax, meaning after tax about 3% more) for taking higher risk debt.  To put the “absolute” dollar amount in perspective, if you put in $100,000, you’d make $3,000 risk free with CD’s and then you’d make $4,000 with principal risk for corporates, and after tax the difference between the two is even less.  Why bother?

Picking stocks based on dividend yield is risky.  For one thing, stocks with a high yield (> 5%, for instance) tend to be paying out dividends at unsustainable rates, and when the dividend is cut, the stock price tumbles.  Examples of this from my portfolio include GE (since sold) and Nokia (likely soon to be sold).  Stocks with high dividend payouts are often valued by some investors on the stream of income, so that any “hit” to the dividend brings a disproportionate reduction in stock prices.  For other types of investors, dividends are one component of the valuation stream (along with potential appreciation in the stock price itself) so a hit to the dividend, while bad, won’t lead to a price free-fall.

Dividends currently receive a more favorable tax treatment than interest income from a bond.  Bond income is taxed as ordinary income (the highest rates), unless you are buying municipal bonds, which are an entirely different topic.  Dividends are taxed at a lower rate because they are already taxed at the corporate level, so taxing them again heavily when paid to investors essentially amounts to double taxation.  Dividends are currently taxed at 15%, while regular tax rates on interest income can go as high as 35%.  There is a lot of talk about letting these dividend rates lapse for personal taxpayers, however, in 2011 which would significantly reduce the value of these payouts and potentially impact behavior of corporations (who can often choose to do stock buy-backs which don’t have the same tax disadvantages), as well as likely pummeling the value of heavy dividend paying stocks. No one knows what is going to happen with tax policy; as I wrote here NO ONE thought that the US government would let the estate tax totally lapse in 2010, but it did.

Thus while you can view interest bearing bonds and dividend paying stocks as “equivalents” from a yield perspective, the stocks are MUCH more likely to fluctuate in value. Stocks can easily move 3% – 5% in a single day; bonds rarely move that much. Your “yield premium” from investing in a stock vs. a bond could be wiped out in ONE DAY due to a move in the stock price itself. Thus ideally you’d want a decent yield with the hope of price appreciation (or at least only a limited downside on price).

Utility Stocks

One possible substitute for bonds are utility stocks. I did a stock screener at google finance for utility stocks that were paying dividends between 3% and 7% with a reasonable sized market cap of > $1B, and a price / earnings or PE ratio of less than 12. In laymans terms I am looking for stocks paying a high but not unreasonable dividend yield, that were large enough that their stocks would be relatively more stable, and that weren’t over-priced relative to their profitability. Another item I was looking for was a lack of price appreciation over the last year or so; I don’t want to buy a stock that has had a big run up in value if I am looking for a dividend payer.

Out of this list came some reasonable candidates for review (I am excluding the foreign companies), including:

  • Ameren
  • First Energy
  • Exelon
  • UniSource Energy
  • Public Service Enterprise Group
  • Next Era Energy
  • Cleco

I will start to review these companies as potential candidates for the stock selection and for maybe my own “yield portfolio” that I’d put some money into relative to CD’s (not a huge percentage, but a decent start).

Some factors I will be looking at, besides the unique characteristics of each company, include the new EPA rule-making authority on emissions, which could require these companies to shutter older coal burning plants or retrofit them with expensive scrubbers, as well as trying to guess on whether the dividend reduction will be repealed.

Posted in Stocks | 3 Comments

More Good News

Posted on July 23, 2010 by Dan from Madison

This is making my FPRS position look better and better.  I like how they give soooo much credit to Alan Mulally, when in reality he has an army of middle managers who are doing all the hard work while he is cramming down Ford’s debt.  I guess I really don’t care how they do it, as long as they keep doing it.

Posted in Carl's Hero Alan Mulally, Performance, Stocks | Leave a comment

FPRS and Alternative Investments

Posted on July 16, 2010 by Dan from Madison

Stocks are a big part of any portfolio.  But they can’t be the end all - I don’t care how diverse you are in choosing those stocks.  To that end, I try to find other types of investments so not only am I diverse in the companies that I invest in, I am diverse in the instruments I use.  A few of these instruments are corporate paper, preferred stocks, and convertibles.

Back in Dec. 09, my financial advisor turned me on to FPRS, or the long legal name of Ford Motor Company Capital Trust 2.  I bought a block.

So what is it?  FPRS is a convertible preferred.  Here is the skinny:

FprS can be converted into 2.8249 Ford common shares any time before January 15, 2032.  It pays a $3.25 annual dividend per share.
It can be called by Ford at par value ($50) any time before January 15, 2032.  On January 15, 2032 it will be redeemed at par value for $50.

So this thing has a lot of characteristics of bonds and stocks, with the caveat that it is a preferred and a convertible - if there are dividends to be paid, this has priority over the common.  And in the grand pecking order in case of bk, you are after the paper but ahead of the common. 

Ford hasn’t paid a dividend for a long time - FPRS was about a year and a half in arrears.  If Ford suspends their dividend, the dividend payments on FPRS go into arrears, and it gets paid before any of the common gets a taste of any dividend.  And not only does FPRS get paid, it gets paid ALL of the missed payments.  I got paid today by Carl’s hero Alan Mullaly, king of the debt cramdown to the tune of $5.08/share.

The current share price for Ford is $11.86, making FPRS worth $33.50 if you decide to convert it to common.  My original block was bought for $35.44 so I am almost even as far as redemption value goes on that.  I doubled down yesterday at $43.74.  At the $35.44, my dividend payment gave me a 9.17% yield – but remember that I bought these in Dec. 09, so I got a full year of dividends in arrears for free.  Nice.  The current $43.74 price puts the yield at 7.4%, still great.  The key here is the $50 call – I have a sneaky feeling that Ford will be calling these pretty soon to keep retiring debt and I believe others are thinking the same thing as the price is heading close to that $50 mark.  Either way I am a winner as I am really in it for the yield.  Of course the previously mentioned yields are pre-tax.

I have used a simple buy and hold strategy with this thing, but you could certainly lever it with a convertible hedge strategy - but the price is getting pretty high and a convertible hedge is a pretty complex strategy for what we are trying to preach here (although I like it since it is market neutral).

Now, of course, this thing has risks, such as Ford could go TU at any moment - which is what GM and Chrysler did before they got on the federal teat.  I guarantee the GM and Chrysler bondholders and common holders (are there any left?) are hating those dogs right now.  Sometimes you need big stones when taking on the type of risk that Ford had back then – but no risk, no reward as the saying goes.  All the news from Ford has been pretty upbeat lately, and this has been a huge winner for me.  I think the F common isn’t a bad play right now either, but that is a different discussion.

Don’t ignore different types of investments in your portfolio for not only risk diversification, but asset diversification.  Preferreds and forms of them have been a major area of concentration for me in the past several years.

Posted in Carl's Hero Alan Mulally, Fixed Income, Performance, Stocks | 4 Comments

Dartboard

Posted on July 9, 2010 by Dan from Madison

Carl is getting ready for his stock picks for the next portfolio and I am going to play along this time, with a twist.  I am going to take an equivalent amount of money from Carl’s portfolio and go dartboard.  I will restrict my choices to Russell 2k companies (don’t want to totally throw my money in the fire like with penny stocks, etc.) and no ADRs, since (imho) those will be taking it in the shorts (heh) in the next year or so. 

My method is this – I am going to let a computer pick stocks at random.  That is it.  I will track performance much more simply than Carl, by just using the initial purchase price – knowing that a) I don’t want to spend a ton of time on this and b) that both of us reading here understand that the actual performance would be a bit lower due to fees, etc.

I am thinking that in the end I will probably kick myself for not random investing sooner.

Posted in Announcements, Humor, Performance, Portfolio Tracking, Stocks | 2 Comments

Lack of New IPO’s and Impact on Performance

Posted on July 8, 2010 by Carl from Chicago

If you read typical finance articles out in popular media you commonly see facts and figures about how US stocks outperform other investment classes over “the long term”.  As I do my own research I tend to see threads leading back to the premise that US stocks are entering a new environment going forward and past results are going to be less and less relevant in predicting future performance.  One of the reasons for this is the fact that the United States has ceased to be a dominant player in launching new public companies, and in fact is now mostly an also-ran when compared to Chinese markets or even Brazil as of late.

The Agricultural Bank of China is about to come out as an Initial Public Offering next week that will be one of the largest IPO’s of all time.  Per this article:

Hong Kong and China have dominated the global IPO market. That dominance will only increase when Agricultural Bank of China starts publicly trading next week.  In 2009, Hong Kong was the world’s largest IPO market, with companies raising a combined $32 billion in capital, according to Dealogic, a data-tracking firm. This year, China is on track to assume the mantle, with $31.7 billion raised by early July.

The Wall Street Journal had a recent article titled “How to Fix the IPO Market” by Jason Zweig.  I didn’t agree with their analysis or recommendations but the article did have a lot of useful facts and figures that illuminate the changes in the public markets in the United States, such as the following:

Ten years ago, around 9,100 companies filed annual proxy statements with the Securities and Exchange Commission. Last year, roughly 6,450 did; so far in 2010, only about 4,100 have, estimates Wharton Research Data Services.  In two-thirds of the years from 1960 through 1996, the number of initial public offerings exceeded the number of stocks that dropped out. Since then, however, there have been more deaths than births among stocks every year: 7,725 stocks have disappeared over that period, while just 4,299 new ones have arisen to replace them, according to Wharton.

What is happening is that existing companies are swallowing up smaller companies and other ones went bust during the market tumult.  New companies, however, haven’t joined them.  Recently there was a bit of a hoopla about a recent IPO for Tesla Motors, which raised $266M.  However, prospects for the car maker are cloudy and the stock has declined below its offering price since then.  If Tesla, a loss making niche enterprise is the future of our growth companies, we are in trouble.

The reason that this matters is that the entire “stocks outperform over the long run” is based on data from a few markets that haven’t suffered major disruptions (war, occupation) which pretty much brings you down to US and UK market data, mostly US data.  And this data was based on a continuous growth in companies launched through IPO’s with a growing market for companies; today the market for US based companies is small and much of the new and larger IPO’s are happening overseas.

There is nothing wrong with overseas markets growing; it is just that the US markets seemed to have stopped, and investor money (both US and foreign based) is going where the IPO’s are.  While we do not see the “full” effect of this trend, because many large multinationals are still US based and doing well, we will see it in the future as the newer companies don’t fill in the gaps and come through the ranks at some point in the future.

This doesn’t mean that I am saying that US markets will go up or go down as a result of this; I am just saying that the long term data was based on a premise that new companies would grow to replace the old (“creative destruction”) but in fact the new companies aren’t coming up in the footsteps. Perhaps stocks are best in the “long run” in aggregate across all markets but it may not be US based stocks if we just have aging companies and the young, growth companies are nurtured elsewhere.

Cross Posted at Chicago Boyz and LITGM

Posted in The Big Picture | Leave a comment

Contrarian Investing

Posted on July 7, 2010 by Dan from Madison

I have been blogging for a long time at several other sites.  Back in the day I used to fisk articles by Pa*l Krugm*n.  After doing this a few times it was very apparent that Krugm*n was just another partisan hack, and he really wasn’t worth me wasting time on.  In other words, I am better than that.  This doesn’t stop legions of people from picking apart Krugm*n all the time, and some of them do a pretty good job.

He recently came out with some sort of “another depression” deal in a column, and that was my signal to immediately jump in and buy stocks.  Pretty much everything PK says is wrong, so my intent is to go 180 degrees and do the exact opposite of what he predicts.

Barry Ribholz put up this post the other day that got me laughing.  It is about the Lex Team over at the FT.  Here is the money from the letter:

“Dear Investor,

It has been a profitable first half for Contrarian Partners. Our core investment strategy remains unchanged: to mine the research produced by investment banks every six months to establish consensus trading strategies. Then trade against them . . .

In general, though, the advice was reassuringly poor. The markets continue to reward us for listening to the experts – then doing the opposite.”

I don’t have access to the full letter since I don’t subscribe at FT (Maybe Carl can post) but all in all, this is probably a pretty good strategy.  Just like betting against PK, betting against big banks and their “research” can, I imagine, pay pretty good dividends.  Could they make any worse calls than in the last half decade or so?  I think not.

Posted in Performance, The Big Picture | 2 Comments

Portfolio Five Performance Update July 2010

Posted on July 5, 2010 by Carl from Chicago

Portfolio Five began last year. There are 2 stocks in the portfolio, and a total of $1500 invested. The current market value is $1394, which means that a loss of 7% was sustained. The stocks are Sinopec (SNP) and Siemens (SI), which are good long term holdings.

Click on the picture to see a clearer view than it has as an embedded file.  Next year I will break this out into spreadsheet format when there are 4 stocks to track.  Like Portfolio Four this one will benefit from the fact that expenses are lower now for holding an account and also buying and selling stocks since the fiduciary has a number of free trades each year and often they are allocated to the trust funds.

Posted in Portfolio Tracking | 4 Comments

Portfolio Four Performance Update July 2010

Posted on July 5, 2010 by Carl from Chicago

Portfolio Four began last year. There are 2 stocks in the portfolio, and a total of $1500 invested. The current market value is $1310, which means that it dropped about 12% during the year, a bit more than US indexes. The two stocks in this portfolio Wal-Mart and Nucor both seem to be good core holdings. Click to see the details below (the image looks blurry embedded and is better when “clicked-on”). Later next year I will begin tracking portfolios 4 and 5 in spreadsheets to see dividends by stock and also expenses. One benefit of funds 4 and 5 is that in the 9 years that I have been doing this fees and expenses have declined; I also get a number of free trades each year so essentially portfolios 4 and 5 have been going free of expenses since inception; this should probably boost their return by about 2% over the life of the portfolio, all else being equal.

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Portfolio Three Performance Updated July, 2010

Posted on July 5, 2010 by Carl from Chicago

Portfolio three has been in existence for three years, during one of the roughest and most volatile stock market periods. This portfolio is worth $3539 and dropped about 9% during the quarter, which is mostly in line with US indexes. This portfolio has only four stocks, meaning that changes in individual stock prices will have a disproportionate impact on overall performance.

Over the three years of portfolio life this portfolio has lost 21% of its value; $3000 was invested by me and $1500 by the beneficiary, for a total of $4500, against a current value of $3539 above. The annual performance is about -11.5% / year.

This portfolio can be downloaded on the right side of this page, updated for July 2010.

While all losses are painful and teach real-world lessons the beneficiary has still more than doubled their initial investment and it is good that the investment plus match by the fiduciary is 2x their investment in order to provide a buffer for the swings of the market.

Of the stocks in the portfolio, like the others it is suffering with Nokia (NOK) that I am strongly considering selling since they have not been able to fix their core business to date and are getting killed in smart phones. The other three holdings seem reasonable – 2 are majors (Wal-Mart and Siemens) and Urban Outfitters is smaller which means more upside for growth and has zero debt and is managed very reasonably for our difficult environment.

We will continue to invest over the years and it will become more diversified as the number of stocks being added increases, which will make portfolio performance swing less period to period relative to the indexes. With only 4 stocks if one tanks (Nokia, in this instance) it is difficult to recover.

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Portfolio Two Performance Updated July, 2010

Posted on July 5, 2010 by Carl from Chicago

Portfolio two is my second longest running portfolio. It has been in existence for 6 years. The portfolio lost 12% during the quarter, with the indexes dropping about 10% and then the ADR’s in foreign currency generally falling a bit further because of the appreciation of the dollar during this time frame (for the Euro denominated ones).

You can download portfolio 2 in excel on the right side of the page.

Over the long haul (6 years) this portfolio has an annual return of -2% and we have put $9000 into the portfolio ($6000 by me, $3000 by the beneficiary) and it is worth $8387, which is down about 7%. These numbers are good as far as “relative” performance over the 6 year time frame, but as they say, “You can’t live on relative performance”. The portfolio has been above cost and below cost for the last few years during the market tumult. The sales that we did generally turned out OK; in particular we sold China Mobile (CHL) for a big gain and BHP the Australian mining giant for another big gain and their stocks today are far below the price we sold them at. I track subsequent performance of all sales in the cover sheet for each portfolio (I must be a masochist to do this, but the kids ask).

The portfolio has 10 stock holdings, with an average balance of a bit more than $800. This makes it a reasonably well diversified portfolio, all else being equal (at about 10 stocks you achieve most of the benefits of diversification, assuming that the stocks aren’t mostly from industries with the same characteristics). One stock that looks like it is on the block is Nokia (NOK), which has failed to restructure and although it has a large percentage of the worlds’ cell phone market, it is a laggard in smart phones. Toyota (TM) is another holding, and I was very worried about it with the brake issue in the US but since then BP showed us all how to really decimate market value so paradoxically I feel a bit better about this. In the past Toyota has always proved resilient so I am inclined to give them the benefit of the doubt.

Diageo (DEO) has lost about 23% of its value but pays a decent dividend and per my recent analysis on currency moves and an ADR (see this post) the bad performance as of late has mainly been due to the decline of the UK pound against the US dollar and not an absolute decline in the company’s performance.

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Portfolio One Performance Updated July 2010

Posted on July 3, 2010 by Carl from Chicago

Portfolio One is my longest lived portfolio. This portfolio has been building up for nine years, and has a 3.1% return over that period. You can see the detail behind this portfolio as of July 2010 on the right sidebar.

We certainly were hit during Q2 2010, a time when US indexes generally lost about 10%. The balance as of March 2010 was $17,500 and now it is about $15,500, a loss of ($2000 / $17,500) = 11.4%. The loss was greater than the US indexes because the dollar strengthened against the Japanese Yen, the Euro, and the UK Pound during this time which further hurt some ADR’s in this portfolio even harder than the drop in the valuation alone.

This portfolio contains 15 individual stocks, with investments in each stock from a low of about $275 to about $1800, although the average is around $1000. At 15 stocks this portfolio has some reasonable diversification and should be expected to perform roughly in line with the overall indexes, give or take some for performance.

Out of the stocks in this portfolio I am most tired of Nokia. Nokia has a large percentage of the world’s cell phone market but is a dog at smart phones and is trying to re-invent itself. This reinvention has not been going well and I am about out of patience, likely will want to dump this stock as part of the new purchases to make during August, 2010.

I updated performance on the stocks we sold and generally do not have too much remorse for those sales based on their price today. In the past I sold some stocks when I thought they became over valued to try to take some of the risk off the table but as always there is reinvestment risk since you have to put that money back to work someplace else.

Posted in Portfolio Tracking | 2 Comments

Time To Calculate Portfolio Performance

Posted on July 3, 2010 by Carl from Chicago

It takes me some significant time to calculate performance on the 5 portfolios that I run. This is due to the fact that I do a lot of analysis on stocks held today and previous sales as well as calculate expense ratios, dividend ratios, and other tasks by individual stocks. I am going to try to find time to do this over the three day weekend since the stock markets are closed on Monday, January 5th (in the US).

By some measures it is a disheartening time to calculate performance. Indexes are down about 10% for the second quarter, and some international stocks in the portfolio were pummeled even harder by currency moves that hurt the Euro and favored the dollar.

I am going to use this information to distribute to the nieces and nephews and use the month of July and early August to select the six stocks for my 2010 recommendations. There may also be some recommended sales of stocks in the existing portfolios.

The most encouraging part of this for me is that this trust fund effort has done a great job on encouraging savings and thrift and teaching about real-world financial performance, both the good and bad. Since each beneficiary only puts in net 1/3 of the total investment (I put in $500, they put in $500, and then I match $500 more) the odds that the portfolio is reduced to the point where they are losing money on their portion of the investment are low (i.e. that we are down 66%). Every loss is painful, however, and I get questions to answer about how I selected the stocks and what happened. This is part of life today, and will be part of life in the future. There are no easy answers to these questions, just a life of education and the fact that having an in depth understanding of finance and money can be just as important as learning a trade or building an otherwise successful career.

Also if any legitimate commenter are out there, feel free to say something. It was nice to have someone comment that they agreed with my approach on the “match” as far as being an effective approach for teaching and increasing involvement in the outcome. As Dan has noted this site is an insane spam-comment magnet for whatever reason and while I used to occasionally peruse the spam comments before I deleted them now I just delete away because there are over 100 in the queue if I go even a few days without purging it.

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Currency Impact on ADR’s

Posted on June 27, 2010 by Carl from Chicago

In a previous post I calculated the impact of currency change on a specific ADR, Diageo, the UK spirits company. To do this, I looked at the price in US dollars on the US exchange (in this case the NYSE) and the price of the “underlying” stock on its resident exchange, in this case in Pounds on the London Stock Exchange (LSE). In the case of this stock, the ADR (which we own in the US) decreased in US dollar terms (what we really care about) by 25%, while the “underlying” stock on the LSE increased in value by 4%, for a “performance gap” of about 29%. The UK Pound dropped by about 27% during this period against the US dollar, which accounts for this difference.

Due to the large impact of currency moves on ADR’s, I am going to attempt to track this going forward on the spreadsheets that I use for each portfolio. For each ADR I buy I will do the following:

- track the price of the ADR on the US exchange at the time I bought it (already doing this)
- track the price of the ADR on its “home” exchange at the same date (this is new)
- track the ratio of US Dollars to the relevant foreign currency (in the case of Diageo, it is dollar vs. Pound relationship) on that same date
- then for each update I will track how the performance of the “underlying” stock is on its home exchange (in the case of Diageo, up 4%)
- I will track the performance of the US dollar vs. the foreign currency
- Then I will determine the portion of the gap tied to foreign currency moves, which will likely be the total performance difference between the ADR and the underlying value on the home exchange

In this post, I describe the process that I use to track stock performance and overall portfolio performance on each of my accounts (up to 5 now). The process of tracking performance is MUCH more complicated and tedious than you might think, since I am trying to track a lot of items that your brokerage statement either doesn’t want you to know or hasn’t thought through the process of giving it to you in a useful format. For 99% of the population out there (maybe even a higher percentage) taking apart the brokerage statement in detail and looking at the component pieces of return will teach you something that you don’t know. While the quality of the analytics provided by outside vendors is increasing, it is still not simple to track performance, pull out expenses, the portion of return due to dividends, etc… And I would be willing to bet that the average investor doesn’t know the portion of their portfolio’s return due to currency moves between the parent and the underlying exchange for ADR’s, for instance.

For those that are expert investors there are other impacts of currency moves WITHIN the stock price that aren’t simple to show like the Diageo example, above. For instance, if a company produces goods in a country with a strong currency and sells them in a country with a weak currency, that company’s profit will be impacted negatively, which will show up in their profit and loss statement, and impact the stock value. To avoid this impact many companies try to “source” production in the same country where it is sold, if that is possible. Companies can also “hedge” by purchasing contracts which, for the cost of the contract, will make the currency impact go away, and to make it more complex many companies only partially hedge. For the purpose of this analysis I am simplifying this away because it is already captured within the existing stock price valuation and future prospects.

I will add this analysis to the stocks that are ADR’s in the portfolio and get this for the update needed for “stock selection season”, which is coming up in late August before the kids / now some are adults go back to school / college for the year.

Posted in Portfolio Tracking | Leave a comment

A Matter of Perspective

Posted on June 22, 2010 by Dan from Madison

Carl, in his last post, challenged me to write a few words about the topics of saving and thrift.  I come from a pretty thrifty family so here goes nothing.

Continue reading →

Posted in The Big Picture | 2 Comments

MGEE – Safety or Yield?

Posted on June 22, 2010 by Dan from Madison

On June 7 I bought another block of MGEE at $34.36/share and since then it has gone up to $36.76 as of this writing.  I discussed MGEE here.  That is an immense move for a utility, and especially one like MGEE which steadily increases in value, but typically at a much slower rate.  Of course, this makes the yield look worse then when I bought it – but the increase in stock price is a nice problem to have.  Problem for me is that I need to hold it until it is long term as if I sold it now I would get killed on the gains come tax time.  No matter – I hold it like a bond anyway and actually count it against my fixed income side in my allocations.

The only thing I can think of to explain the quick move is that a large institution or some other big baller has plowed in for safety and/or yield.  It will be interesting to see in the coming months if they sell it or hold – that will tell the tale if the institution/baller was buying for safety or yield.

Posted in Fixed Income, Stocks, Taxes, Tracking | Leave a comment

The Importance of Saving and Thrift

Posted on June 21, 2010 by Carl from Chicago

Yesterday I had a chance to talk to my nieces and nephews who participate in this program and they were working summer jobs and other odd jobs to collect the money to invest so that they can receive their “match”. Remember in this model I put in $500 / year, then if they put in $500, I will match $500 more, to bring it up to $1500. After 10 years or so of this, plus some returns (hopefully), they can accumulate a sizable pool of money to either use for college or to start their lives post college (put money down on a house, or have it as a reserve fund).

Many times discussions about investing minimize the absolutely central fact that savings is about deferring consumption and the importance of thrift. You need to put aside money and question all of your spending, and when something adverse happens (you end up paying for something that breaks, or you end up paying a late fee on an account or interest on an open balance) you need to change the course of your activity so that it doesn’t happen again.

In America we don’t say it enough that it is HARD to accumulate any sort of nest egg or positive net worth. Many people’s paychecks are gone before they even receive them and it is so easy to add on debt for your car, your house, or to buy things on credit at a department store. The tax burden is high, and if you aren’t careful your entire lifetime of work will come and go and you will have precious little to show at the end, when you need to rely at least partially on your own savings to fund your retirement.

Kids going into college now also face an immense burden in the form of college loans, which cannot be discharged by bankruptcy, and can stay with you for decades. I think that as people accumulate debt during college for legitimate purposes (tuition) then they just figure that they are in debt anyways and pile in on the living expenses, vacations, and other minor expenses which pile up over the time that they are in college. Since the number seems large, what is the harm in adding a few more dollars to the pile? In addition, I don’t think that all of them consider ways to reduce this debt by 1) completing school faster 2) taking courses in the summer in local community colleges and living at home 3) doing all they can to minimize living expenses, including no vacations from work, living as cheaply as possible without getting robbed, and avoiding having a car.

In order to make money you need to HAVE money, money that you have saved up after day to day expenses and isn’t already spent by debt and living expenses. You can only HAVE money if you save diligently, question expenses continuously, and minimize debt.

Even once you have money and are investing it, it is far from a “sure thing”. Some of my portfolios (particularly #3) have started up during terrible times in the stock market, and haven’t grown like #1 which came during a still bad but not as difficult period. This is another important lesson to learn; that investing takes patience and guts and doesn’t always turn out like you planned. This is “real money”, not money like you see on TV or in a video game, and it is painful when investments don’t pan out and you lose money, but you also can’t just put it all in a bank account and watch it sit there and essentially earn nothing.

These are real life lessons and if I can do anything to help them along during the course of this trust fund effort then I feel that I am helping, even if just a bit. And through this web site I am trying to help anyone else who would want to do the same thing and directly or indirectly impart these same lessons.

Posted in The Big Picture | 5 Comments

Tax Update

Posted on June 19, 2010 by Carl from Chicago

When Dan and I were first invited to join Chicago Boyz Jonathan mentioned my high quality posts on energy and taxation.  Recently I have not been writing too often about taxation because the news from the US perspective has been almost universally negative.

Two core principles of taxation are:
1) the tax should be effective, meaning that if it intends to raise a certain amount of revenue that it should be designed to achieve that end
2) the tax should minimize negative impacts on overall economic behavior

Japan Considers Lowering Its Corporate Tax Rate

There was an old joke that Arkansas’ motto was “thank god for Mississippi” because else Arkansas would have been #50 in the rankings by state on various metrics.  In that same vein, when ever I talk corporate taxes and about how the United States is the least competitive corporate tax environment in the world, they would say that in fact, Japan was worse.

Now even Japan has woken up to the fact that high corporate tax rates push investment overseas (since companies can choose where to invest in new plants, subsidiaries and businesses) and are a relatively poor way to raise incremental tax revenues.  According to this Wall Street Journal article titled “Kan Seeks Cuts in Japan’s 40% Corporate Tax Rate” the newly installed Japanese government is considering reducing this punitive rate, which would take away our “Mississippi” per the analogy above.
Continue reading →

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Word Press 3.0

Posted on June 17, 2010 by Carl from Chicago

This site recently upgraded to Word Press 3.0.  I initially did not understand all of the enhancements present in the new version.  I went to the Word Press.org site and saw a brief video and boy, oh boy are there lots of new features to learn about.

While any half-way decent programmer could always customize a Word Press site, I don’t qualify as a half-way decent programmer.  I focus on content and am only marginally interested in spending hours tweaking code.  In fact if I get 30 minutes to focus on anything that is an eternity.

To me the most immediate benefits were due to the fact that a new Word Press THEME comes with 3.0.  The original Word Press theme is called “Kubrick” and it is VERY old.  You have probably seen it all over the web and this theme screams “I am all about content” and don’t care about presentation.

This new theme finally makes it easy to customize the header and the sidebar and widgets and a million other features.  You’ll notice the picture on the top – it is one of my own and while it may or may not have much to do with investing it is a nice start.

I will be spending some time with Word Press 3.0 and will put in some more advanced features on the site over time.  Since Dan and I run a few sites any knowledge gained can easily be applied across all these sites with a bit of work.

I would like to thank Word Press for putting out such a great product and all of the volunteers who do all the work.  And I especially want to thank them for updating the default theme because this will allow me to learn a lot without having to navigate through myriad themes on the site which all have different features, capabilities and bugs.  These default themes are really for people like me because skilled programmers just tweak them anyways, so thanks again for thinking of us poor people who just want to focus on content.

Posted in Announcements | 1 Comment

Impact of Currency Moves On An ADR

Posted on June 17, 2010 by Carl from Chicago

One of the stocks recommended in prior years’ and currently held in Portfolio 2 is Diageo, the UK spirits company.  Since the portfolios that I run for my nephews and nieces only purchase and hold stocks on US exchanges (for simplicity reasons), in order to get international exposure to companies like Diageo they are purchased as an ADR, or “American Depository Receipt”.    Here is a decent definition of an ADR, from wikipedia:

An American Depositary Receipt (abbreviated ADR) represents ownership in the shares of a non-U.S. company that trades in U.S. financial markets. The stock of many non-US companies trade on US stock exchanges through the use of ADRs. ADRs enable U.S. investors to buy shares in foreign companies without the hazards or inconveniences of cross-border & cross-currency transactions. ADRs carry prices in US dollars, pay dividends in US dollars, and can be traded like the shares of US-based companies.

Each ADR is issued by a U.S. depositary bank and can represent a fraction of a share, a single share, or multiple shares of the foreign stock. An owner of an ADR has the right to obtain the foreign stock it represents, but US investors usually find it more convenient simply to own the ADR. The price of an ADR often tracks the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares.

Thus for practical purposes the ADR is issued in US markets which enable US investors to easily hold and trade the stock and receive dividends.

Our shares of Diageo (the ADR is on the NYSE,  while the “main” stock is issued on the London Stock Exchanges or LSE) were purchased in late September, 2007 at a price of $88.75.  The current price of the ADR as of mid June 2010 is $66.42, calculated as (88.75-66.42/88.75) a LOSS of 25% of its value, as traded on the NYSE as an ADR.

The “main” stock on the LSE, however, traded for about 1074p in September, 2007 and is now worth 1,115p as of mid June 2010, for a (1115-1074/1074) GAIN of 4%.

Leaving aside the issue of tracking error on in the US ADR which is not likely to be significant, the gap in performance of 29% between our loss and their gain is measured by the performance of the US dollar vs. the British Pound.  In September, 2007 the British Pound was trading for roughly $2 against the dollar.  It is currently trading at approximately $1.46 against the dollar, for a  (2 – 1.46/2) LOSS OF  27%.

Thus the difference in performance between the two stocks was 29% and the fall in the British Pound vs. the US dollar was about 27%, so you can see that this delta is almost totally caused by the change in currency value during this time.

For years this currency effect has worked in FAVOR of US investors putting money in overseas stocks because the dollar was declining against other major currencies (the pound, the Euro).  However, now the US Dollar is strengthening against foreign currencies so the impact is reversed, and if you have significant overseas exposures in most currencies you are now seeing losses when they are translated into US Dollar terms.

Since I track a lot of items on the custom spreadsheets that I make for each portfolio I will start tracking the currency impact on ADR’s as distinguishable from the performance on the underlying exchange.  This will highlight the DIRECT portion due to changes in currency costs.

A couple of minor items:

- for my portfolios where I don’t usually owe taxes one minor annoyance is that taxes are withheld for overseas dividends.  If you pay foreign taxes you can net them against your US obligations (at a simplistic level) but since my portfolios don’t generally pay taxes due to their low level of gains and losses I don’t get this back.  Here is a company site explaining how a Finnish company withholds taxes on dividends which is useful.  For my purposes in the portfolio I only show the “net” proceeds; on my yield calculation I may start to show it “net” of withholding since I don’t get it back

- of course currency issues are far more complicated than this in that the company may earn in USD or in British Pounds; for example Diageo earns a lot of its income on US sales so it may book gains or losses anyways on currency but these are already “embedded” in the income statement.  The ADR price between the LSE and NYSE is due to the  “currency change” impact, but changes in currency rates may also impact the price of Diageo on the LSE itself

Posted in Stocks | 1 Comment

Don’t Forget Sin Companies

Posted on June 17, 2010 by Dan from Madison

This is an interesting story from Bloomberg.

A Scotch whisky matured for more than six decades sold for 25,200 pounds ($37,245) at an Edinburgh auction today as collectors vied for rare malts.

The bottle is one of 61 produced by the Glenfiddich distillery and the whisky has matured for 64 years, host Bonhams said in its catalog. It was bought by an unidentified purchaser over the telephone. Bidding started at 10,000 pounds.

Many of the uber-rich are making what are called “alternative” investments and buying things like aged scotch, paintings, diamonds, expensive cars, and other worldly goods and storing them away for fear that their paper investments will cascade down in value.  It is an interesting concept.

Of more relevance here on this blog (joe blow retail investor) is the whole concept of Sin Companies, as I call them.  Some people try to let their consciences get in the way of their investing, but I have never looked at it that way.  People are always going to smoke, drink and do other things to try to escape their realities.  It isn’t my problem.  My problem is to find ways to maximize yield for my investments.

I have always been a huge fan of MO and I own a sizable chunk in my portfolio – and I always will.  The cigarette business is almost a purely cash business, as is liquor.  Hardly any accounts receivable.  I wish my business ran that way!  Right now, the yield on MO is a staggering 7% ($1.40, at $19.86/share as of this writing).

I don’t see an end in sight for MO as many, many young people smoke and in the key area of the Far East, EVERYONE smokes like chimneys all day long.  Phillip Morris International is also a nice choice.

If you like booze companies, try to pick one with large international exposure.  As people in China and India get more money, they will be buying more, and better quality booze.  I have some exposure to Indian technical people and in off the cuff conversations, it seems that they are crazy for Jack Daniels of all things.  Brown-Forman might be for you, although over the past year that stock has had a huge run-up.

I guess in the end, I am the type of person that doesn’t really care about what others do with their bodies and always look to the Sin Companies to round out parts of my portfolio.  Others don’t share this same philosophy and I can respect that as well.

Posted in Stocks | 1 Comment