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| Finding successful investments is hard work. My colleague Dan Ferris and I routinely evaluate dozens of companies before finding a few that are worthy of additional research. Unfortunately, that means we probably spend more time reading about businesses that we don't recommend than reading about those we do. Often, our research begins with a company's annual report. To achieve transparency with investors, public companies are required to file these reports with the U.S. Securities and Exchange Commission (SEC), which refers to them as "10-Ks." Annual reports provide a wealth of valuable data. Better yet, the data are accessible 24/7 on the SEC website. These reports are often 100-150 pages long and contain a mind-boggling array of numbers. Our challenge is to quickly separate what's important from what's not. Or as Arthur Conan Doyle's famous fictional sleuth Sherlock Holmes says…
How do you separate "incidental" from "vital" in a document loaded with thousands of seemingly important facts? You must have a plan. I have read thousands of annual reports in my investing career. Over time, I've developed a system that helps me quickly assess if a company is worthy of further study. My system starts with these five questions…
Question No. 1: Are there risks related to the company's revenue stream that aren't readily apparent? Typically, an overview of the business and how it generates revenue can be found within the first few pages of an annual report. Spend some time there. I specifically look for two risks…
Customer Concentration Ideally, we're looking for companies that sell to many, many customers. This limits the risk that revenue might suddenly decline from the loss of any one customer. It also limits the leverage any one company can have on the business. Raising prices on a customer that's responsible for 60% of your business will always be a challenge. Be aware that some industries routinely experience high customer concentration. Food manufacturers like Hain Celestial Group often report Wal-Mart as a major customer (10% or more of sales). Suppliers of original equipment manufacturer (OEM) auto parts typically have high exposure to one or more of the major car manufacturers. BorgWarner, for instance, reports that 17% of its 2014 sales were made to beleaguered Volkswagen. Companies in the semiconductor industry also routinely experience high exposure to just a few customers. Cirrus Logic is an extreme example. In 2014, 72% of its sales were made to a single customer, Apple. Exposure to Commodity Prices In addition to assessing customer concentration, you also want to determine if there is hidden exposure to cyclical commodities, like oil and gas. Remember, a company doesn't have to be in the oil and gas business to have significant exposure to its boom and bust cycle. Last November, I addressed this problem in the Stansberry Digest. Oil prices were starting to fall hard. I warned investors they might be unwittingly exposed if they owned companies that did a significant amount of business with oil and gas producers. Here's what I said at the time…
After I wrote that, the drop in oil prices did resume. And Emerson's stock price has dropped about 29% since then. Question No. 2: Are there other unusual risk factors? Toward the middle of a typical annual report, you'll find the Risk Factors section. Here, a company identifies and lists the primary risks for its business. Many of these risks are generally the same from company to company. For instance, if a recession appears, sales are likely to decline. If another company is acquired, the integration may underperform the expectations management has set. What I'm looking for are unique risks. Here's an example from the 2014 10-K of Molina Healthcare, which provides health care plans to more than two million members across the U.S. (emphasis added)…
This is something you don't see every day – a change of one percentage point in expenses potentially reduces income 91%! No matter how attractive Molina might otherwise be, this vital fact about its business model was a deal-breaker for me. Question No. 3: Has the company demonstrated that it can grow revenue and earnings? Near the Risk Factors section, you'll usually find a financial review covering the past five years. This lets you quickly see whether the company has been successful at growing sales and profits. Growth in these two metrics is vital because it typically means the products and services the company sells are enjoying greater demand over time. Companies that get bigger and better are exactly what we're looking for. Acxiom is an example of a company that has not been growing revenue or earnings. The provider of enterprise software has been around for more than 40 years, but sales the past two years were actually lower than they were five years ago. Earnings also trended down during this period. By glancing at Acxiom's five-year financial history just a few minutes into my research, I was able to quickly eliminate it from consideration. Question No. 4: Is there evidence of operating leverage? Operating leverage is simply the ability to grow profits faster than revenue. Superior business models often grow profits faster than revenue, so I consider this a vital fact that helps me quickly determine whether a particular company is worth further evaluation. Fleetmatics provides fleet management software services to 25,000 enterprise customers with large truck fleets. It's a textbook example of operating leverage. Over the past five years, revenue grew about 37% per year on average. Income grew a much faster 85% per year on average. Adding lots of new fleet customers didn't require the company to build a new plant. It just needed room for a few new employees and their computers. Capital-light businesses such as Fleetmatics routinely demonstrate operating leverage. Investors love rapidly growing companies that can grow earnings quickly. They regularly pay dear prices to own them. That's why these kinds of companies are rarely found in the Extreme Value model portfolio. Ideally, we look to buy these kinds of businesses during major market downturns when everything goes on sale. Question No. 5: Is the company generating free cash flow? The last thing I look for when starting the evaluation of a new company is its ability to generate free cash flow. This can be easily determined by going to the Statement of Cash Flows, which normally follows the Balance Sheet and Income Statement about two-thirds of the way into a typical annual report. Free cash flow is not a line item on the cash-flow statement. Instead, it has to be calculated by deducting expenditures for property and equipment (i.e. capital expenditures, or "CapEx") from net cash from operations (or operating cash flow).  As Dan likes to say, free cash flow is what gives equity its value. This is the surplus capital management has at its disposal to grow the business, reduce debt, and give back to shareholders via dividends and share repurchases. The cash-flow statement in an annual report normally covers the last three years. Ideally, what I'm looking for is growing free-cash-flow generation over that period. If a company was unable to generate even a moderate amount of free cash flow over the last three years, I usually lose interest in it as a potential investment idea. There are almost 7,000 companies listed on the three major U.S. stock exchanges: NYSE, Nasdaq, and Amex. Finding the handful of businesses that will translate into successful investments is hard work. Having a plan like the one outlined above helps us eliminate many subpar businesses from consideration quickly… and focuses our attention on those that are worthy of your investment capital. As you conduct your own research, I highly recommend you follow this guide. Good investing, Mike Barrett Source: Daily Wealth Follow us on Twitter: @blacklioncm |
Showing posts with label Daily Wealth. Show all posts
Showing posts with label Daily Wealth. Show all posts
Friday, December 11, 2015
Successful Investments Start With These Five Questions...
Monday, December 7, 2015
Four Easy Steps to Banish Fear and Change Your Life, Today
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| I used to dread the thought of public speaking. And when I was forced to make a speech, I did a terrible job – which only made me dread the next speech even more. It was a vicious cycle. When I became the editorial director of a newsletter business in South Florida in 1982, I found myself in an uncomfortable position… I had to conduct meetings and give presentations at industry functions on a fairly regular basis – something I was ill-prepared to do. So, I decided to enroll in a Dale Carnegie program for public speaking. Somehow, I registered for the wrong course. Instead of focusing on speech-making, it had a broader goal. And that program changed my life. It taught me the importance of setting goals and taking action. But it also taught me to be more comfortable as a speaker. My speech-making skills improved almost accidentally. Every week, we had to read a chapter of Carnegie's classic book, How to Win Friends and Influence People, and then make a two-minute in-class presentation about how we were going to put the principle of that chapter to work in our lives. On Thursday evenings after work, I would drive a half-hour to the meeting place. During that drive, I thought about what I was going to say. It was difficult in the beginning, but it got a little easier each week. By the end of the 14-week course, I was performing at a near-professional level. I had won several awards in competitions and was routinely rated at the top of the class. The final session was a sort of commencement ceremony. Relatives and friends were allowed to attend, which tripled the size of the audience we had to speak to. I gave the last speech. I was still a little nervous when I got up to the podium, but I'd learned a lot by then. So, I took a deep breath and did my thing. I got a strong round of applause. Several people I didn't even know came up to congratulate me… and one suggested I should become a comedian. I wasn't foolish enough to take his advice to heart, but it did make me happy to think I had made so much progress in so little time, starting from practically zero. How did I conquer my fear of public speaking? The same way you would conquer the fear of anything else. Humiliation and Humility A big part of what we are afraid of is embarrassment – being shamed in front of other people. When embarrassment is extreme, we call it humiliation. If you pass gas at a fancy dinner party, you feel embarrassed. If your big project at work fails miserably – and you've been bragging it would be a "sure thing" – you feel humiliated. Humiliation is what happens to embarrassment when it's mixed with pride. The prouder you are, the more failure hurts. Which brings us to our cure for the fear of failure: humility. I'm guilty of priding myself. I'm proud of my writing, for example, and the success I've had in business. So, I have to keep reminding myself to be humble about those things. But I'm not proud of everything I do. I take no pride in my ability to dance, sing, or speak foreign languages because I do those things so badly. And because my ego isn't involved, I'm not embarrassed to ask stupid questions, to show myself as a beginner, and, ultimately, to fail again and again as I attempt to master those skills. The truth is, when I started out in business, I wasn't very good at that, either. Again, that made it possible for me to ask lots of questions, look stupid, and make mistakes… which accelerated my learning curve. That last observation brings us to an important principle of success. I call it "the secret of accelerated failure." It's a principle I developed in the early 1990s. The principle of accelerated failure is this: To develop any complex skill, you must be willing to make mistakes and endure failures. The faster you can make those mistakes and suffer those failures, the quicker you will master the skill. At the Palm Beach Research Group, we teach this secret to our managers. We encourage them to allow their employees to fail. Not to fail stupidly. Not to make the same mistakes over and over again. But to feel free to fail at something – so long as it was done in the pursuit of knowledge. If you play golf or practice Brazilian jiu-jitsu, you know this to be true: If you tense up and focus on avoiding mistakes, you will learn very slowly. If you relax, let the mistakes happen, and learn from them, you will advance quickly. It starts with being humble. Humble enough to accept the fact that when you begin anything new, you're likely to do it poorly. Humility Is Nature's First Gift Pride prevents us from admitting we are incompetent. But we're all incompetent when we're learning. Think of how a baby learns to walk. He begins by crawling, then advances to "forward falling" (as my brother calls it), then to walking like a little drunkard, and then, finally, to walking masterfully. Babies don't feel shame, because they're not proud. There's a reason pride doesn't invade the human psyche until 6 or 7 years of age: There's simply too much to learn before then. If toddlers had pride, it would take them years – or even decades – to walk and talk properly. Humility is a much-underrated virtue. It provides us with at least three significant advantages:
If Humility Is the Solution, How Does a Proud Person Become Humble? Now we are coming to the most important part of this discussion – a practical plan for defeating the fear of failure. Here's how you can do it:
Defeat your fear of failure by being happy – and even eager – to try and fail until you succeed. That's how Edison invented the lightbulb. That's how Michael Jordan, a very mediocre basketball player in high school, became the greatest hoops player of all time. They weren't afraid of failure. You shouldn't be, either. Regards, Mark Ford Source: Daily Wealth Follow us on Twitter: @blacklioncm |
Friday, December 4, 2015
Don't Let 'The Glidepath Illusion' Ruin Your Retirement
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| The traditional notion of retirement says you should take bigger risks in the stock market when you're young. You have more time to make up for losses than when you're older. As you age, you should take less and less risk, so you won't lose your retirement money. This strategy is called "Glidepath investing." And it could ruin your retirement. Let me explain… The emotional appeal of Glidepath investing is obvious. Young people feel like they're going to live forever, so it feels better to them to take more risks. Buying more risky stocks and fewer safe bonds feels right. Older people feel they have more to lose and might not be able to support themselves one day, so they tend to be more risk averse. For them, buying fewer stocks and more bonds feels safer. There's an army of financial planners and other "helpers" out there selling products designed to get you to retirement with a big, safe nest egg, based on this feel-good notion. However, research suggests that what feels good isn't necessarily what you should do… Investor and researcher Rob Arnott of Research Affiliates published a report in September 2012 called, "The Glidepath Illusion." Arnott says Glidepath investing will make you less money because it will lead you to put less money in higher-return investments (stocks). Arnott studied 141 years of stock and bond returns from 1871 to 2011. From these data, he hypothesized a range of possible outcomes. In general, Arnott found evidence that the range of outcomes from doing the opposite of Glidepath investing was superior to the range of Glidepath-based outcomes. It's well documented that stocks outperform bonds over the long term.Glidepath investors wind up putting a bigger percentage of their assets in stocks when they're younger and have less to invest. They put a higher percentage into bonds when they're older and have more to invest. That's the basic error. Investors put fewer dollars into higher-return investments, then interrupt the compounding process to put more dollars into lower-return investments. So they make lower returns than if they had done the opposite of Glidepath investing. Glidepath investing is a good recipe for feeling good, but a poor one for making as much money as possible in stocks and bonds. Arnott's conclusion is worth quoting and keeping close at hand as a reminder… Investors who are prepared to save aggressively, spend cautiously, and work a few years longer (because we're living longer), will be fine. Those who do not follow this course are likely to suffer grievous disappointment… No strategy can make up for inadequate savings or premature retirement. Save aggressively. Spend cautiously. Let your investments compound as long as possible before drawing them down. That's sound advice. Sadly, it makes perfect sense that the financial services industry is once again doing exactly the wrong thing for clients. Don't trust financial planners and brokers. They're commissioned salespeople. They're incentivized to sell investments, NOT to make you money in stocks and bonds. For as long as my health holds out, I'll stay productive and hopefully get well compensated for my efforts, saving aggressively and spending cautiously. I recommend you do the same. Good investing, Dan Ferris Source: Daily Wealth Follow us on Twitter: @blacklioncm |
Thursday, December 3, 2015
The Ultimate Cash-Management Guide
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| No one talks about how to manage your cash. As regular readers know, we suggest holding cash in an emergency fund and in your portfolio. If you've followed our advice, you likely have tens, and maybe hundreds, of thousands of dollars in cash. But you need to give some thought to where you put it… As with every investment, when you look at where you put your cash, you need to balance yield and risk. Some of these cash accounts I'm going to cover today are 100% risk-free. Others claim to be low-risk, but may have hidden risks that are difficult to understand. We'll start with the lowest-risk, most "pure" cash accounts… And we'll proceed through investments that could offer a higher yield. The safest cash accounts are FDIC-insured checking and savings accounts with banks. FDIC insurance means that even if the bank makes disastrous loans or a bank manager absconds with the money in the vault, the Federal Deposit Insurance Corporation will make depositors whole, up to $250,000. These accounts are liquid, meaning you can access your cash almost instantly via online banking or at a branch office. Checking accounts are a good example. You can write checks directly from your account. However, they pay little in interest. I recommend keeping your checking balance just high enough to avoid any overdrafts. Or do what I do and link your checking accounts to your savings account for overdraft protection. Savings accounts offer better yield, with the same safety. Were it not for historically low interest rates, this would be a Golden Age for savings accounts. The advent of secure online banking has removed geography from the equation. So smaller banks looking to boost deposits often offer higher rates to anyone. Big national banks, like Bank of America and Wells Fargo, offer savings accounts that currently yield 0.01% and 0.03%, respectively. You can do much better with a little searching. Websites like Bankrate.com orNerdwallet.com/rates can help you find the best rates. A word of caution: Always read the fine print to be certain that your account is FDIC-insured. Just because you've walked into an FDIC-insured institution (or visited their website), it doesn't mean every account is insured. These banks offer all kinds of products and many don't fall under the FDIC's watch. One such FDIC-insured product is a money market account, or MMA. MMAs, sometimes referred to as money market deposit accounts, will usually have higher minimum deposit requirements than savings accounts, though this can be as low as $500 in some cases. If you meet those minimums and have your checking accounts covered, MMAs almost always pay a higher rate than savings accounts. So use them when you can. Again, you can use the tools at the websites we've mentioned to find the highest rates on MMAs. For both savings accounts and MMAs, regulations state that you can't have more than six transfers per month into or out of the accounts. So it takes a little planning to make sure that your checking balances can handle whatever you need. Certificates of Deposit, or CDs, have many of the benefits of savings and money market accounts… For example, they're FDIC-insured, with no risk of loss unless our entire government collapses… with just one drawback. However, that drawback comes with a higher yield, and it just may be the perfect place to place your cash depending on your needs. The risk they do carry is liquidity risk. When you put your cash in a CD, you agree to leave it there for a particular amount of time, between three months to five years. If you want to get it back before then, you need to pay a penalty. Since the money is locked up, the bank will give you a higher interest rate. You can collect about 1%, or even 1.15%, on a one-year CD from some of the more competitive banks… with higher yields for longer time periods. Check the websites we've recommended to find the best rates. Given that your money is locked up, CDs work better for the cash allocation of your portfolio as you approach retirement, not your emergency fund. All the prior cash accounts have a major advantage: They are FDIC-insured. The peace of mind that should give you can't be overstated. When you branch out into money market mutual funds (or MMMFs), you do not have an FDIC guarantee. You now face the risk of loss. You have become an investor, and not a saver. That's not how MMMFs are sold, though. They are sold as ultra-safe places to hold your cash savings. You'll see language from fund companies like, "[the fund] seeks to provide current income and preserve shareholders' principal investment by maintaining a share price of $1." This $1 share price is the central focus of MMMFs. You buy shares for $1 and the fund invests that cash in short-term securities. By law, the investments must expire within 90 days. When the fund makes money, its share price doesn't rise. Instead, it creates more $1 shares and adds them to your account. If you check your balance, it doesn't look like you're an investor. It looks like your dollars are growing. Here's the trick with MMMFs… They are exceptionally safe… until they aren't. MMMFs use a wide range of securities to generate their returns. There is a massive market of short-term securities that you've likely never explored. They use securities like short-term Treasury bonds and T-bills, but they also use things like overnight repurchase agreements, or repos. This is a complex system whereby a bank will borrow $99.99 overnight and pay back $100 the next day. Of course, this is happening on the scale of trillions of dollars. This system is called the "shadow banking" system. It works flawlessly almost all the time. But when things go wrong, there's trouble. This is what happened in the financial crisis. In 2008, the short-term paper markets froze up. People were too scared to lend to one another, even overnight loans to the biggest banks. The market was in a panic. A few funds got themselves into trouble. The Reserve Primary Fund was one of the largest and most respected funds, with $68 billion in assets. In particular, it had a big pile of securities issued by Lehman Brothers. Since everyone was in a panic, the fund couldn't figure out what these loans were worth. The fund was unable to maintain its $1-per-share value. This is known as "breaking the buck." Investors in the Reserve Primary Fund had their cash frozen while the fund sorted things out. It was more than a year before a court ordered the fund to pay out whatever funds it did have to shareholders. Some people had hundreds of thousands of dollars in "cash"… but they couldn't access a penny. Now, trouble like this doesn't happen often. Prior to 2008, not a single fund broke the buck in the 37-year history of MMMFs. So you shouldn't fear MMMFs… but you do need to understand what's happening with your cash when it no longer has FDIC insurance. There are also some tricks you can use to ensure you get the best MMMFs. The shadow banking system is a highly efficient market. That means if a fund has a higher yield than its competitors, it's taking on more risk. You should also back out the fees. For instance, take two funds that each yield 1% after fees. You would think that they have the same risk. However, one might charge a 0.5% management fee and the other might charge 0.25%. That means the fund with the higher fees has to use riskier investments to get the same yield. In this case, the low-fee fund is unequivocally better than the high-fee fund. And diversification will benefit you here as well. If you have a substantial amount of cash and you don't want it frozen during a crisis, spread it around a few different MMMFs managed by different investment companies. Three different funds should be enough. MMMFs do have some remote risk, and right now their yields are not high enough to justify taking those risks relative to FDIC-insured accounts. MMMFs, on average, yield only about 0.01% today. When you look up funds, you'll see it quoted as the seven-day yield. This uses the fund performance from the last seven days to determine its annual yield. Considering you can earn much better than that in an FDIC-insured savings account, we consider MMMFs mostly off the table until interest rates rise. MMMFs might not be such a great investment then, either. The U.S. Securities and Exchange Commission has drawn up a new set of rules for MMMFs to make them safer. The trouble with MMMFs comes partly when everyone tries to withdraw their funds at the same time. So, effective October 2016, MMMFs used by individual investors can deny you access to your money for up to 10 days, or they can charge a redemption fee of 2%. To make that worth it, MMMFs are going to have to yield a heck of a lot more than they do today. To sum up:  Most people don't spend too much time thinking about their cash. But sitting down and taking a rational look at your cash needs can provide for emergencies and immediate needs without sacrificing long-term returns. And making sure you hold your cash in the right place can help you sleep well at night while keeping inflation off your back. Here's the good thing about getting your cash investments in order: Once you do, it takes little time to keep things in order. If you're an income investor, you should be successfully generating cash month after month and quarter after quarter. This essay should help you know what to do with it. Here's to our health, wealth, and a great retirement, Dr. David Eifrig Source: Daily Wealth Follow us on Twitter: @blacklioncm |
Wednesday, December 2, 2015
How to Get One of the Highest, Safest Yields in Today's Market
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| Before we get started, I must admit… It's one of the most boring sectors of the market… You probably won't be bragging about it at the summer barbecue or your company's water cooler… If everyone purchased this type of investment, the financial news channels would die. Headlines would get a bit less shrill. And people would mostly ignore CNBC's latest "hot take" on the market… But most people would also enjoy better returns and have greater diversification. Rather than selling at bottoms and buying at peaks, investors would ride the inevitable waves and earn a fat return over the years. You see, the advantage to investing in this sector isn't just that it's safe… or nearly unknown outside of a group of select Wall Street "insiders"… It also returns a higher yield than nearly any other safe investment you could make today. In other words, this investment is a powerful tool for income investors that's right at the intersection of yield and safety. Today, I'm detailing the opportunity in what's known as preferred shares (or "preferreds")… the hybrid blend between bonds and stocks. Based on the benchmark S&P U.S. Preferred Stock Index, preferreds offer an average yield of 6.24%. That's a huge payout in today's low-rate world. That yield is also safer than traditional dividends. Preferreds are able to do this because they are fundamentally different than other securities… Here's how a preferred share works… If a company needs to raise $100 million in capital it could do this several ways:
The company could sell four million preferred shares at $25 each, collect $100 million, and agree to pay a dividend rate of, say 5%, in quarterly installments. Now, the preferred dividend isn't guaranteed (and neither are common stock dividends). If the company runs into financial trouble, it canchoose to suspend its preferred dividends. However, it can't pay a single penny in dividends on its regular common stock unless it keeps paying dividends on its preferred shares. Many preferred shares are also "cumulative," meaning that if the dividend is suspended for a few quarters, that tally keeps adding up and it must all be paid back when the company starts paying a dividend again. Preferred shares are typically issued as "perpetual" preferreds, meaning that they will go on paying that dividend rate indefinitely. Though like a bond, if the market price of a preferred share is higher than its issue price, a new buyer would earn a lower yield than the original rate. Other preferred shares are "callable," meaning the company can buy them back at a set price after a specific date in the future. So as a practical matter, preferred shares' dividends are much safer than regular dividends. And there are some additional benefits to preferreds… The way to build a safer and more profitable portfolio is by combining uncorrelated assets. For example, stocks and bonds don't move perfectly together. When you combine them, you can earn a better return relative to your risk. When investments move perfectly together, they have a correlation of 1.0; and if they bear no relation to each other, they have a correlation of 0. As you add more uncorrelated assets, you make a portfolio stronger and stronger. Preferreds, in particular, are in a class of their own. Preferreds have only a 50% correlation with stocks and are even less correlated with the bond market.  The closest correlation with preferreds are investment-grade corporate bonds. That makes sense. Preferred shares are high-quality, safe investments that pay regular income flows, just like good bonds. By adding preferreds to your portfolio, you've utilized an entire new asset class, making your portfolio more resilient to volatility. On top of that, the dividends paid by preferred shares are often considered "qualified dividend income." This means that they are taxed at the lower capital-gains rate, rather than as income. It depends on your income level, but if you're in the 25% tax bracket, you'll pay 25% on interest income from bonds, but only 15% on qualified dividends from preferreds. That means collecting $1 from a preferred is the equivalent of collecting $1.13 from a bond. Preferreds have improving financials, rising stock prices, and more potential upside than bonds if a company does well. At the same time, the income stream of preferreds is more dependable and fixed, like bonds. It also has a better claim on assets in the rare case of bankruptcy. If a company goes bankrupt, bondholders get to take what they are owed from the assets. After that, preferred shareholders take what they are owed. Investing in individual preferred shares is relatively simple – most preferreds trade over the major exchanges and are easily accessible through your broker. For investors looking for short-term capital gains, preferred shares don't make for the best investment. But the opportunity for an income investor should be clear. High yields paired with safety are exactly what I look for in Income Intelligence. Here's to our health, wealth, and a great retirement, Dr. David Eifrig Source: Daily Wealth Follow us on Twitter: @blacklioncm |
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