DOW HITS 7634! What now?

February 24, 2012

The father of irrational exuberance. If Bush had just yanked his hands down, a lot of problems could have been avoided

 

Huge, breaking, earth-shattering, paradigm-shifting, cliché-inspiring news this week, as the Dow Jones Industrial Average finally pawed its way back over the critical 7634 mark. No longer will we have to suffer in a world where the sum of the prices of 30 blue-chip stocks multiplied by a constant will begin with 7-6-2 or some lesser string of digits. Instead, let’s all stop at this milestone and take a needed respite.

Oh, sorry. Yeah, we were using base-12. Would you prefer we used base-10? Fine, but we’re going to use a different currency, euros. Which would make the Dow level 9807. No wait – let’s use base-12 and euros. That’d make the Dow level 5813. Isn’t this fun?

Most of the stock market “news” results from humans having 5 fingers on each hand and needing a way to count things. There isn’t any appreciable difference between a Dow at 12,999 and a Dow at 13,000, except that the latter burns a different array of bulbs in a digital readout and gives mathematically challenged journalists a chance to write headline fodder. Stop believing that this is in any way important.

From our favorite purveyors of loaded rhetoric, the Associated Press:

The Dow passed 13,000 about two hours into the trading day.

And from another AP story:

The average was above 13,000 for about 30 seconds before dropping back. It reclaimed the mark just after noon.

In the words of Anti-Nowhere League, “So (expletive) what?” They’re talking about this like it’s the moon landing, calibrating the event by time and duration so future generations will have a historical record of it.

Furthermore, the mere addition of one point to the Dow then becomes the catalyst for everything that follows. One more AP story, and a stunning example of why reading the news with a trusting eye is worse than not reading it at all:

The 13,000 level is a psychological milepost, but in a market built on perception, it could influence more cautious investors to pump more money back into the stock market, analysts said.

“You need notches along the way to measure things, and that’s as good as any,” said John Manley, chief equity strategist for Wells Fargo’s funds group…

Dan McMahon, director of equity trading at Raymond James, called the 13,000 marker a “positive catalyst, and that’s what we need to get us through the next range.”

Sounds like these Wall Street guys are as susceptible to “decimal bias” as the rest of us, right? No. McMahon continues:

In the end, he said, it’s just “a big round number.”

Which shows that the claims that “analysts said…it could influence more cautious investors to pump more money back into the stock market” is an unmitigated lie. Or if not a lie, then at least an unprovable assumption. Sure, Dow 13000 “might” influence investors to buy stocks. It also “might” turn the milk in your fridge sour. You don’t think so? Then show why it can’t.

CBS News has a video clip with the wonderfully objective title: “Dow 13,000: Time to Invest?”, which itself summarizes why financial illiteracy is pandemic. Yes, first let’s overpublicize a rise, however modest, in the Dow level. Then, let’s imply that people should buy stocks. Because that’s when you want to buy, when prices are rising.

You want superlatives? The Dow is now at its highest level since May 2008. When the Dow was at 12,990, that was its highest level since…May of 2008. Add the inexorable effects of inflation, however modest, not to mention whatever fees you paid for your index fund, and if you’d bought before May of 2008 you’d still be behind. If, however, you were dollar-cost averaging and buying units regularly since then, including when the market hit a local nadir of 6627 in March 2009, you’d be ahead. The Dow’s most recent movements, i.e. what it’s done in the past week, mean nothing.

We’ve talked early and often about the need to handle your financial transactions in a cold, calculating manner. Save the emotion and the irrationality for your personal, non-monetary life. When everyone else is chasing something, step back and ask why. When everyone else is fleeing something, same thing. And when a numerical quirk becomes front-page news, bumping Iranian oil embargoes to the second line, think about what that really means. To the extent that it means anything.

Yet another reason why our use of exclamation points on this site is so judicious. If a bunch of talking empty heads filling time in a TV studio have somehow convinced you that a .06% rise in the Dow is a reason to get your money out of your beer fund and put it towards stocks, we can’t help you. Besides, you don’t want to be helped.

There’s a time to get going, and a time to sit back (apologies to St. Francis.) If you don’t have an investment plan yet, run to the nearest brokerage house, bank, or human resources office and get one. It’s never too early to start.

But once you’ve invested, which we’re presuming you have, don’t drown in the details. Try to look at your portfolio quarterly. That recommendation is like Tolstoy’s challenge to not think of a white bear, but if you can do it, you’ll not only have greater peace of mind, you’ll be able to notice measurable differences in your portfolio more easily. It’s the same reason why parents marvel at how quickly their nieces and nephews grow, rather than how quickly their own kids do.

Getting excited, depressed, or even having an opinion about Dow 13,000 is mayfly syndrome. But you’re a human, with a lifespan tens of thousands of times longer than your typical mayfly. Even a giant daily swing in the Dow is utterly irrelevant, let alone one of just a few points.

This article is pick of the week in:

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A Whole New Way To Diversify

February 3, 2012

You can't have corporate fraud without a corporation

 

Every company you can invest in has to be a corporation by definition, right? The corner barbershop that operates as a sole proprietorship can’t trade publicly, nor can any partnership.

Not quite. One of the least publicized securities available to you, the private investor, is the master limited partnership. People buy these when they want income, rather than capital gains. And despite their obscurity, MLPs are easy to buy.

You already know what a partnership is – multiple people create a business; and for tax, credit and legal purposes, those people are the business. They have no protection against being sued for more than the business is worth, which is why most entrepreneurs will forgo a partnership to create a limited liability company or corporation. Long story short, the tax rate is more favorable. If you want the details, read Chapter X in “the best personal finance book ever written” (Len Penzo.)

The general form of a partnership is called, somewhat anticlimactically, a general partnership. In its variant, a limited partnership, some of the partners aren’t liable beyond what they’ve invested. For these limited partners, the partnership works like a corporation in this respect. The remaining partners, the general partners, are on the hook for everything. If you’re wondering what the advantage is to being a general partner, well, someone has to be. And the general partner(s) are the only ones who receive dividends. The limited partners enjoy a proportionate share of profits, or losses, but that’s it. As you can imagine, the general partners have enormous incentive for the company to do well. If it does, the general partners enjoy bigger dividends.

Master limited partnerships trade publicly. The limited partners again receive a share of the profits, while the general partner manages the MLP and gets paid contingent on how well it does. Managers form an MLP when they want to avoid the scourge of double taxation, which plagues standard corporations (a/k/a C corporations, as opposed to the S corporations that small businesses operate as.) Major corporations’ profits are taxed first when the corporations calculate their earnings. When the corporations pay dividends out to the shareholders, the shareholders also pay income tax on that.

There’s more to it, though. Not every limited partnership can qualify to be a master limited partnership. At least 90% of an MLP’s cash flow has to come from commodities, natural resources, or real estate. In practice, almost all MLPs are in the energy business.

MLPs offer “units” that pay out quarterly “distributions”, rather than “shares” that pay out quarterly “dividends”, a distinction largely without a difference as far as we’re concerned. Sell your units, regardless of how much the MLP appreciated while you owned it, and the IRS will charge you at standard income tax rates, rather than capital gains tax rates. Should the MLP depreciate while you own it, that’s what’s called a “passive loss”. If the MLP eventually appreciates, you can use the losses to offset the gains for tax purposes.

Enterprise Products Partners is the biggest MLP in existence. They transport natural gas and oil through 50,000 miles’ worth of pipelines. They also gather, process, ship and store it. The company is a giant, with $32 billion in revenue during its last fiscal year (comparable to Aetna) and shareholders’ (check that, unitholders’) equity totaling $11 billion, which is larger than that of M&T Bank. Enterprise Products Partners trades on the New York Stock Exchange, under the symbol EPD. Management owns 39% of the units, the remainder available to the public.

Let’s look at one of EPD’s biggest competitors, both to illustrate the similarities and to explain the subtle differences.  (And to show you how serious the general partners are about enriching themselves in concert with the company, rather than in spite of it.) Kinder Morgan Energy Partners (NYSE: KMP) also deals in stuff extracted from the earth, and clearly owes AC/DC a royalty whenever they produce something with the company logo on it:

To the casual observer, Kinder Morgan’s business is almost identical to Enterprise Products’. The former transports refined petroleum and natural gas, operates terminals, and also transports carbon dioxide. According to the company’s website, its namesake and CEO Richard Kinder draws a $1 salary and doesn’t receive stock options.

Ha! It seems they just wanted to see if we were paying attention. Of course he doesn’t receive stock options, there’s no stock. Only units. KMP also goes to the trouble of telling us that they don’t screw around with “unnecessary overhead…such as corporate aircraft, sponsorships, sports tickets…” And “we cap senior executives’ base salaries far below industry standards. (The executives’ bonuses) are tied directly to the performance of the company.”

Wow. Is it too late for Richard Kinder to run for president?

KMP’s equity stands at around $7 billion, its revenues $8 billion. And these two are just the tip of the industry. A disproportionate number of the players are situated in Texas, specifically Houston, for reasons that are hopefully obvious.

Like anything else that can be securitized, master limited partnerships can be packaged into mutual funds, too. One of the biggest is the ClearBridge Energy MLP Fund (NYSE: CEM). ClearBridge Advisors is a subsidiary of Legg Mason, one of the biggest mutual fund companies in existence. Another MLP Fund is SteelPath MLP Income Fund (NASDAQ: MLPDX), founded 2 years ago. CEM’s biggest component comprises less than 10% of the fund, MLPDX’s biggest barely 6%. MLP funds typically hold fewer components than do your standard mutual funds, largely because there are so few MLPs for the funds to be comprised of in the first place.

Master limited partnerships are attractive to many investors because the managers clearly have skin in the game. Managers are less inclined to jump ship, too: when you’re running a successful MLP, why would you want to leave? From our perspective, there’s plenty of reason to look at MLPs (and their funds) over more notorious securities. We don’t expect you to sit through consecutive posts about MLPs, so we’ll do something wildly different Friday and then hit this topic in detail a week from today. And, as always, look for value that most people can’t bother to find. ‘Til then, class dismissed.

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Our Financial Uproar Stock Picks

January 6, 2012

See cube, eat cube

 

One of the few personal finance bloggers who remains on speaking terms with us is Nelson Smith at Financial Uproar, who’s hosting a stock-picking contest. We were told to submit 4 stocks by December 30. We’ll regroup 359 days from now, assuming we can stave off nuclear war with Iran, and see who gained the most.

We had to pick stocks, as opposed to other investments, otherwise we’d have loaded up on “Mitt Romney will be elected” futures at InTrade. They currently pay 8-to-5.

Of course, entering a stock-picking contest is different than investing. As any poker player knows, the game changes drastically when there’s real money on the line. So knowing that finishing dead last will hurt nothing more than our egos, we were fairly aggressive. With a couple of caveats:

1. We’re not going to win this thing. 

Seriously, we won’t. Not that we don’t believe in ourselves, but intelligence and discretion will only take us so far here. Luck is a huge variable, both as a noun and an adjective. Again, if we could buy futures as part of this contest, we’d look long and hard at buying one called “The winner will have chosen 4 penny mining stocks on the TSX Venture Exchange”. 

But that depends on how many entrants Nelson gets. (12, including himself.) The more entrants, the greater the chance of luck being the biggest determining factor (and rendering our research worthless.) If the objective is to make money, then you don’t have to win this contest to win, if you catch our drift.

2. We’re not looking for long-term investments. We’re not even necessarily looking for stocks that we think will instantly skyrocket. The window is specific: 1 year. A stock whose acceleration will top out in 2 months, or 24 months, won’t do us much good. Heck, if we can get a 25% return out of this contest, we’ll consider ourselves winners. Nelson probably won’t, but we will.

That’s enough qualifying, don’t you think? On with our picks. Our strategy is the same as it is in our real lives: look for temporarily wounded value. A stock with good fundamentals but bad (in the short run) publicity is ideal. A low price-earnings ratio, and either negative or non-existent headlines.

NETFLIX

This fits our criteria almost perfectly. The company took a public relations hit this past summer when it told customers they were going to have to suffer through the barbaric ordeal of having to hold separate accounts for renting DVDs and for streaming videos online. Customers swore they’d never return, and a movement took hold.

We don’t patronize Netflix, never have and never will, but couldn’t understand why customers decried a company that seems to offer selection, speed, and value.

The stock traded at $304.79 in July and is now at $79.30. Cash flow is positive, and profit increases by 50% or so annually. That can’t last forever, but all the indicators are good. Netflix is one of those companies that does better the less it charges. In its early days, memberships cost 4 times what they do today. A company that succeeds on both high markups and low markups will get our attention every time, especially when it’s the undisputed market leader.

FORD

A strikingly low price/earnings ratio, barely over 6. A stock price at an 18-month nadir. And an implicit guarantee that the taxpayers will be there with billions to prop up the company if necessary. Which it won’t be, but investors like to keep these things in mind.

The industry itself is as close to a staple as we have in this society. Ford’s competitors remain in even worse shape than it.

Ford’s worst days are behind it. Yes, its liabilities are greater than its assets, but the numbers are going in the right direction. And the company is profitable. There’s no way we’d invest in Ford until its financials improve a little more, but to enter a stock-picking contest with no downside? Sure.

(NOTE: Not to hedge our bets, but the two of us had to flip a coin on this one. Ford vs. Toyota. If it turns out that a Toyota pick would have ended up winning the contest for us, blood will be shed.)

SEACUBE

This is one of those under-the-radar companies that you never heard of until 2 seconds ago, yet that impacts your life greatly. As the name implies, and as its NYSE ticker symbol (BOX) reinforces, SeaCube deals in shipping containers. The company is on every continent, and just about every freighter.

SeaCube doesn’t even make the containers. It only buys and leases them. Revenue is stable, with a couple of anomalous items distorting the 2009 numbers. Profit margins are enormous, 22%. The company paid out a dividend last month, with a dividend yield of 6.3%.

What gets us excited is its price/earnings ratio, currently under 8. Its peers average thrice that. Because a container lessor can’t expect gigantic growth year-over-year, the only remaining legitimate reason for SeaCube’s low P/E is simply that it’s undervalued. The price is low with regard to sales, with regard to book value…

So why isn’t it more expensive? It’s carrying a lot of debt, although that debt is relatively stable year-to-year. This is one we might buy in the real world, too.

TOYOTA

Alright, fine. We were going to go with GlaxoSmithKline but it’s trading at 40-something times earnings and pharmaceutical companies (or more specifically, reaction to and regulation of them) can be fickle.

Instead, the car manufacturer whose 2011 was as bad as anyone else’s in Japan. The Tōhoku earthquake and resultant tsunami didn’t just kill 20,000 people, they did a number on every manufacturer in the country. No hydroelectric and nuclear power meant no way to build cars, and a damaged seaport meant nowhere to send and receive shipments. Toyota’s sales numbers suffered, and the stock price tumbled accordingly. A positive, at least as far as stock-picking contests go.

Besides, Toyota already knows all about singular events hampering its stock price. In 2009 a series of Lexus owners testified on Capitol Hill that their vehicles were accelerating suddenly and without apparent impetus. What made that unusual was that it’s usually politicians lying through their teeth in D.C., not private citizens. The claims were unfounded: to keep it brief, these imbeciles all confused the brake pedal with the gas. Toyota stock sank to the point where the CEO flew over from Aichi headquarters to control the damage. The stock rebounded and then some, and Toyota maintained its healthy habits of keeping debt under control and buying back treasury stock. Which it continues to do today.

So those are our picks. We’ll keep you updated daily on what they’re doing.

No, of course we won’t. You shouldn’t look at your investments daily, either. We’ll check back on ours quarterly: enough time to see legitimate growth (or shrinkage) develop, without keeping us daily enslaved to a series of numbers beyond our control.

**This article is featured in the Baby Boomers Blog Carnival One Hundred Twenty-sixth Edition**

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