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September 2006 - Posts
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Talk about unconventional wisdom.
Investment U. Chairman Mark Skousen went to Las Vegas earlier this year to attend the money show. While there, he asked thousands of investors which they thought was a better bet right now: Stocks that pay little or no dividends. Or, earning five percent in, say, a no-risk money market fund?
Their answers were surprising, if not alarming, to armchair economists. By a wide margin, the group said that the best investment right now can now is a Treasury bill, a money-market fund, or a bank CD. In other words, cash-rich investments.
The fact is that, in today’s environment where economic volatility is as much a part of the landscape as Wall Street, cash has become the wisest and safest investment in town.
Consider Warren Buffett, who has $40 billion of Berkshire Hathaway parked in cash and cash equivalents these days.
Recently, Buffett chatted with PBS’ Charlie Rose and explained why a great stock investor likes to sit on so much cash. He used a baseball analogy. If a player swings at every pitch, Buffett said, he will likely swing and miss more often than not. But a seasoned hitter is more selective, and thus more productive as the pitches he slashes away at are right down the middle of the plate -- turning misses into hits. And sometimes it's best to leave the bat on your shoulders and create a walk out of four bad pitches.
Buffett’s message couldn't be clearer in today's economic and investing environment. It’s better not to invest – or swing – at "bad pitches" in today’s market. You may not hit a home run, but you won’t strike out, either. And you'll still get to first base.
That's the baseball analogy for sitting on cash.
To understand cash investing better, it’s worth noting that Buffett does not bluntly say, “I am sitting on cash because I believe the market is overvalued and will slide. In the future I will buy stocks cheap.” In fact, it's more helpful to avoid listening to what Buffett says and focus instead on what he does.
As one of the greatest gurus in stock market history, Buffett knows that his every utterance can shift the market. He does not want to cause a stock market panic – or be blamed for causing a slide in stock values that may hurt his considerable equity portfolio.
But if you read between the lines and watch what Buffett does with his money, his investment success is fairly easily to emulate.
This year, Buffett-watchers are seeing the Oracle of Omaha move into cash. Millions of savvy investors have followed suit.
But why? The reasons are both numerous and logical. You only need to read the economic tea leaves to understand why.
In the next few blogs, I'll explain why, in the next year, cash will be king.
Reason #1 – A Global Recession Is Likely
You may not hear about it from the Wall Street bulls, but the U.S. is the world’s biggest debtor nation, printing money with abandon to sustain the illusion of prosperity. And we’ve been doing this for years.
In 2005, the US government owed $7 trillion and that number is climbing every day.
For decades, Americans have been told by government, by Wall Street, and by mass media that the economy is just fine, even as the cancer grows below the surface.
Part of that problem is with the deficit. A slew of government and private analysts put the actual U.S. "fiscal gap," (which means all future receipts minus all future obligations,) at $40 trillion (Government Accountability Office) to $72 trillion (Social Security Board of Trustees). The International Monetary Fund estimates the gap at $47 trillion; the Brookings Institution at $60 trillion. To solve the deficit problem the US government would have to stick taxpayers with an immediate and permanent 78 percent hike in the federal income tax.
The story of the weakening dollar—and how it’s the loosened lynchpin in the coming economic recession—is a key cornerstone of this argument. There is ample evidence showing that the U.S. dollar is in a major long-term bear market. Consequently, it’s critical for investors to limit their exposure to the dollar to an absolute minimum. Many are doing so to insulate themselves from a failing dollar and likely recession.
These investors believe that, in general, U.S. equities remain substantially over-valued, and that the major U.S. stock indexes are in the early stages of long-term secular bear markets. In fact, economic policy decisions by the U.S. Federal Reserve is greasing the skids for the stock market’s demise, primarily by flooding the world with dollars and credit. Since 1995, the amount of money in the world has increased almost exponentially, growing an average of $525 billion a year. (For comparison, between 1990 and 1995, the money supply rose a total of $468 billion.)
Most of that money is in the stock market, buying up stocks with no earnings and companies with no prospects. That cash will disappear once stocks start dropping. Meanwhile, a cash flood is also washing overseas. Foreigners are holding nearly nine trillion U.S. dollars. That is a vicious cycle. Less profits means lower stock prices. Just like Americans, foreign investors have watched their stock market wealth disappear. Overseas, American investments are becoming less and less attractive, and foreigners may soon abandon the dollar altogether.
The last piece of the global recession puzzle is real estate, specifically the downward trend of U.S. housing prices in 2006.
There’s no great trick to understanding the current status of the US real estate market. If it looks like a bubble, walks like a bubble, and quacks like a bubble, it's a bubble. The combination of artificially low interest rates, foreign central bank intervention, an irresponsible Fed, excessive credit availability, the proliferation of low or no-down payment, adjustable-rate, interest-only, and negative-amortization mortgages, a can't-lose attitude among speculators, validated by ever rising "comps," the complete abandonment of lending standards, wide-spread corruption in the appraisal industry, rampant fraud among sub-prime lenders, and the moral hazards associated with loan originators re-selling loans to buyers of securitized products who perceive minimal risk and an implied government guarantee, has produced the "mother of all bubbles." As the real estate bubble slowly expands, it's not just real estate speculators and home owners who will suffer, but the entire U.S. economy, its banking and financial systems, and anyone with U.S. dollar denominated savings.
Those who hold cash positions in their portfolios will be among the few left standing.
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George Soros owes his wealth to superb risk management and knowing when to be cautious and knowing when to be aggressive. His investment tenets, as follows, come from the book “Becoming Rich: the Wealth-Building Secrets of the World’s master Investors: Buffett, Icahn, Soros” -- Believes the first priority is preservation of capital. -- As a result, is risk-averse. -- Has developed his own investment philosophy, which is an expression of his personality. As a result, no two highly successful investors have the same approach. -- Has developed his own personal system for selecting, buying and selling investments. -- Believes diversification is for the birds. -- Hates to pay taxes, and arranges his affairs to legally minimize his tax bill. -- Only invests in what he understands. -- Refuses to make investments that do not meet his criteria. Can effortlessly say 'no'. -- Is continually searching for new investment opportunities that meet his criteria and actively engages in his own research. -- Has the patience to wait until he finds the right investment. -- Acts instantly when he has made a decision. -- Holds a winning investment until a pre-determined reason to exit arrives. -- Follows his own system religiously. -- Is aware of his own fallibility. Corrects mistakes the moment they arise. -- Always treats mistakes as learning experiences. -- As his experience increases, so do his returns. -- Almost never talks to anyone about what he's doing. Not interested in what others think of his investment decisions. -- Has successfully delegated most, if not all, of his responsibilities to others. -- Lives far below his means. -- Does what he does for stimulation and self-fulfillment - not for money. -- Is emotionally involved with the process of investing; but can walk away from any individual investment. -- Lives and breaths investing, 24 hours a day. -- Puts his money where his mouth is (Soros invests primarily in his own fund) Of all of the tenets listed above, the one I like best is how Soros invests not for money alone, but because unearthing great investments that others overlook is his passion in life. Soros knows that you have to love what you're doing to be successful, whether that means your a commodities trader on Wall Street or a sous chef in Cincinnati. That's the key to both wealth creation and to happiness in life.
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While Soros doesn’t worry about the consequences of his investment actions, there are many who do. They watch him with a keen eye, hoping to emulate him and the characteristics that have made him successful. Among his investment strategies, six principles are clear and include: #1: Financial markets are highly dependent upon the human beings who buy and sell them The theories of an open society, fallibility and relativity have given George Soros a solid system for selecting, buying, and selling investments. And he follows it religiously. That’s obvious, say experts, in the cool way that he monitors stock, bond, and currency prices. Simply, he leaves his emotions out of the equation but realizes that the crowd does act – often improperly – out of emotion. As Soros has noted, too many traders “react” instead of simply acting on cool and logical calculations. He believes the best opportunities are had by detaching from emotions. Instead, he believes investors should simply focus on market prices and value of underlining assets. #2: The first priority: preserve capital In a recent interview, Soros said he likes to avoid pure chance. While he has learned that surviving requires some element of risk, he’s said that it’s smart risk that makes the difference. So he only invests in what he understands and meets his criteria. He has no problems saying no. And he’s willing to wait for the right bet. “I like to have a better understanding of the situation than the market and then I bet on my judgment so I know I can anticipate the future,” he stated. “So that’s not gambling. Now, you can’t avoid taking risks. But I only [do it] when I think I have a better and different perspective.” Put another way, Soros does not believe he needs to place his bets on the table for every spin of the wheel. He will sit on the sidelines – with his capital secure – and wait for an opportunity. Then he pounces. “George Soros has made his mark as an enormously successful speculator,” writes Former Federal Reserve Chairman Paul Volcker in 2003 in the forward of Soros’ book, “The Alchemy of Finance.” “Wise enough to largely withdraw when still way ahead of the game.” #3: Diversification is not what you think it is: The general definition of diversification from most Wall Street advisors is to acquire many smaller holdings thus ensuring that all your investment nest eggs are not in one basket and that will protect you from large losses since your money is spread out. But Soros believes that just the opposite happens when you diversify too much, even if you amass a tidy profit in one area it will have little impact on your total overall portfolio’s worth. Instead Soros believes it is better to invest in a handful of strong companies that have the capacity to produce huge profits, thus offsetting any losses on other investments. For example, compare two portfolios. The first is diversified among 100 different stocks; the second is spread among five stocks. If one of the stocks in the first portfolio doubles in price, the value of the entire portfolio rises just one percent. The same doubling in the second portfolio pushes that portfolio’s performance up 20%. For the investor in the first portfolio to achieve the same result, 20 of the stocks in his portfolio must double – or one of them has to rise 2000% -- an unlikely scenario. In Soros’ view, it’s much easier to identify one stock that’s likely to double in price, or identify 20 stocks that are likely to double. That’s the difference between average investors and investors like George Soros. Because Soros’ portfolio is concentrated, he focuses his energies far more intensely – and for more effectively – on identifying the right investments. George Soros spends his time looking for high probability stocks that meets his criteria. When he finds one, he knows the risk of losing money is low. So when Soros buys – he buys big. #4: Fortune favors the brave While Soros is a risk taker who also relies on reserves and intelligence, and not just verve, he also knows that luck is not the operative term for investing. Courage is. His activities in 1992 are a perfect example. The amount of money he invested in speculation that the British pound would be devalued represented a staggering proportion of his assets. And the result was fame and fortune. Still, Soros himself calls that risk, in particular, an exaggeration, claiming the “odds were very much in his favor when he took that bet.” Otherwise he wouldn’t have boldly gambled it. #5: Keep quiet about your investments, what others think is meaningless You need only listen to his critics and watch him work two sides of an issue (i.e., reform global finances and create his own wealth) to understand the dichotomy that makes up his character. He is an investor for the times, a role model, and still a man who keeps his interests and activities close to the vest. He doesn’t let the court of public opinion sway him. In fact, in June, 1981, when Soros was featured on the cover of Institutional Investor, he was depicted as “something of a mysteryman, a loner who never telegraphs his views, who even keeps his associates at a distance.” Why such secrecy? Soros believes that if others find out what he’s doing, they’ll pile into the market and the price will run away from him. That actually happened in October, 1995 when a burst of speculation that Soros was shorting the French franc helped drive that currency down against the German mark. For a heavy hitter like Soros. Who often has huge short positions, it’s not a good idea to trumpet your market moves and thus risking squeezing yourself. George Soros is also a man who doesn’t advertise his losses, if he can help it. And when he can’t, it doesn’t seem to tarnish his reputation. This was the case when the press leaked word of his multi-billion dollar losses in Russia after the collapse of the Soviet Union. Still, he remained a guru. #6. Take advantage of chaotic markets Soros’ theory of reflexivity drives his investing decisions. He believes that financial markets are chaotic. The prices of stocks, bonds and currencies depend on the human beings who buy and sell them, and those traders often act out of highly emotional reactions rather than coolly logical calculations. Opportunities can be found by carefully studying the value and the market prices of assets. Traditional global bourses and developing economies are two of Soros’ favorite targets. For example, Soros and other big-name investors have recently been pouring money into Germany’s banks and financial institutions on the cheap, believing that Germany is in line as the next big global economic success story. With orders for goods and supplies flowing in from Eastern Europe and the Pacific Rim, Germany has now surpassed the United States as the world's largest exporter. Soros is betting that German banks will soon be crammed with cash after several lean years. Another example is in another high growth success story. Soros has also been investing in real estate companies in India of late including Anant Raj Industries, Unitech, and GMR Infrastructure according to a recent article in the online edition of India Times. In a country where land development is akin to the U.S. in the 1950’s, Soros is right on the money in getting into Indian real estate early. #7. Profits in life sciences Soros has also recently bulked up in the biopharmaceutical sector in a big way. The life sciences sector satisfies Soros’ desire for a big score. The sector is ripe for opportunity, but typically so for investors like Soros who dig deep, leave no stone unturned, and figure out where opportunity actually lies. To that end, Soros has made a slew of buys within the biotechnology, pharmaceutical and medical equipment sectors including: CR Bard Inc., Valley Forge Scientific Corp., Alcon Inc., MedImmune Inc., Vertex Pharmaceuticals, Allegan Inc., Celgene Corp., Human Genome Sciences Inc., Sanofi-Aventis, Idenix Pharmaceuticals Inc., each accounting for around a third to a half of a percent of his total portfolio (0.35 – 0.56%). He also added to his holdings in several high-tech and bio-tech firms including Ciphergen Biosystems, OmniVision Technologies, Affymetrix Inc., Mobile Telesystems OJSC, in addition to more diverse companies such as apparel retailers Bluefly Inc., specialty retailer Bombay Company, and real estate holding & development company McGrath Rentcorp. To hedge his bets in life sciences, Soros also made buys in a variety of sectors adding the following companies: Petroleo Brasileiro, an exploration and production company. ConocoPhillips, an integrated oil & gas company, Fair Isaac Corp., a business support services company, Brooks Automation, a semiconductor company, Internet giant Yahoo, in addition to health care provider Aetna Inc., broadcast and entertainment powerhouse Liberty Media Corps Capital Common Series, specialty retailer GameStop Corp., gaming giant Harrah’s Entertainment Inc., telecommunications companies Sprint Nextel and Nokia. Meanwhile he sold out his holdings in Verizon Communications, AT&T Corp., NASDAQ Stock Market Inc. and NYSE Group, Inc. common stock, health care provider WellPoint Inc., the consumer electronics giant Sony, and Internet giant Google, along with many other holdings in various biotech and high-tech sectors, investment services companies, specialty retailers, and oil equipment and services operators to name a few. That's it -- seven steps to investment success from George Soros himself. Hey, we all can't have his money, but we can take a few pages out of his playbook -- and make a little money of our own.
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Soros’ investment story dates back to 1970, when he co-established the Quantum Fund with Jim Rogers, another accomplished trader. Rogers would go on to be a world famous investor as well. The Quantum Fund was a private company that would, over the next decade, create the bulk of his fortune.
To say its performance has been stellar is an understatement. If $1,000 was invested with Soros in 1969 it would be worth nearly $6 million today. Compare that to a $1,000 investment in the Standard & Poor’s Index in 1969, which would be worth a little more than $34,000 today.
In fact, with a compounded annual rate of return in excess of 28 percent, the Quantum Fund makes Soros known as the most powerful and profitable investor in the world.
While Soros’ rise to wealth—an estimated $11 billion by the mid-eighties—was relatively steady, it wasn’t without its challenges. In 1988, Soros was asked to join a takeover attempt of a French bank. He declined, but did buy the bank’s stock, later claiming the takeover was public knowledge. The French court didn’t buy it. And, in 2002, it accused him of insider trading. He was fined $2.3 million and appealed the conviction, but in June 2006 it was upheld by France’s highest court.
Still, the incident didn’t stop him from betting against the British pound in 1992, hastening its devaluation. It was another defining moment for Soros, since it marked the making of his first billion—and instant fame.
Since then, Soros has greatly leveraged his fortune as a shrewd investor, a trend spotter, and a savvy manager. In addition to managing the Quantum Fund, now valued at $12 billion, and acting as President of Soros Fund Management, valued at $2.72 billion, he is also a renowned author, philanthropist, political activist, speculator, investor and overall financier.
He’s also a man who draws great criticism for claiming that the current system of economic globalization undermines healthy development in many underdeveloped countries.
Still, his critics have accused him of being personally responsible for many financial debacles, including the British collapse. Soros, however, is nonplussed. He continues to work on furthering his own economic self interests and lobbying for an overhaul of the global financial system simultaneously. “As a market participant,” he’s said, “I don’t need to be concerned with the consequences of my financial actions.”
Soros: Global Slowdown in 2007?
As a self-proclaimed “investment philosopher” and global investor, Soros does have some interesting views of late on the U.S. economy – and the direction it’s headed. In the short-term at least, it’s not a bullish view.
At this year’s World Economic Forum in Davos, Switzerland, billionaire financier George Soros was reflecting on the U.S. dollar and the future of the American economy, among other issues.*
*On the U.S. dollar:
"The explanation is very simple. The U.S. economy was strong because of the housing market, which made up for the price of energy. Interest rates were rising so interest rate differentials were widening and they still look like widening further. When you reach the point where interest rates might be turning around, then the dollar might become more vulnerable."
* On the U.S. and world economy:
"As the housing boom cools off, the wealth effect wears off and the consumers are going to start saving a little more than they did in the past. And that will give you the slowdown in the U.S. economy, which I think will actually be transmitted to the rest of the economy so that's why I expect a global slowdown in '07."
* On hedge funds growing bearish:
"Hedge funds are in my view a superior form of managing money, but it has become generally recognized. When hedge funds become the dominant force in the market then they can't outperform the market. So it's kind of a self-correcting process. Hedge funds have become a little too popular. I think that a lot of hedge funds managed to tie up capital for quite some time, so it may be more difficult to set up a new hedge fund. And I think probably the fee structure will weaken."
*Source: Bloomberg News
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From time to time I like to augment this blog with profiles of investors who have changed the face of Wall Street. George Soros is one such man. He's worth a closer look. When George Soros shorted the pound sterling with $10 billion worth of leverage (as he did in 1992), the man who would become famously known as “The Man Who Broke the Bank of England” sent the world a message on just how exactly world-class risk managers operate. Soros, who is fond of saying that risk comes from “not knowing what you are doing,” knew going in that the most he could lose was about 4% of his portfolio. “There was really very little risk involved,” he said after walking away with $2 billion in profits.What’s more interesting to Soros - -and vital investment advice to the rest of us – is not the amount of risk one takes but, more importantly, how much money you make when you’re right about a stock and how much money you lose when you’re wrong about a stock. The key to Soros’ investment legend is embedded in that simple philosophy – to invest in a handful of positions that generate big profits that can offset losses on other investments.That’s not diversification – one of the top commandments from Wall Street types -- but Soros doesn’t believe in diversification. He believes in getting a few big picks right and sticking with them. A Life Well Lived After a lifetime of picking stocks – and then taking on global political causes, George Soros should be tired. At 76 years old, he’s survived the war, the Holocaust, the devaluation of several foreign currencies, the chaos of global financial speculation, a conviction by France’s highest court for insider trading, international criticism, the democratic upheavals in Eastern Europe and the former Soviet states which his Soros Foundation has helped to foster, and has been a key player in the increasingly fractured political environment in the U.S.It’s not been easy. But Soros shows little signs of slowing down. He has just released a new book The Age of Fallibility: Consequence of the War on Terror, in it he argues why President Bush’s war on terror is actually a disservice to the tenets of democracy, human rights and freedom. He’s hit the talk show circuit, appearing on NPR and has been interviewed recently for the Wall Street Journal, LATimes.com, New York Times magazine, and MSNBC.com. Soros commands attention not so much for his political views, but the bank account he puts behind his political agenda.His personal fortune is estimated at $7.2 billion. In 2005 Forbes listed him as the 28th richest person in the United States and for 2006 he checks in as the 71st richest person in the world – that out of the more than 6.5 billion people who inhabit this earth.While George Soros has had some pretty heady hills to climb, his intellectual, political, and financial crampons have been strong. And today, the president of Soros Fund Management, chief investment advisor to Quantum Fund N.S. is not only still climbing them—he’s moving them aside. Quantum Leap Soros’ investment story dates back to 1970, when he co-established the Quantum Fund with Jim Rogers, another accomplished trader. Rogers would go on to be a world famous investor as well. The Quantum Fund was a private company that would, over the next decade, create the bulk of his fortune. To say its performance has been stellar is an understatement. If $1,000 was invested with Soros in 1969 it would be worth nearly $6 million today. Compare that to a $1,000 investment in the Standard & Poor’s Index in 1969, which would be worth a little more than $34,000 today. In fact, with a compounded annual rate of return in excess of 28 percent, the Quantum Fund makes Soros known as the most powerful and profitable investor in the world. The Man Who Moves Markets While Soros’ rise to wealth—an estimated $11 billion by the mid-eighties—was relatively steady, it wasn’t without its challenges. In 1988, Soros was asked to join a takeover attempt of a French bank. He declined, but did buy the bank’s stock, later claiming the takeover was public knowledge. The French court didn’t buy it. And, in 2002, it accused him of insider trading. He was fined $2.3 million and appealed the conviction, but in June 2006 it was upheld by France’s highest court.Still, the incident didn’t stop him from betting against the British pound in 1992, hastening its devaluation. It was another defining moment for Soros, since it marked the making of his first billion—and instant fame. Since then, Soros has greatly leveraged his fortune as a shrewd investor, a trend spotter, and a savvy manager. In addition to managing the Quantum Fund, now valued at $12 billion, and acting as President of Soros Fund Management, valued at $2.72 billion, he is also a renowned author, philanthropist, political activist, speculator, investor and overall financier. He’s also a man who draws great criticism for claiming that the current system of economic globalization undermines healthy development in many underdeveloped countries. Still, his critics have accused him of being personally responsible for many financial debacles, including the British collapse. Soros, however, is nonplussed. He continues to work on furthering his own economic self interests and lobbying for an overhaul of the global financial system simultaneously. “As a market participant,” he’s said, “I don’t need to be concerned with the consequences of my financial actions.” (Continued Tomorrow)
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I got my start on Wall Street back in 1984, as a floor runner for Bear Stearns on the Philadelphia Stock Exchange.
Considering the complexity of stock options – the trading vehicle of choice on the PhilEx – and considering that I knew nothing about them, I’m lucky I made it out alive.
Some background: A stock option is a specific type of option with a stock as the underlying instrument, (the security that the value of the option is based on). An option is a contract to buy (known as a “call” contract) or sell (known as a “put” contract) shares of stock, at a predetermined or calculable price.
For example, you could own an option to buy a share in XYZ corp. for $100 in one months' time. If the actual stock price at the time is $105 then you would exercise (i.e. use) your option and buy a stock from whoever sold you the option for $100. You could then either keep the stock, or sell it on the open market for $105, netting a profit of $5.
However, if, in one month's time, the stock price was only $95, you would not exercise your option, and if you really wanted a share in XYZ Corp, you could buy it in the open market for $95 rather than using your option to buy it for $100. If you have an option, you might make a profit and are certain not to make a loss. This means an option must have some positive monetary value itself.
A stock option contract's value is determined by five principal factors - the price of the stock, the strike price, the cumulative cost required to hold a position in the stock (including interest + dividends), the time to expiration, and an estimate of the future volatility of the stock price. Options themselves are traded as securities.
You have also probably heard of “Employee Stock Options.” Stock options for a company's own stock are often offered to upper-level employees as part of their compensation package. Non-executive employees are occasionally offered options, especially in the technology sector, in order to give all employees an incentive to help the
company become more profitable and to lure quality employees to work.
Employee stock options differ from the options that are traded on exchanges as securities primarily in the time frame under which they can be exercised. Employee stock options typically allow an exercise timeframe of up to ten years, while exchange traded options typically expire within 2 years.
Me? I prefer employee stock options, primarily because, since your company pays you to take them, you can’t lose your own money on them. They may plummet and lose all their value, and that is regrettable, yes. But you don’t lose money out of your own pocket when that happens.
Put-and-Call-type Stock options are another story. Once it’s your money, and your risk, the stakes get higher. So be careful when you play the options game.
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There’s a “P” word on Wall Street that should be avoided – “penny” stocks.
Penny stocks are stocks that sell for five dollars or less and, in many cases, you’re lucky if they’re worth even that much. Most penny stocks usually have no substantial income or revenue. You have a high potential for loss with penny stocks. If you have a strong urge to invest in this type of company, take time out to follow the stock to see if it has made any headway. Learn all you can about the company and don’t be tempted to act on a “hot” tip that may have been passed your way or one that you overheard in your travels.
Penny stocks trade in either “pink sheets” operated by the National Quotations Bureau or on the NASDAQ small-cap market. Pink sheets, in brief, are listings and price information literally printed on pink sheets of paper that go to select brokers.
The companies behind these stocks are thinly capitalized and are often not required to file reports with the SEC. They trade over the counter and there is a limited amount of public information available. This in itself is reason for concern. How many astute investors want to put their money into an investment offering little to no information? Nonetheless, people do invest in these stocks.
One of the most interesting—and alarming—aspects of penny stock dealing is that brokers are not always acting as a third party but are setting prices and acting as the principals in the transaction. In other words, the broker selling the stock owns large chunks of it. Penny stocks most often do not have a single price but a number of different prices at which you can purchase or sell them. Like bonds on the market, penny stocks have asking and bidding prices. Unlike bonds, you often cannot find the price listed that is being quoted to you by a penny stock dealer.
Okay, so there’s little information about the company, the price, or anything else to investigate. But the guy on the phone—making a cold call—says it will be the next Starbucks! This is where they get you. Thanks to the Internet and the selling of phone lists, penny stocks dealers can reach out far and wide. They use high-pressure sales tactics and armies of callers to tell you anything to make you buy the stocks
Typically, unscrupulous brokers hype up and promote companies that have either no assets or minimal assets. The practice called “pump and dump” is where these hard-selling wheeler-dealers hype the stocks, making outrageous claims about the company that are substantiated by absolutely nothing. They bring the price up so that they can cash in on an artificial price that is high for a company that is worth nearly nothing, or not in business at all.
Fraudulent practices by brokers could also include unauthorized trading, churning, bait and switch, and other fun methods of pulling the wool over unsuspecting new investors. Their goal is to convince naive investors that these stocks are an incredible bargain. They are so cheap you can’t pass them by. AND, when they become the next Google, you’ll be rich. Or so you think.
All of this is not to say that there are no low-priced legitimate stocks on the market. They are usually small grassroots companies that, if you pick the right one and wait a while, can grow over time. You should invest cautiously and conservatively at first. Look for a new company with good leadership in an industry where you see growth potential. It’s also advantageous to find a company that holds the patent on a new product. If the product may potentially take off, so could your stock. All of this is information you must seek out; it will not come to you via a cold caller.
All in all penny stocks are a high-risk investment, but in some instances it can payoff. Nonetheless, you should remember a few things about questionable investments in general:
1. Nothing that is a great deal needs to be hammered into you by a hard-line sales approach. No one called you on a cold call and told you to buy Intel or Yahoo. No one had to. Anything that good will sell without high-pressure tactics. In short, DO NOT BUY FROM COLD CALLS. The same holds true for the high-pressure online sales pitches of some penny stock brokers.
2. Anything worth investing money into should be easy to research and investigate. The SEC has updated information about companies registered with them. Call 1-800-SEC-0330 and ask for the form “10k,” which is the annual financial statement for a public company. Moody’s, along with Standard & Poor’s, also have information on most investments (including penny stocks), so you can look at their financial history. Moody’s and S&P are companies that provide financial information and ratings. They monitor the financial world.
3. Make sure you are dealing with a broker with a reputation you trust (get a referral). And make sure the person you’re dealing with is not someone who “specializes” in penny stocks.
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Purchasing shares of stock is a lot like buying a business. That’s the way Warren Buffet, one of the world’s most successful investors, views it—and his philosophy is certainly worth noting When you buy stock, you’re actually buying a portion of a corporation. If you wouldn’t want to own the entire company, then you should think twice before you consider buying even a piece of it. You are, indeed, buying a proportional share of the business when you purchase shares of stock. If you think of investing in these terms, you’ll probably be a lot more cautious when singling out a specific company.
Most people wouldn’t buy a business without conducting a thorough investigation of every aspect of the company. It’s important to become acquainted with all of the details. What are all of the products and services the company offers? Which part of the business accounts for the greatest revenue? Which part of the business accounts for the least revenue? Is the company too diversified? Who are its competitors? Is there a demand for the company’s offerings? Is the company an industry leader? Are any mergers and acquisitions in the works? Until you understand exactly what the company does and how well it does it, it would be wise to postpone your decision to rush into an investment.
Let’s say you wanted to buy a convenience store in your hometown. You’ve reviewed such factors as inventory, the quality of the company’s employees, and customer service programs. In addition to selling staple grocery items, the company also rents videos and operates a gas pump. The grocery side of the business may only account for a small percentage of the overall revenue. It would be in your best interest to value each part of the business separately in order to get a complete and accurate picture of the company’s profit potential. Many companies may have traditionally been associated with a specific business, yet that same company may have expanded into totally new venues.
Disney, for example, has historically been associated with the Disneyland and Disney World theme parks. The reality is that Disney is also involved in a host of other ventures. Among other things, the multifaceted company also has interests in television and movie production, including Miramax Film Corp. and Buena Vista Television. Disney’s ABC Inc. division includes the ABC TV network, as well as numerous television stations and shares in various cable channels like ESPN.
Philip Morris is commonly associated with tobacco products. The company also profits from food and beer subsidiaries, including Kraft (featuring popular brands like Jell-O, Oscar Mayer, and Post) and Miller Brewing.
Just like any other career, making money via investing requires work. The more research and thought you put into your strategy, the more likely you are to reap rewards. Although there are no guarantees in the world of investing, the odds will be more in your favor if you make educated and well-informed investment decisions.
When you make an investment, you will be putting your money into a “public” company, which allows you—as part of the public—to become an owner or to have equity in the company. That’s why stocks are often referred to as equities.
In our next blog, we’ll examine what kinds of stocks are available to you to put your investment plan on the right track.
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Like Baskin-Robbins, Wall Street has no shortage of investment flavors when it comes to stocks.
Simply put, common stocks are securities, sold to the public, that constitute ownership in a corporation. They come in all sizes—you can invest in a mega-company or a micro-cap company that has just begun to soar. While some individuals prefer to invest in well-established companies, other investors prefer investing in smaller, growth-oriented companies. No matter what type of company fits in with your overall strategy, it’s important to research every potential stock you buy. Just because a company has been around for decades doesn’t mean it’s the best investment vehicle for you.
Companies are always changing, and it’s important to make sure that the information you are reviewing is current. Mergers and acquisitions have practically become commonplace, and it’s essential to know if a company you are considering buying is undergoing, or is planning to undergo, such a transaction.
It’s also a good idea to research a company’s market capitalization. The market value of all outstanding shares of a particular stock is synonymous with its market capitalization (or cap). Market capitalization is calculated by multiplying the market price by the number of outstanding shares. The number of outstanding shares refers to the number of shares that were sold and are, therefore, now shares outstanding. Larger companies will usually have a lot more outstanding shares than their smaller counterparts. Shares that are issued are outstanding until they are redeemed, reacquired, converted, or canceled.
A public company with 20 million shares outstanding that trade at $40 each would have a market capitalization of $800 million. Although there are no concrete rules to categorize stocks, they can be differentiated by the following:
Large-cap: $5 billion and over
Mid-cap: Between $1 billion and $5 billion
Small-cap: Between $300 million and $1 billion
Micro-cap: Below $300 million
There are also different categories of stock, which suit almost every personality. The variety includes blue-chip, growth, small-cap, cyclical, defensive, value, income, and speculative stocks, and socially responsible investments (SRI).
Blue Chip Stocks
These are considered to be the most prestigious, well-established companies that are publicly traded, many of which have practically become household names. Included in this mostly large-cap mix are IBM (NYSE: IBM), Disney (NYSE: DIS), and Coca-Cola (NYSE: KO). A good number of blue-chip companies have been in existence for more than twenty-five years and are still leading the pack in their respective industries. Since most of these organizations have a solid track record, they are good investment vehicles for individuals leaning to the conservative side when stock picking.
Growth Stocks
As the name suggests, growth stocks comprise companies that have strong growth potential. Many companies in this category have sales, earnings, and market share that are growing faster than the overall economy. Such stocks usually represent companies that are big on research and development. Earnings in these companies are usually put right back into the business. Growth stocks may be riskier than their blue-chip counterparts, but in many cases you can also reap greater rewards. Pioneers in new technology are often growth stock companies. In recent years, growth stocks have outperformed value stocks. That has not been the case at times in the past, and the trend may well turn around in the future.
Small-Cap Stocks
This category comprises many of the small, emerging companies that have survived their initial growing pains and are now witnessing strong earning gains with expanding sales and profits. A small-cap stock today may be tomorrow’s leader—it can also be tomorrow’s loser. Overall, such stocks can be very volatile and risky.
Large-Cap Stocks
Large-cap stocks are a broad subset of the stock market. Generally considered integral to an investor's diversified portfolio, they tend to have fairly similar characteristics and so are grouped together. As a whole, large-cap stocks are an important part of the economy and therefore essential to asset allocation.
Larger companies tend to have a more established business presence and less uncertainty in sales or profits than smaller (small-cap) companies. Although there are exceptions, larger companies often have slower growth rates, but are less risky investments than many smaller companies. Large-caps are considered long-term investments, and 50+ years of historical market returns yield slightly lower than short-term returns, but with less volatility.
Cyclical Stocks
Companies with earnings that are strongly tied to the business cycle are considered to be cyclical. When the economy picks up momentum, these stocks follow this positive trend. When the economy slows down, these stocks follow, too. Cyclical stocks would include companies like DaimlerChrysler (NYSE: DCX) and United Airlines (NYSE: UAL).
Defensive Stocks
No matter how the market is faring, defensive stocks are relatively stable under most economic conditions. Stocks with this characteristic include food companies, drug manufacturers, and utility companies. For the most part, you can’t live without these products no matter what the economic climate may be at any given time. The list of defensive stocks includes Merck and Co. (NYSE: MRK) and Johnson and Johnson (NYSE: JNJ).
Value Stocks
Such stocks look inexpensive when compared to earnings, dividends, sales, or other fundamental factors. When there is a big run on growth stocks, value stocks may be ignored. However, many investors believe that value stocks are a good deal given their reasonable price in relation to many growth stocks. Warren Buffet would probably vouch for that.
Income Stocks
Income stocks, which include REITs (Real Estate Investment Trusts), may fit the bill if generating income is your primary goal. One example of an income stock is public utility companies because such stocks have traditionally paid higher dividends than other types of stock. As with any stock, it’s wise to look for a solid company with a good track record.
Speculative Stocks
Any company that’s boasting about their brilliant ideas but doesn’t have the earnings and revenue to back it up would be classified as a speculative stock. Since these companies have yet to prove their true worth, they are a risky investment.
Socially Responsible Stocks
Another investment strategy that is growing in popularity is socially responsible investing (SRI). Here, investors put capital into companies that represent their personal values. Such individuals may avoid tobacco or liquor companies or any company with products or services that damage the environment. Socially responsible investors favor companies that have a positive influence on society.
Preferred Stocks
Although it is a much less popular alternative to common stock, you can also purchase what is known as preferred stock. These stocks share more in common with bonds than they do with common stock. Essentially, this type of stock has a fixed dividend and a redemption date. Income received has nothing to do with the company’s earnings. If the company goes under, holders of preferred stock have priority when it comes to dividend payments. You normally have no ownership as a preferred stock owner; however, it can be a viable option for income-oriented investors. This book will concentrate on common stock because, like its name, it’s the far more common choice for stock investors.
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Purchasing shares of stock is a lot like buying a business. That’s the way Warren Buffet, one of the world’s most successful investors, views it—and his philosophy is certainly worth noting. When you buy stock, you’re actually buying a portion of a corporation. If you wouldn’t want to own the entire company, then you should think twice before you consider buying even a piece of it. You are, indeed, buying a proportional share of the business when you purchase shares of stock. If you think of investing in these terms, you’ll probably be a lot more cautious when singling out a specific company. Most people wouldn’t buy a business without conducting a thorough investigation of every aspect of the company. It’s important to become acquainted with all of the details. What are all of the products and services the company offers? Which part of the business accounts for the greatest revenue? Which part of the business accounts for the least revenue? Is the company too diversified? Who are its competitors? Is there a demand for the company’s offerings? Is the company an industry leader? Are any mergers and acquisitions in the works? Until you understand exactly what the company does and how well it does it, it would be wise to postpone your decision to rush into an investment. Let’s say you wanted to buy a convenience store in your hometown. You’ve reviewed such factors as inventory, the quality of the company’s employees, and customer service programs. In addition to selling staple grocery items, the company also rents videos and operates a gas pump. The grocery side of the business may only account for a small percentage of the overall revenue. It would be in your best interest to value each part of the business separately in order to get a complete and accurate picture of the company’s profit potential. Many companies may have traditionally been associated with a specific business, yet that same company may have expanded into totally new venues. Disney, for example, has historically been associated with the Disneyland and Disney World theme parks. The reality is that Disney is also involved in a host of other ventures. Among other things, the multifaceted company also has interests in television and movie production, including Miramax Film Corp. and Buena Vista Television. Disney’s ABC Inc. division includes the ABC TV network, as well as numerous television stations and shares in various cable channels like ESPN. Philip Morris is commonly associated with tobacco products. The company also profits from food and beer subsidiaries, including Kraft (featuring popular brands like Jell-O, Oscar Mayer, and Post) and Miller Brewing. Just like any other career, making money via investing requires work. The more research and thought you put into your strategy, the more likely you are to reap rewards. Although there are no guarantees in the world of investing, the odds will be more in your favor if you make educated and well-informed investment decisions. When you make an investment, you will be putting your money into a “public” company, which allows you—as part of the public—to become an owner or to have equity in the company. That’s why stocks are often referred to as equities. What kinds of stocks can you buy? That's the subject of our next blog.
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