Author: Team Editor

Passive Income

Generate Income Like a Music Star

Posted on by Team Editor

music autions

“Telephone number checks” is one way to describe the income some performers make from royalties. These are checks containing seven digits, as long as a telephone number. Of course, there are a relatively small number of individuals who earn telephone number checks.

But, there are many performers who enjoy smaller royalty streams. They may write a song which gets picked up as the theme song for a television program that airs five days a week, something like ABC’s Good Morning America.

It’s important to remember that royalties are generated every time a song is played, whether the song is played in a concert, by a local band in a public performance, streamed through a music service, on a television show, commercial or movie, or any other venue.

Well, there was an opportunity to invest in that theme song. The writer’s share of a catalog of songs including the theme music used in ABC’s flagship news programs: Good Morning America, This Week, and America This Morning, was recently auctioned.

Specifically, the auction entitled the winner to receives 50% of the writer’s share of public performance royalties for those songs.

The auction notes highlighted the fact that “this catalog’s earnings have grown 273% in the last four quarters over the four previous quarters. In the last 12 months, this collection of theme music produced $11,317 in royalties.”

Assuming no upside, that’s an income stream of more than $5,600 a year and the payouts would last for the lifetime of the author plus 70 years. This is an asset that could require you to create an estate plan.

Now, the winning bid for that auction was $60,000, a yield of 9.3% for the current payout. But, there are many other auctions and there are always new opportunities.

A New Asset Class for Income Investors

The Royalty Exchange explains the value of these type of investments.

Intellectual property assets with a strong track record of consistent earnings may be the perfect investment for those seeking income. Owners of intellectual property of any kind are paid every time their IP is used. They create an asset once, and then collect payment over and over again.

Billy Goodrum, for example, wrote original music for the hit comedy Dumb and Dumber (1994), among others. Below, you can see that the royalties he earned from that movie increased at least 15% every year from 2011 through 2014, ultimately reaching a 12-month total of over $22,000 before he sold it in early 2015.

royalties paid by year

Source: Royalty Exchange

Royalty Exchange was founded in 2011 to help artists raise money and take control of their financial future. Creators enjoy a powerful new way to fund their career. Investors can generate income that’s hard to beat.

Even before 2011, royalties were available to investors. But, “royalty transactions took place in private. They were available only to industry insiders who held all the cards.

This kept prices low and values cloaked in mystery. Deals were all-or-nothing, take-it-or-leave-it offers. Only the biggest and richest creators could attract interested buyers. And private investors lost out on opportunities for significant returns.”

Now, there are fully transparent auctions that any investor can consider.

The site reports that over 22,500 investors are registered for auctions. Since 2016, creators have raised over $14 million on Royalty Exchange.

A Recent Auction

pop catalog

Source: Royalty Exchange

Music fans may be familiar with names like Ariana Grande, Jennifer Lopez, Meghan Trainor or Chris Brown. They many not know they could earn money when they hear one of those songs.

Potential investors can see a complete listing of the songs included in the catalog and the terms of the auctions were clear.

auction results

Assuming income of about $1,100 a year, the minimum income would be about 8% a year. An investor could determine the value of the income stream to them, perhaps it would be 5% a year. Dividing the expected initial income by the minimum required return would indicate this could be worth $22,000.

It might be reasonable to limit the bid to just 70% of that amount to provide a margin of safety. Of course, there is no guarantee the income stream will remain at the recent level.

A New Opportunity For Individual Investors

A recent product innovation is the Peer Advance. This type of opportunity occurs when future proceeds are pledged to an investor at a stated interest rate.

As one example, the classic song “These Boots Are Made for Walkin'” was recently ensured of a royalty payment of $56,250 that would be payable in September 2018. The owner wanted funds earlier and offered a return of 9.75% for a 10 month loan, secured by the rights.

In other deals, the returns are fixed but the time period is variable. One recent deal gave investors the opportunity to receive the next $25,000 in royalty payments on a catalog of songs recorded by Earth, Wind and Fire.

The investor would pay $18,750 for the right to collect the seller’s royalty income until the investor receives a total of $25,000. The total return equals the Advance Amount plus a 33% return ($18,750 x 1.33 = $25,000).

With this investment, the variable is not the amount of return the investor can expect. The investor will receive all royalties generated until the total return is achieved.

Instead, the variable is the amount of time it takes for the investor to receive the full Repayment Amount. The investor will receive $25,000 in royalty payments. The only question is how long it will take.

If future quarterly payments equal the average of the last four quarters, the investor will receive the Repayment Amount in 24 months. That’s approximately a 15% Annual Rate of Return.

If future quarterly payments equal the most recent quarterly payment, the investor will receive the Repayment Amount in 27 months. That would generate approximately a 14% Annual Rate of Return.

There is risk, but there is also the possibility of above average returns. Uniquely, there is also an opportunity for bragging rights the next time a song you own an interest in comes on the radio.

 

 

 

Stock Picks

Stocks Analysts Like, and Some They Dislike

Posted on by Team Editor

Analysts were generally optimistic after companies reported results last quarter. They were, in fact, historically optimistic. We can see how unusual this is by considering some data.

As companies reported their results for the final quarter of 2017, they also provided guidance on what to expect in the first quarter of 2018 and for the full year. Analysts then use this guidance to revise their earnings expectations.

According to the research firm FactSet, analysts increased their earnings estimates for the companies in the S&P 500 to $157.77 from $147.24, the estimate they published on December 31, 2017. This is the estimated earnings per share (EPS) for the index, with the EPS of individual companies weighted to reflect their contribution to the price of the S&P 500.

This is a 7.1% jump and the “increase marked the largest increase in the annual EPS estimate for the index over the first three months of the year since FactSet began tracking the annual bottom-up EPS estimate in 1996.”

Change in S&P 500

Source: FactSet

Changes From Analysts Point to Sectors to Watch

In addition to publishing estimates on the index, they also publish EPS estimates and ratings for individual stocks. Overall, there are 11,094 ratings on stocks in the S&P 500. Of these 11,094 ratings, 52.2% are Buy ratings, 42.9% are Hold ratings, and 4.9% are Sell ratings.

In general, analysts are reluctant to use a Sell rating. It is widely believed that analysts who rate a company as a Sell can hurt their firm. This is because companies often use investment banking services and they may penalize analysts with Sell ratings.

A company uses investment banking services when they complete an initial public offering. But, they also use these services when they issue or refinance debt and many companies are selling debt at any given time.

Investment bankers can also help a company repurchase its own stock or handle the sell of large blocks of stock for executives looking to diversify their personal portfolios. In other words, there are a number of opportunities for Wall Street firms to generate revenue from publicly traded companies.

Those opportunities could be limited if an analyst releases a negative report on a company. And, there are rare reports of companies firing analysts who issue negative reports.

In one example, The New York Times reported that Merrill Lynch replaced an analyst who had annoyed Enron executives by issuing a neutral rating on the energy company. Of course, Enron collapsed into bankruptcy and the analyst was correct.

For traders looking at sectors, analysts are most optimistic on the Information Technology (60%), Health Care (59%), and Energy (59%) sectors, as these three sectors have the highest percentages of Buy ratings.

To gain exposure to these sectors, traders could buy exchange traded funds, or ETFs. An ETF is a diversified basket of stocks that tracks an index. ETFs trade like stocks and carry low expenses, making them attractive for investors seeking to invest in indexes.

In this case, there are indexes associated with these three sectors and specific ETFs tracking the sectors with the most buy rating. Traders could buy Technology Select Sector SPDR ETF (NYSE: XLK), Health Care Select Sector SPDR ETF (NYSE: XLV) and Energy Select Sector SPDR ETF (NYSE: XLE), for example.

Traders interested in following analysts’ recommendations should the Telecom Services and Utilities sectors. These are the two sectors that have the lowest percentages of Buy ratings.

The Telecom Services sector has just 33% recommended buys and also has the highest percentage of Hold ratings, at 66%. The Utilities sector has just 39% buy recommendations and also has the highest percentage of Sell ratings with 9%.

Stocks Analysts Like

At the company level, the 10 stocks in the S&P 500 with the highest percentages of Buy ratings are shown in the next table.

stocks analysts like

Stocks to Avoid

Now, turning to stocks to avoid, at the company level, the 10 stocks in the S&P 500 with the highest percentages of Sell ratings are shown below.

stocks to avoid

The list of stocks with a large number of sell ratings could be of particular interest to traders. Although it is rare, remember that analysts can see negative impacts to their careers for bearish reports. This means analysts will generally have a high degree of conviction on Sell ratings.

However, the Hold ratings should also be considered when evaluating a company. Hold is often an indication of bearishness. As we saw above, Sell ratings make up about 5% of all ratings. This indicates the Hold rating also carries a negative tone.

In the table above, there are three companies with no Buy ratings. These stocks are unlikely to be winners in the coming year and traders could benefit from that.

To benefit from a down trend, a trader could sell a stock short. A short trade gains in value as the price of the stock declines. However, short trades are expensive and carry a high degree of risk. Many traders avoid short selling because the risks are so high.

However, traders could use a put option to obtain the benefits of a short trade. By buying a put option, the trader could benefit from a decline. The put carries limited risk. When buying an option a trader can never lose more than they originally paid to enter the trade.

Put options on the stocks with no buy ratings could be profitable trades in the coming months. This is especially true if stocks continue to decline as they have in the past few weeks.

In a declining market, the weakest stocks, or the biggest losers, are likely to be companies with fundamentals that cause concern.

The three companies with no buy ratings, for example, are all growing slower than their industry peers, a warning sign that if a recession occurs these could be the companies that suffer more than average.

Even without a recession, traders should be concerned with the possibility of a bear market. Now could be an ideal time to hedge a portfolio and put options, especially on weak stocks, which could provide profits even in a bear market.

 

Value Investing

The Truth About Value Investing

Posted on by Team Editor

value investing

Value investing works. Plus, it is intellectually appealing. Yet, it is difficult for many individual investors to strictly follow a value investing philosophy in the long run. There are some very good reasons why value investing is so challenging to implement.

First, let’s consider its intellectual appeal. Value investing is widely described as buying assets at a discount. As Warren Buffett says, it’s best to buy both socks and stocks at a discount. Bargain hunters are drawn to value investing because of this idea.

Discounts Can Be Misleading

In retail stores, shoppers know that markdowns can be misleading. For example, a “70% Off” sign will often include fine print that the discount is based on a suggested selling price and the item may never have actually been sold at that higher price.

In stocks, the discount that investors believe they are getting may also be based on a price that is well above what the stock would sell for in the market.

For example, an investor might find a stock priced at $3 a share. But, the book value is $22 a share. They believe the market price is a deep discount to its book value and they buy, expecting to reap a significant profit when other investors notice the value.

Unfortunately, the investor is buying just weeks before the company announces that it is writing off billions of dollars in book value because of changes in the market conditions. After the write offs, the book value drops to just $2 a share and traders are concerned the value is still overstated.

This simple example demonstrates that the appeal of value investing could be an illusion in some cases. There will be times when the apparent value is not real. The market is simply discounting a problem at the company that has not been fully revealed yet.

Importantly, this is not just a hypothetical problem. The chart below shows that book value does change, suddenly at times, and can make a bargain into in an overvalued situation with a single announcement from the company.

 book value

Source: Standard & Poor’s

The same is, of course, true for retail bargains. That $2 knock off of a $200 watch is not going to last and many shoppers avoid buying this type of merchandise. But, in stocks, the true value of a company can be difficult to determine.

But, Value Works in Studies

Although many individual investors have suffered large losses buying stocks that appeared to offer value. They take solace in the fact that many studies have demonstrated that value investment strategies work.

Many of the studies show a chart similar to the one below.

invested growth

Source: Alpha Architect

The value portfolio outperformed the market portfolio, in the long run. Studies consistently confirm this and the studies show any measurement of value is likely to deliver results that beat that market.

That means investors could select stocks based on a low price to earnings (P/E) ratio, low price to book (P/B) value, a high dividend yield or nearly any other valuation metric. In the long run, studies show the strategy should provide market beating results as long as the strategy implemented in the same way the strategy is presented.

The key is that to obtain the type of results shown in the studies, the investor must invest like the study says. And, the truth is, that’s impossible for individual investors to do.

Studies generally sort stocks into deciles, or ten groups that each include several hundred stocks. Many studies then assume a long and short investment where the investor buys the stocks in the most undervalued decile and sells short all of the stocks in the most overvalued decile.

Doing this would require holding several hundred positions and the minimum account size required to duplicate these strategies is, quite simply, beyond the reach of almost all individual investors.

The reason the portfolio outperforms is because some of the positions will deliver very large gains. Many of the positions are likely to deliver either small gains or losses and some will result in relatively large losses.

Overcoming the Obstacles

Now, the problem is clear. The success of value investing depends on identifying the few stocks that will be among the biggest winners. Simply buying undervalued stocks will not guarantee success since there is no way to determine in advance if any single stock will be a large winner or not.

To overcome this problem, even small investors should consider the need to diversify their investments. They should always hold at least a few stocks but there is no right answer as to how many is the correct number of holdings.

One solution is to cut losses quickly and let winners run. This means an investor will sell a position when it falls in value and could even add available funds to the winning positions. This strategy is not one that is easy to follow.

Many individual investors add to losing positions. They seem to be thinking that if the stock offered value when they made the first purchase, it is now on sale at an even better price. This, however, will mean that they add to the stocks that are destined to deliver losses.

Rather than adding to losers, an investor should give a stock sufficient room to decline and then sell. The meaning of what represents sufficient room will depend on the investor’s risk tolerance. Many investors sell when prices fall by 20% while others may use a 30% loss as their sell signal.

One way to limit losses is to know what percentage loss will trigger a sell when the buy is made. Then, stock with that decision, no matter what happens. If the stock truly offers value it could always be bought back later.

Another important consideration is to use multiple indicators. Rather than using solely the P/E ratio, consider requiring growth in sales as an additional factor, for example.

These simple steps – diversification, cutting losses and using confirming indicator – will not guarantee success but they will help an investor avoid the large losses that are possible even with a value investment approach.

 

 

 

Cryptocurrencies

Cryptocurrencies Could Factor Into the Next Trade War

Posted on by Team Editor

crytocurrencies

It was just a few years ago that trade wars seemed to be a subject confined to the history books. The devastating impact of trade wars in the 1930s demonstrated that actions taken to restrict trade could hurt economic growth.

Often, a trade war begins when one country imposes tariffs or other trade barriers on goods from another country. The second country, perhaps angry or fearful of adverse economic impacts, retaliates by imposing its own tariffs or barriers on goods from the first country.

At times, this prompts the first country to impose new tariffs or to increase existing tariffs. A series of retaliatory steps summarizes the trade war.

Trade Can Create Winners and Losers

Trade can be summarized as a series of transactions between countries, with each transaction requiring a decision. In game theory terms, each play makes a choice to cooperate or defect. As one analyst explained:

“You can cooperate with the other country, allowing the free flow of its goods into your country. Or you can defect, imposing tariffs on the foreign goods.

And because you will trade with the same country over and over again, you have to decide whether to stick with a single strategy no matter what or whether to change course in response to your opponent.

The other country faces the same choice, but you can’t know in advance what plan they’ve chosen. Free trade helps both countries, generating big windfalls for both sides.

But it’s possible for a single country to improve its own situation at the other’s expense — you both have a selfish incentive to defect, taxing the imports from the other country and helping only yourself. However, if you both defect, you both wind up isolated, cutting yourselves off from the market and reducing earnings on both sides.”

This can be summarized with the payoff descriptions shown in the figure below.

trade game

Source: FiveThirtyEight.com

Now, interestingly, each decision assumes that countries control the means of the payments.

Cryptos Can, Perhaps, Evade Trade Wars

This dynamic has defined the structure of international trade for centuries. Now, suddenly, bitcoin and other cryptocurrencies are threatening to destroy the capability of governments to completely set the rules for international trade.

In theory, cryptocurrencies prevent governments from manipulating their own currencies, as the cryptocurrency makes a new way to evade ­official controls and move money throughout borders.

In short, blockchains have the potential to revolutionize transactions, understanding their limitations is crucial for policymakers and users.

Any individual or company that uses a blockchain technology must understand how ultimate control of the nodes is distributed—who will decide the ledger’s accuracy. In many regards, the innovators of the technology intended for decentralization and democratization of transactions, thus revolutionizing the way payments are made, assets are exchanged and contracts are recorded.

As an example, we can look at Venezuela.

Petro is the first cryptocurrency which is purportedly backed by natural resources. According to Venezuelan President Nicholas Maduro, the sale of his pet cryptocurrency has raked in over five billion dollars during its pre-sale period.

The cryptocurrency has also reportedly received 186,000 certified purchases. If true, Petro could potentially be viewed as a successful circumvention of aggressive international sanctions. In all, 83,000 purchasers in 127 countries participated in the offering.

The U.S. Treasury Department has claimed that the Venezuelan cryptocurrency is essentially “an extension of credit to the Venezuelan government,” which is strictly forbidden under U.S. sanctions. The U.S. Treasury Department also noted that:

“U.S. persons that deal in the prospective Venezuelan digital currency may be exposed to U.S. sanctions risk.”

The fact, however, that Venezuelan currency can be exchanged into bitcoin already shows that sanctions could, in theory be avoided.

VEF to XBT Chart

Source: XE.com

This presents a pathway for the unscrupulous to interact with the government, or with other unsavory international characters.

The Impact on Investments

The introduction of cryptocurrencies has potentially altered the world order. It creates opportunities to conduct businesses that lie outside the legal system. But, none of this detracts from the more legitimate uses of cryptos.

Cryptos have always enabled activities that are beyond the bounds of the law. This, of course, has also been true for currencies issued by governments. Drug deals, for example, have always been possible with cash and large amounts of cash are a potential indicator of criminal activity.

Central banks recognize this potential problem. A paper published by the Dallas branch of the Federal Reserve recognizes the problem. In a paper called, “The Potential Impact of Decentralized Virtual Currency on Monetary Policy,” economists note:

“The border-free nature of decentralized, virtual currencies — Bitcoin is only one example — presents an interesting challenge for monetary policy which assumes some amount of government control over cross-border financial flows and exchange rates. At the extreme, decentralized virtual currencies systems may force all countries to accept floating exchange rates and unrestricted financial flows.”

The bank noted there were two means of converting currencies now that the cryptocurrency market has developed liquidity.

U.S. dollars to Euros

Source: Federal Reserve

This simple diagram demonstrates that the possibility of skirting regulations exists and that creates a potential floor of demand for cryptos.

This is important for the market because it indicates cryptos do possess at least some degree of ​intrinsic value. In other words, it is unlikely that widely used cryptos will fall to zero. This provides at least some assurance to investors that the losses are limited.

Bitcoin is the leading candidate for widespread acceptance among both legitimate and illegitimate users of cryptos. But, smaller currencies could fill niche opportunities. This is important for traders to recognize.

Sharp moves in a small currency could be an indication that the crypto is filling a specific need in the marketplace. And, it is important to remember that market needs ultimately dictate value.

As a trader, it could be profitable to research small cryptocurrencies, exploring how the crypto is intended to be used and how it is being used. This could identify cryptocurrencies that possess at least some fundamental value and ultimately they could be the largest gainers in percentage terms.

 

 

 

 

Weekly Recap

Weekly Review

Posted on by Team Editor

weekly review

Eliminating the Risks of Bitcoin Investments

Risk and return are always assumed to be inseparable. In other words, you always have to accept higher than average risks in the pursuit of higher than average gains. Likewise, lower risks are only available when the potential rewards are lower than average.

This is the standard investment theory and something that any financial adviser can explain in detail. But, it might not always be true.

To read about the truth behind eliminating risks associated with Bitcoin investments, continue reading here.

Pitfalls of Value Investing: Value Traps

Investors are a diverse group. Some focus on the long term and others have a shorter term time target. Some pursue quick gains, others want to hold positions for years and still others try for short term gains but if they experience a loss, they decide to hold a position for the long term.

Despite the diversity, many investors share common experiences, which can lead to pitfalls in value investing. We discuss those pitfalls, right here.

This Industry Could Lead the Market Lower

Stock prices have been volatile in the past few weeks and we could be in the early stages of a bear market. The news is bearish and recent consumer sentiment polls are also increasingly negative. Investors are becoming concerned and those concerns could lead to more selling.

There is one industry in particular that could lead the market lower and we discuss it, in this article.

Passive Income from Preferred Stocks

Preferred stocks are an often overlooked asset class. Preferred stocks are assets that combine some of the features of stocks with some of the features of bonds. In our latest article, we provide passive income opportunities from preferred stocks.

 

Passive Income

Investing in high quality preferred stocks

Posted on by Team Editor

Nasdaq

Source: Nasdaq.com

Learn about Investing in high quality preferred stocks and get passive income. Preferred stocks are an often overlooked asset class. Preferred stocks are assets that combine some of the features of stocks with some of the features of bonds.

Shares of preferred stock are a claim on the company’s assets, just like common shares which are the class of stock that is more commonly traded. However, preferred shares have a higher claim on the company’s assets and earnings than common stock.

Preferred shares generally have a dividend that must be paid out before dividends to common share holders can be paid. Unlike common stock, preferred shares usually do not have voting rights that provide share holders with a say in the company’s operations.

One benefit of preferred stock is that although it pays a fixed level of dividends, like common shares the market price of the security can go up.

Preferred Share Prices Correlate With Interest Rates

The amount of the dividend is fixed when a company issues preferred shares. That amount will often be expressed as a percentage because the par value of the shares.

The par value is the face value of the shares. This is a concept that is usually applied to bonds. The par value of a bond is the amount that will be paid when the bond matures. It is typically $1,000. The market price of a bond may be above or below par, depending on factors such as the level of interest rates and the bond’s credit status.

Par value for preferred shares is usually $25 or $100 and the market price will be determined by the current level of interest rates and the financial health of the issuer.

Many well known companies issue preferred shares. Below are recent price quotes for preferred shares issued by Citigroup.

Citigroup

Source: The Wall Street Journal

The symbol usually includes the stock’s symbol (C in this case) and the series of the preferred C.PC, at the bottom of the listings, is the C-series issue and carries an interest rate of 5.8%. The shares par value is $25, and the current price is slightly above that at $25.26.

The quotes will be familiar to stock market investors who see the open, high, low and closing prices for common shares of stocks they follow. Notice that the volume on the preferred shares is sufficient to provide liquidity to individual investors.

The 52 week high and 52 week low columns show that these investments are not very volatile. This is because Citigroup is a financially stable company and the preferred shares move in line with changes in interest rates.

The dividend is expressed in dollar terms and as a percentage of the current price of the preferred shares. Dividends are usually paid quarterly but could be paid more or less often, depending upon the terms of the individual security. The amount shown in the table is the annual payment, not the quarterly payment.

The YTD change, or the year to date change in the price in percentage terms, confirms the low volatility in the issuers.

The Long Term View of Price Volatility

While preferred shares generally track interest rates, their prices are not immune to bear markets. The next chart shows the S&P U.S. Preferred Stock Index, a broad index that tracks the securities. Notice the steep decline in 2008 and then the lack of volatility in the bull market.

S&P U.S. Preferred Stock Index

Source: Standard & Poor’s

This chart demonstrates that these securities could be best for income investors with a long term horizon. The long term outlook is needed to accept the risk of the steep drawdown that is possible in a bear market.

There are many individual issues available, or an investor could choose to invest in an index of preferred securities. Several exchange traded funds, or ETFs, make it possible to conveniently invest in a diversified basket of preferred shares at a low cost.

One ETF is iShares US Preferred Stock ETF (NYSE: PFF). The next chart shows the price action in this ETF is similar to the movements seen in the broad index above.

PFF

The drawdown in the bear market was more than 68% but investors who held through that decline did recover their losses, just as investors in the broad stock market indexes did.

Given the risks related to a price decline in the ETF, investors need to be comfortable with the level of income provided. The yield on PFF was recently 5.7%.

Who Should Consider Investing in Preferred Stocks

There are many investors who could benefit from this asset class. Long term investors may find the yields to be suitable in the current market conditions.

Small investors can target specific yields in specific issues. Many of these securities have a par value of $25 and trade near $25 a share. As the table above showed, it is possible to buy securities yielding more than 7% at a price of less than $30 a share.

Preferred dividends are not subject to being reduced like dividends of common stocks are and the dividends of cumulative issues will always be paid even if they are omitted for a period of time.

This means a company could skip one or two payments in a time of distress but will make the payments when funds are available, assuming the company is not headed towards bankruptcy.

Preferred shares can also be noncumulative (or non. cum as shown in the price table above). In that case, the company would not make up any missed payments. Because of that, cumulative shares which have more safety will usually trade at prices that are lower than similar noncumulative shares.

Investors could also consider using margin, especially if they maintain a long term outlook. Buying securities on margin could boost income but it carries the cost of margin interest. However, at discount brokers, many investors may find the yield on the preferred shares or on PFF exceed the cost of a margin loan.

When the risks and potential rewards of the preferred stocks are considered, many investors will discover that this overlooked asset class is an ideal source of passive income.

Stock Picks

This Industry Could Lead the Market Lower

Posted on by Team Editor

Source: Intel.com

Stock prices have been volatile in the past few weeks and we could be in the early stages of a bear market. The news is bearish and recent consumer sentiment polls are also increasingly negative. Investors are becoming concerned and those concerns could lead to more selling.

This is in line with the teachings of Ben Graham, Warren Buffett’s business school professor. Graham said that in the long run, the stock market is a weighing machine but in the short run, the market is a voting machine.

What this means is that in the long run, stock prices reflect value. But, in the short run, prices move on emotion and can become significantly disconnected from the underlying value of the stock. When sentiment turns negative, we could see sharp declines in the stock market as the voting machine registers sells.

News Reflects the Mood

When investors are in a bearish state of mind, news takes on an added emphasis. Recent news of a fatal accident involving a self driving car are an example of how news can overwhelm fundamentals. A self-driving Uber vehicle crashed and killed a woman in Tempe, Arizona earlier this month.

This is the first fatality in a promising industry. Less than two years ago, the cars were expected to have the potential to save lives. Each year more than 30,000 people die on the road in the United States, with the vast majority of those fatalities attributed to human error.

Now, the question is how safe are driverless cars? And, the answer is really that it’s too soon to tell. As the Washington Post noted,

“Motor vehicle fatalities are measured in terms of “vehicle miles traveled,” which is just what it sounds like. In 2016, there were 1.18 fatalities for every 100 million miles that Americans drove. Since Americans drove nearly 3.2 trillion miles that year, that still added up to tens of thousands of deaths.

To know whether self-driving cars are safer than the traditional kind, you’d have to know how many miles they traveled before incurring this first fatality. And the answer is “fewer than 100 million” — a lot fewer.

Waymo, the industry leader, recently reported logging its 4 millionth mile of road travel, with much of that in Western states that offer unusually favorable driving conditions. Uber just reached 2 million miles with its autonomous program. Other companies are working on fully autonomous systems but adding them all together couldn’t get us anywhere close to 100 million.”

But, traders are selling rather than waiting for the answer after more test results are available.

Technology Leaders See Selling Pressure

Uber is not a publicly traded company and it’s impossible to see how the accident impacted the company’s valuation. But, Nvidia (Nasdaq: NVDA) is one of the companies that supplies the technology. The stock dropped nearly 8% after the fatal crash.

NVDA

News reports indicated that Nvidia will suspend self driving car tests. Nvidia does its own testing of self driving technology in Japan, Germany, New Jersey and Santa Clara, California.

Tesla also uses Nvidia chips for computers that automate the driver-assisted control system.

TSLA

Tesla has had several problems with self driving technology. One of the company’s cars was also involved in a fatal accident this month but it was unclear if Tesla’s automated control system was driving the car.

The accident involved two other cars, the National Transportation Safety Board (NTSB) and police said. The California Highway Patrol said the electric-powered Tesla Model X crashed into a freeway divider on Friday and then was hit by a Mazda before colliding with an Audi.

The Tesla’s lithium batteries caught fire, and emergency officials consulted company engineers before determining how to extinguish the battery fire and move the vehicle safely. NTSB said the issues being examined include the post-crash fire and removing the vehicle from the scene.

Tesla vehicles have a system called Autopilot that handles some driving tasks. Tesla’s Autopilot allows drivers under certain conditions to take their hands off the wheel for extended periods. Still, Tesla requires users to agree to keep their hands on the wheel “at all times” before they can use Autopilot.

This is the second NTSB field investigation into a Tesla crash since January.

In January, the NTSB and U.S. National Highway Traffic Safety Administration sent investigators to California to investigate the crash of a fire truck and a Tesla that apparently was traveling in semi-autonomous mode. The agencies have not disclosed any findings.

The NTSB did, however, fault Tesla in a prior fatal Autopilot crash.

In September, NTSB Chairman Robert Sumwalt said operational limitations in the Tesla Model S played a major role in a May 2016 crash in Florida that killed a driver using Autopilot. That crash raised questions about the safety of systems that can perform driving tasks for long stretches but cannot completely replace human drivers.

Tesla later added improvements to Autopilot, adding new limits on hands-off driving.

One Potential Leader to Buy

While NVDA and TSLA are under pressure, another player in the sector may be unscathed by the news.

Officials with Mobileye said its computer vision system would have detected the pedestrian who was killed in Arizona. The company called for a concerted move to validate the safety of autonomous vehicles.

Amnon Shashua, chief executive officer of Mobileye, the vision system company owned by Intel Corp (Nasdaq: INTC), in a blog post also criticized “new entrants” in the self-driving field that have not gone through the years of development necessary to ensure safety in the vehicles.

Mobileye said it took the dashboard camera video released last week by police and ran it through Mobileye’s advanced driver assistance system (ADAS), a building block of even more sophisticated full self-driving systems that is currently found in 24 million vehicles around the world.

Despite the low quality imaging from the police video, Mobileye’s ADAS technology was able to detect the pedestrian, Elaine Herzberg, and the bicycle she was pushing across the road.

“Experience counts, particularly in safety-critical areas,” Shashua wrote in a veiled reference to Uber, which only began to develop its self-driving program in 2015.

Mobileye’s CEO has previously argued for a formal model for “provable safety assurances” that all self-driving companies could use to validate the safety of their systems and ensure their vehicles do not cause accidents.

“I firmly believe the time to have meaningful discussion on a safety validation framework for fully autonomous vehicles is now,” Shashua wrote.

Those high standards could be helping push INTC higher.

INTC

Traders will find opportunities and risks in self driving cars. INTC may pose the least risk, for now.

 

You can read other market related articles, here.

Value Investing

Pitfalls of Value Investing: Value Traps

Posted on by Team Editor

GE logo

Source: GE.com

Investors are a diverse group. Some focus on the long term and others have a shorter term time target. Some pursue quick gains, others want to hold positions for years and still others try for short term gains but if they experience a loss, they decide to hold a position for the long term.

Despite the diversity, many investors share common experiences. One experience many investors share is the pain of a value trap. This occurs when investors buy a stock because it is undervalued, and the stock becomes more undervalued or refuses to move higher.

This amounts to dead money and is something no investor can afford. Trading capital is limited and dead money is capital that fails to deliver a significant gain for an extended period of time.

An Example of a Value Trap

The value trap is often in a well known company. General Electric Company (NYSE: GE) is an example of a well known company which until recently enjoyed a reputation for outstanding operations and management.

Over the past year, the stock price has plummeted as investors question the ability of management to continue delivering gains. Like almost all events in the stock market, this isn’t the first time we’ve seen a plunge in the price of GE. Looking at the past could help us develop a plan for the future.

In the bear market that bottomed in 2009, GE was also plummeting. This was, of course, true of almost all stocks. However, many investors initially viewed GE’s decline as a potential buying opportunity. At this point, the company’s reputation was still intact. However, even then, problems lurked under the surface.

The problems then were related to GE Capital, the company’s financing arm which had, in fact, become highly leveraged. Eventually, GE Capital would require a bailout, catching many investors and even policy makers by surprise.

Despite the looming problems, the stock was attractive to many individual investors. The chart below shows why. The stock’s price to earnings (P/E) ratio was below 10. In the chart, the P/E ratio is shown at the bottom and the horizontal line marks the value of 10, a level often considered attractive.

GE

Investors who bought when the P/E ratio broke below 10 in the summer of 2008 would see the value of their investment fall by more than 60%. They had bought based on value and become trapped in an investment that was falling.

GE, in 2008, was an example of a value trap. Looking solely at value is a mistake, but it is a mistake many investors make. This is true for both individual investment and professional investment managers.

Why Value Traps Exist

Value, on its own, can be deceptive. For our purpose here, value refers to a stock trading with low P/E ratio or offering low valuation on other metrics. It is important to remember that P/E ratios are just one metric. Any valuation metric offers the same benefits and potential pitfalls to investors.

A low P/E ratio carries one of two meanings. The stock is either undervalued and due to rebound or overvalued and due for even more problems. The truth will only be known for sure in hindsight.

We generally think of value highlighting bargains rather than problems. But, consider the stock of a company that is headed towards bankruptcy. The company might have some earnings from the past twelve months but the company is troubled.

Assume the earnings of a drug company are $1 per share. The stock is at $20 and the P/E ratio is 20. Analysts see that the company’s product is losing patent protection next year and there is no replacement in the research pipeline. The company will be bankrupt in two years.

As traders begin acting on this insight, the stock falls to $10 in a matter of weeks. The P/E ratio is now 10. Some individual investors may now believe the stock was worth $20 just a few weeks ago and it is now on sale. They buy, expecting a rebound to $20.

The stock falls to $5 after the next earnings report where the company manages to report earnings that are unchanged from a year ago because of share buybacks and accounting benefits. Now the P/E ratio is $5 and some investors buy more, averaging down because they believe the stock is worth $20.

Notice the P/E ratio in this case is plunging because the stock is facing problems and likely headed to zero. But, some investors believe it reflects a bargain. That leads to the value trap.

Look for Momentum and Value

James O’Shaughnessy published “What Works on Wall Street: A Guide to the Best Performing Investment Strategies of All Time” in the late 1990s and demonstrated that value is an excellent investment strategy. But, it works better when combined with momentum.

The next chart adds MACD, a momentum indicator to GE.

GE with MACD indicator

 

Avoiding GE when the MACD is bearish is one way to avoid the value trap. This is a daily chart and would require active trading. The next chart is a weekly view and would require less trading.

GE

Other indicators such as relative strength could also be used, and they would be less active than a MACD strategy, but those indicators are less widely available.

What About Now?

GE is once again trading at low valuations, and many investors are tempted to buy, noting that the company has survived for more than 100 years and seems unlikely to be headed towards bankruptcy and a stock price of zero.

The stock chart below shows the recent price action, using weekly data.

GE recent price data

Notice that momentum, again shown with the MACD, has been negative throughout the stock’s decline. This indicates there could be more downside.

Of course, using a momentum filter to buy stocks offering value will result in buying after the bottom has formed. This guarantees an investor will never catch an absolute bottom. It also reduces the risk of a value trap. There will always be tradeoffs and individual investors need to decide which is more important to them.

If they are truly focused on the long term, they could ignore momentum. However, if they lack unlimited resources and want to avoid dead money, waiting for confirmation that a decline has most likely ended could be the best approach to a value based investment method.

 

 

Cryptocurrencies

Eliminating the Risks of Bitcoin Investments

Posted on by Team Editor

Eliminating Bitcoin risks

Risk and return are always assumed to be inseparable. In other words, you always have to accept higher than average risks in the pursuit of higher than average gains. Likewise, lower risks are only available when the potential rewards are lower than average.

This is the standard investment theory and something that any financial adviser can explain in detail. But, it might not always be true.

Derivatives Serve Useful Purposes

Large banks and investment firms often use derivatives to meet their investment goals. Warren Buffett is, rather famously, not a fan of derivatives, having once called them “financial weapons of mass destruction” but does often use derivatives in his own portfolio.

It’s more likely that Buffett was highlighting the fact that derivatives can be dangerous for uninformed investors but if you take the time to understand them, they can be used to manage risks. In fact, risk management was one of the reasons derivatives became popular.

One of the most popular derivatives is the structured note. This is “a debt obligation that also contains an embedded derivative component that adjusts the security’s risk/return profile.”

One example of a structured note is a popular annuity contract that guarantees investors they will not lose money and they will be able to participate in the gains of the stock market. For example, they may be assured their account value will never decline below its value on a certain date every year.

So, every May 31, for example, the account is valued. If the value fell from the previous year, the annuity provider makes up the difference. If it increased in value, the annuity holder sees a gain in their wealth.

This sounds risk free. But, and there is almost always a but, there is a cost. In this example, the investor might only get to keep half of the stock market gains or their gains in any year may be capped at 10%. They still benefit from the gains and they still hold no risk. They just pay for that protection.

For institutions, structured notes often take on a different form. Bloomberg recently explained the strategy used by institutional investors:

“[I]f you have $10,000 to invest for five years, you spend some of it buying a risk-free security (classically, a Treasury Strip) that matures at $10,000 in five years, and then — because that Strip costs something like $8,750 today — you spend the rest buying the risky thing that you really want to buy.”

Instead of directly buying the risky asset, you could buy call options on the asset to enhance the return profile of the structured note.

Bloomberg explained that the transaction is actually a little more nuanced:

“Instead of just telling clients to buy Strips and options to get the asymmetric payoff profile that they want, you can take the clients’ money, use some of it to buy Strips, some of it to buy options and some of it to pay yourself a fee, and guarantee the clients the asymmetric payoff profile that you think they want.”

That is often the essence of a Wall Street transaction where the client obtains something of value and the investment bank providing the service is entitled to a fee for providing the service. For small investors, the fees aren’t worth the effort for Wall Street so individuals face challenges obtaining these products.

A Bitcoin “Structured Note”

At least one firm is currently working on this delivering this type of strategy to small investors using Bitcoin. The firm is “building a tax deferred savings product that gives you some participation in stock market upside with protection against any losses.”

But, they also address the question of whether or not a similar model could be applied to bitcoin and other cryptocurrencies and their answer is yes. The example provided is for a $10,000 investment but the idea works for any account size since Treasury notes could be bought for as little as $100.

Treasuries can always be bought, for free, through the Treasury’s web site, TreasuryDirect.org. Individuals obtain the interest rate available to large investors by submitting noncompetitive bids for bills, notes or bonds through that site. There is no fee so returns are generally going to beat those available through passive money market funds or exchange traded funds (ETFs).

Examples of How to Guarantee Your Investment

Now, to the example, assuming you have $10,000 to invest, you could buy a Treasury note maturing in five years. The recent interest rate of 2.6% for this investment means the cost will be about $8,800. You could then hold the remainder in cash and in five years, you have $11,200.

bonds

Source: Benjamin.com

Now, you could also put that money into bitcoin. In that case, you would place $8,800 into the risk free Treasury note maturing in five years and the remainder into bitcoin or other crypto currencies. The next chart assumes the crypto investment doubles in value.

bitcoins

Source: Benjamin.com

In this scenario, you earn a total return of 24% on your $10,000 investment. If you had instead invested $1,000, you would still enjoy a 24% return in this scenario and have an account worth $1,240. In the worst case, there is zero risk as the next chart shows.

bitcoins

Source: Benjamin.com

That’s the worst case and it means an investor loses nothing with this strategy.

Now, you may understand why Wall Street uses this strategy of structured notes. It can be applied to ensure a portfolio never suffers a loss.

The Risks Are Not Completely Eliminated

There are still risks with this strategy. There is the risk you may have to sell the Treasury early and that could mean a loss is incurred in closing that part of the structured note. There is, of course, the risk of loss in the asset that is used to boost returns.

This strategy could be applied with bitcoin or any other crypto currencies. It could also be applied with stocks, ETFs tracking market indexes or even volatility, gold or any other asset. It redefines risk and could allow an investor to boost returns in a portfolio even when losses are completely unacceptable.

Provided the Treasury is held to maturity, there is no chance of loss and potential gains are possible.

 

 

 

 

Weekly Recap

Weekly Review

Posted on by Team Editor

weekly review

How to Invest in Cryptocurrency

There are two very common questions about cryptocurrencies. One is “what are cryptocurrencies?” Second is “how do I invest in cryptocurrencies?” We are going to ignore, for now, the question of whether or not you should invest in cryptocurrencies. That will be the subject of another article.

To find out the answers to these questions and more, click right here.

Think About Stocks Like a Business

Stock market investors often think about companies in terms of their price-to-earnings (P/E) ratio or other valuation metric. But, if they were looking at their own finances or the purchase of a small business, the P/E ratio might not be the first thing they would consider.

When looking at a small business, the analysis would be more complex. To read more about that analysis continue reading here.

Macrotrends Point to These Stocks as Potential Winners

Traders often focus on the daily moves in the stock market. They might look at the change in the S&P 500 index to determine whether or not the trend is up or down. They might then look at the list of most active stocks to find trade candidates.

This is certainly an approach to the markets that can work. But, it is also an approach that can be labor intensive and, unfortunately, many individuals don’t have as much time to spend on market analysis as they thought they did. In that case, when they discover a lack of time, they can face losses. We explain an alternative approach that can be profitable for traders, here.

Bad News Provides a Passive Income Trading Opportunity

Investors know that news can move a stock. Often, the price moves that occur because of news is a short lived over reaction. When news knocks a stock’s price down, that could present a buying opportunity.

Occasionally, news can set up passive income trading opportunities and we have one for you in our latest article.