Questions on the Stock Market

Question:
I have a few questions about short term trading, where the speculator holds the stock anywhere from several days to a month. Currently, I am using what I call an "optimist" strategy. I search on Yahoo Finance for companies that register a considerable drop because of lackluster earnings reports, failed drug trials, unfavorable news, etc. Generally, the price drops anywhere from 15-30%.

Of these companies, I try to pinpoint whether the value has dropped too far and should bounce back, whether by looking at the key statistics or by looking at previous all time lows. The first time I used this strategy, I netted about 27% in 3 weeks. However, currently, it has been going nowhere. Is this a good strategy? Are there any improvements that can be made to augment it so that it is more reliable?

Answer:
Regarding your first question, it is a good strategy to observe if stocks that have been hammered are going to bounce back right away. However, you cannot employ this strategy effectively if the company isn't a quality company to begin with. This means the company needs to have an established track record of getting through tough times. If no history has been established then it would be difficult to get value investors and others to jump in at the new low price. A history of over 30 years is ideal.

To improve your observations on this strategy, I would concentrate on the companies that are the top 100 of the Nasdaq and S&P 500 indexes. The reason for this is because almost all mutual funds have to buy the top 100 of the respective index. Do not bother with companies 101 and lower. Only the top 100 from each. This will make your observations easier.

Question:
My second question is trend analysis. Is it good to, essentially, follow the lemmings? I'm going to use Google as an example. In the past 2-3 months Google's stock price has been increasing like clockwork at a rate of about $50/month because of stellar earnings and profit reports. However, I am worried that Google is rising too quickly and will eventually burst. Would it be advisable to jump in and ride the wave, even though the stock price may become unstable?

Answer:
Regarding your second question, I don't think you need to follow the lemmings especially when you know you're following lemmings. Few people are able to identify lemmings when they see or hear them. If you have that ability, then always avoid taking the path of lemmings.

I looked up GOOG and found that it is up only 131% from the low. Contrast this with the 20+ companies that are part of my Dividend Achievers list which range from 138% to 414% above their respective low. Remember, these companies are considered the most conservative and have had a history of paying their shareholders for the time that they hold the stock, something that GOOG doesn't do at all.

GOOG is popular now but it will be a "has been" before you know it. Everyone, I mean everyone, has a target on Google and want to take over their market share. However, ask yourself this, "how many college students are trying to take out Nordstrom's department store?" Nobody. Despite this fact, Nordstrom's stock has increased 414% since November 21, 2008.

Question:
I have been trying to find markets with a lot of short term volatility, with large jumps or falls within a period of weeks. What markets would exhibit these characteristics.

Answer:
In answer to your last question, the market with the most short term volatility is the stock market. It's just a matter of which stocks to observe. Personally, I would be satisfied if I could get 3% in 3 months. As long as that 3% is on 50% of my portfolio and CDs (certificates of deposit) are yielding less than 6% annually.

Thanks for the questions and keep them coming.

Technical or Fundamental: Which is Better?

Question: Do you value fundamental analysis over technical analysis, or vice versa? Also, could you explain your reason why?


Answer: My view is that both are important to know. I like to see that a stock is technically at a new low (within 20% of a 1 year low.) Afterwards, I verify that the company can continue to operate as a business using fundamental analysis.

Basically, the technicals provide the symptoms of the patient while the technicals determine of the subject is going to live through the underlying condition. If everything checks out then you determine how much of your capital you'd like to commit. Personally, I like to commit a minimum of 20% of investment capital...otherwise it just isn't worth it.

I practice many kinds of technical analysis but my specialization is in Dow Theory. Dow Theory happens to be the basis of all modern American technical analysis and therefore provides a greater level of insight.

Although I use fundamental analysis, I have to admit that I am a skeptic of fundamental analysis for many reasons. The main reason is the fact that all financial data can be manipulated. Therefore, I focus on the one thing that has never been manipulated and that is dividend payments. In all the history of manipulation of financial information, the dividend payment is the only thing that has never been revised or taken back after it has already been paid out. Either the dividend has been paid or it hasn't. This is not the same for other types of company data that is reported.

If a company claims to pay a dividend but somehow doesn't, then I ignore that company. This is the reason why I focus on companies that have a history of dividend increases. These companies have established their reputation as being trustworthy. In the world of finance, trust is everything.

Now, don't get me wrong I still run all the numbers for fundamental analysis. It's just that I don't get too excited about how good the results might be. Additionally, with fundamental data I always assume the worst case scenario just in case.

I hope my response is helpful and leads you to examine the aspects of both technical and fundamental analysis further.

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Monsanto (MON) is within striking distance

According to Google Finance, "Monsanto Company along with its subsidiaries, is a worldwide provider of agricultural products for farmers. The Company’s seeds, biotechnology trait products, and herbicides provide farmers with solutions to produce foods for consumers and feed for animals. The Company operates in two segments: Seeds and Genomics, and Agricultural Productivity."

Although Monsanto (MON) isn't a Dividend Achiever or a member of the Nasdaq 100, the company has a solid history and provides investors with an exceptional opportunity.

MON is currently trading within 5.85% of the the 52-week low. What is significant about the low that MON is approaching is that it is close to the November 2008 low. This is a critical support level for the stock which could indicate that a major reversal is ahead.

According to Dow Theory, MON is projected to decline to the following levels:

• $52.17
• $37.08
• $21.99
• $6.90

Each of the downside targets, based on Dow Theory, should provide some kind of support level. Interestingly, MON's 50% level, based on the decline from the prior peak and the July 2002 low, is at $67.90. This means that either the stock declines much further or the stock rebounds from here.

According to Value Investment Survey dated August 2009, MON typically reverts to a level of 17 times cashflow. Full year 2008 cash flow was $4.50 per share. This equals a price of $76.50 that the shares should revert to at some point in the future. Value Line seems to believe that, for 2009, MON should achieve cash flow of $5.55 per share which implies a mean price of $94.35. I would opt for the lower price just to play it safe. In the period from 1981 to 1996, Value Line had a smaller mean price to cash flow (13x). This means that as time has gone on since 81' to 96' MON has managed to improve their price to cash flow figures.

With MON trading at 11% below the historical mean value, as well as being within 6% of the low, this is a good opportunity to get your research in as the share price declines. Focus on the downside risk and good luck. Touc.

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Investment Observation: Aqua America (WTR)

Today's investment observation is AquaAmerica (WTR). According to Yahoo!Finance's water utilities review, WTR is ranked as the second largest water utility based on market capitalization.

The most important point about this investment observation is that WTR has fallen to a brand new low during market hours on Friday October 30th. This low may soon match the 2-year low of around $14.50 set in mid-October 2008. This is fascinating because the actual lowest point after the market peak of 2006 at $30 is no longer on our last 52-week radar. However, we will watch to see if the ultimate low of $14.50 is reached.

According to Value Line Investment Survey, WTR normally trades around 1.6 times the per share dividend divided by the "interest rate" (1.6x $0.51/interest rate). Valueline doesn't tell us by which interest rate we should apply to the company, so I have decided to apply the 30, 20, and 10 year U.S. Treasury rate. The following are the mean prices that WTR would trade at for each interest rate:

• 30 year rate- $19.29
• 20 year rate- $19.47
• 10 year rate- $23.93

Based on the 30 year rate, WTR is selling 19.91% below the historical mean value. I chose the $19.29 value since it was the most conservative figure.

However, according to Investment Quality Trends, WTR is considered undervalued when it is selling for $12.27 or less. This indicates that WTR is not currently undervalued but could easily get to the $12.50 range if market conditions continue on the downside. Additionally, WTR has a large debt low and a high dividend payout ratio of 74%. This means that the stock could only "afford" a decline in earnings of 25% before the company has to borrow or issue more share to service the dividend.

According to Dow Theory, the following are the most important downside targets to watch for:

• $14
• $11.25 (fair value)
  
• $9
• $6.50

These targets are supposed to act as support levels. Support levels are points which the stock falls to but should not go below. If the stock goes below one support level then we should expect the stock to decline to the next target level.

One support level that is significant is the $15 level. This happens to be the most obvious level that the stock needs to hold above. Falling below $15 could indicate the negative nature of the markets.

Although this is a water utility and water is critical to life, investors need to understand that companies in this industry aren't a "sure thing." The biggest reason for this is that when, and if, water becomes scarce, government regulators will step in to take over (nationalize) what should otherwise be sold at the most profitable price (thereby curbing wasteful consumption.) There is literally an upside cap on profitability to a company like this due to the critical importance of the resource being sold.

Take your time to consider this Dividend Achiever for the good and the bad attributes. Your careful analysis of this company might compel you to purchase the stock. It is my hope that the stock falls further before your next acquisition. Touc.

Please revisit Dividend Inc. for editing and revisions to this post.

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Required Reading for New Investors

After today's meeting it was pointed out that the members of the club would like to learn a little bit more about investing in a specific format. Therefore, I am recommending that you pick up a copy of Peter Lynch's book Learn to Earn.

This is what Amazon.com has to say about Learn to Earn:

One of the best managers in the history of mutual funds, Lynch is certainly the person to help people choose the right stocks and understand the market. More so than One Up on Wall Street or Beating the Street, this Lynch book is for beginning investors of all ages. Lynch and coauthor John Rothchild are family men who are worried that teenagers aren't learning enough about the importance of American companies in improving lives and creating wealth. Lynch questions why students are taught that Hamlet was a tragic hero and Napoleon was a great general, but they don't know that Sam Walton founded Wal-Mart. In fact, Lynch's grasp of the past is one of the strengths of the book. One of the best chapters is "A Short History of Capitalism," a witty and homespun look at characters like Karl Marx, the Communist who believed capitalism was doomed, and the robber barons, the shrewd railroad magnates of the late 19th century who amassed huge fortunes by manipulating the markets.

While I agree with 70% of what Mr. Lynch has to say about the stock market, I'm 100% in agreement about his performance as a stock market investor. Mr. Lynch averaged 29% a year during the time that he was the Fidelity Magellan mutual fund manager. Such investment performance is exceptional for anyone to accomplish.

If there are any ideas or concepts that you wish to discuss about Learn to Earn then please use the email or comment section of this blog.

Please share this information with anyone you think might find this useful.

• Email me.

Pharaceutical Product Development Inc. (PPDI)

Pharmaceutical Product Development Inc. (PPDI) at $19.75 is ready for review. Remember, all that I'm asking for is one positive and one negative attribute about the company.

Also, please email other members to let them know what we're doing, your help in getting the word out is greatly appreciated.

• Click here to submit your own research report or comments.

Research Report on GENZ and CEPH

Written by D.X.

Both CEPH and GENZ are at their one year low, which is good. It means that they are at the cheapest point within this year. Both of them don't provide dividends. This could be good or bad, depending on if other companies within their sector give dividends or if they have enough cash to support it.

However, GENZ is a considerably larger company than CEPH. GENZ has a market cap of around 13.8 Billion while CEPH's is around 3.79 Billion. However, even though both were big companies, they suffered one year of huge losses. GENZ suffered in 2006, and CEPH suffered in 2007

CEPH has a PE of 16 and an EPS of around 3. This is considerably better than GENZ stats of PE 32 and EPS of 1.6. However, CEPH holds considerably more debt than GENZ, 700 million and 100 million respectively. Looking at their balance sheet, most of CEPH's and GENZ's debt is in accounts payable, or the amount of money it owes to its vendors, suppliers, etc. There is little long term debt relative to their accounts payable debt. In addition, GENZ has a higher book value per share $27.2, cash $702 million, as well as profit $3.46 Billion than CEPH, which has a book value of $21.75, cash $614 million, and a profit of $1.56 Billion.

The high book value is an interesting factor. This means that they both have lots of manufacturing plants and or research facilities. Both companies may be focusing on R&D and production. But, after looking at their balance sheet, they don't seem to be incurring lots of long term debt. This means that they are financing R&D and production using cash on hand. Taking a closer look at the Income Statement, however, GENZ is taking the initiative on R&D as well as production. It is spending as much on R&D $1,308,000,000 as much as it is spending on Selling and Administrative $1,338,000,000. CEPH, on the other hand, is spending half as much on R&D $362,000,000 as Selling and Administrative $840,000,000. Also, looking at the balance sheet, GENZ's plant/equipment is increasing while CEPH's is decreasing. This means that GENZ's will be able to produce more in the future compared to CEPH.

This means that while CEPH has a higher profit margin and growth rate CURRENTLY, GENZ is going to be in a better position in the future due to the massive amounts of R&D it is pouring in relative to CEPH.

Finally, both companies are currently losing money according to the cash flow statement. This means that the stock price could continue going downwards. How far it will go is anyone's guess.

As far as which company is a better buy, I feel that GENZ is probably better for the long term. Although both companies look attractive, GENZ seems like it is poised to completely take over it's niche.

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Let's Review These Companies

Because we cannot meet this summer we should review two stocks that I have found interesting.

The first is Cephalon Inc. (CEPH) at $53.59.

The 2nd is Genzyme Corp. (GENZ) at $53.52.

Based on whatever you know about stock investing, tell me at least one good and one bad thing about each company. We'll review these stocks on this blog based on your responses.

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Meeting Notes

• Stress Test on Bank of America
• The most recent stress test done on the nation's largest banks is supposed to determine how much a banking institution would need to be able to lend if the current recession were to get worse. Unfortunately, if Bank of America was unwilling to lend when the stock price was at the lowest price of $2.53 on March 9, 2009, what would make the bank want to lend when and if the stock price is at $1.53? It is unreasonable to expect that if Bank of America were to raise $34 billion then they would lend it to the public if the economy were to get worse. A rational bank will stop lending when the economy is doing poorly and give away money when the economy is doing well. This is the reason that the U.S. government is, and always will be, the lender of last resort.

• Stop Loss Orders
• From my personal experience stop loss orders, stop order and trailing stops must be done mentally instead of as a standing order that is placed with your broker. The reason for this is:
• a stock that has a price of $20 that has a stop loss at $19 could go as low as $18.99 and then go all the way up to $21 and above. Market makers on the NYSE floor are in the position of being able to place all trades that are coming in. If the market maker can see that there is a 10 million share order to buy and you have a stop loss of 2000 shares to sell, then he can place a 10,000 order to sell that triggers your stop loss then place his own trade before the 10 million shares to buy. The ethics of this maneuver is clear, however our goal is to mitigate this problem by placing only market orders to buy and sell. Don't leave a transaction to buy or sell in someone else's hands.

• Ross Stores (ROST)
• After looking at the stock chart of Ross Stores we learned a couple of important things. First, Ross has recently hit a brand new high, this is despite the fact that the stock market had been falling for the last 2 years. This means that if you had bought ROST when the Dow Jones Industrials Average peaked in October 2007, you would have more money today than back in 2007. The second thing that we can see is the matter of ROST having a clear pattern of peaks and troughs. The troughs have occurred on the following dates:
• 11/20/08
• 1/8/08
• 8/14/06
• 9/28/05
• 8/31/04
• 3/4/03
• From this data we can expect that the next bottom in the price of ROST will take place between the period of Oct. 3 2009 and May 20, 2010 at a price near $23-$19. Along with ROST, another company in the apparel business with a similar price pattern is Aeropostale (ARO). Look for ARO to fall along with ROST.
  

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April 30th Meeting Notes

• Research techniques
• Good research is the key to good decision making. Good research is based on seeking those who have been able to accurately look ahead of the current conditions. Therefore, you will need to first go backwards to read old articles about the topic that you're interested in. Afterwards you'll need to verify if the person was generally right. Being 10% right and 90% wrong is acceptable if you retain the 10% and discard the 90% that was wrong. Follow these steps to get started on you research:
  
• First, go to your local library's website (for example Fremont Public Library)
  
• Next, find the articles and databases section
• Then, search the article or business database for whatever you're interested in.
• Always verify any information you get from at least 2 sources that are not related to each other. For example, if you got an article from the Wall Street Journal then you couldn't use Fox News, Barron's, MarketWatch.com, or SmartMoney.com since they are all owned by, or in partnership with News Corp.
  

• Quality writers of the economy and stock market
• What's the purpose of all this information if we can't verify the quality of the information. From my experience the following sources have been able to write thoughtful articles for their respective publications. My suggestion is that you pull articles from the library database that are written by the authors and see what they said before the stock market decline of October 2007. You'll find that they have a lot of good knowledge that will help you think about the economy and the stock market from a healthy perspective. Information is only good if it adds perspective or is generally accurate.

• Mises- Hard Core Economics
• John Reed -Real Estate
• Caroline Baum -Interest Rates
• John Rogers -small cap values
• Gary Shilling -big pic and stocks
• James Grant -big pic and stocks
• Steve Hanke -big pic and stocks
• David Dreman-big pic and stocks
• Richard Russell's Dow Theory Letters
• Prudent Bear -potential pitfalls
• Financial Sense- Book Author Interviews


• The discounting mechanism
• The stock market is known as a discounting mechanism (please read the first paragraph to get another sense of the concept.) This means that a stock or the stock market will go up or down based on future expectations. This explains why, even though the GDP news is really negative, the stock market doesn't crash. The fact that the stock market had already fallen nearly 56% from October 2007 until March 2009 means that somehow the decline in the GDP was anticipated. Take a look at when the stock market declined in 2000. It occurred long before the recession of 2001. This also affects individuals stock performance. We can see a company come out with good earnings but the stock doesn't move up on the day the news comes out. Well, in most cases the stock would have moved up in anticipation of actual news. In some instances, the stock will actually fall even though good news is reported. Again, discounting mechanisms help to anticipate the future direction of the economic and political events to the farthest know point into the future.

• Options are derivatives
• Options are often call a form of investment insurance. In fact, options are really a speculative bets on the direction and time that a stock will either rise or fall. When a person buys a stock they're only betting on the direction with no need to be right about the time the stock will go up. Options require you to be right about the direction and the time which is pretty difficult. Few people are able to make a living by using options, even though many investment companies say that unlimited wealth can be found in the use of options.
• Options are great if they make money however they don't have the same impact that a common stock shareholder would have if the company wants to share their profits with the investor. For example, if a company pays the shareholder $35 per share in cash, the people who hold the option don't get any of that cash. The benefit to option investors is that if they're right about the direction and price of the stock then they make huge profits. In our meeting today there was mention of covered calls, writing puts, writing calls and writing covered calls. All of these different types of contracts are available to you however the transaction costs, over time, make this approach a waste of money...unless, unless...you're using other people's money.
  

• Don't believe me, try it yourself
• Obviously, I'm only one person with some experience and a biased perspective. I'm only giving you one side of the equation. The other side of the equation is that you go out and try the things that I suggest you don't do. First, make 10 different trades on paper but don't put your real money at risk. For example, find the price of call or put contracts on any company you're interested in until you make a profit, loss or expiration. There are plenty of websites that will let you enter imaginary trades before actually committing money. This is the best way to know how using options works. I'm sure we can discuss this further in future meetings.
  

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April 23rd Meeting Notes

• The Importance of Compounding
• The issue that was brought up was that investing really doesn't work until a person has a lot of money otherwise investing can't possibly worth it until that time comes. Actually, the critical element to any wealth is the ability to compound small amounts of money now far into the future. One example was demonstrated on MoneyChimp.com where we used the compound interest calculator to determine what the impact would be if a person had money compounded at 8.5% for 30 years or 50%. Using $50,000 as the starting point we found that the difference was astronomical. $50,000 at 8.5% grows to $2,954,315.78 after 50 years. The same principal amount at the same rate of interest grows to $577,912.58 after 30 years. While $50,000 seemed like a lot, the amount is easily achievable. Using a smaller amount will have an equally large difference. Get started now so that you have no excuse.

• Making Easy Money isn't Easy
• While the idea of compounding income makes sense, it is very hard to resist investing in a company that has gone up 400% in a month. However, companies like Citigroup are able to go up so much because the fell to extremely low levels based on the fact that the company is in such dire condition. For anyone who has managed to get in at the bottom, getting out is almost impossible. The dilemma that a trader faces it the possibility that the stock might go up another 500%. A trader might want to hold on to such a stock in hopes of getting more. Another problem exists for those who are able to get out and lose money trading in and out of stocks trying to replicate their Citigroup trade. As time goes on the trader eventually gives back all the profits in the fruitless pursuit of "easy" money.

• History is our guide
• History is our guide in the financial markets because markets have clear cycles. In our meeting we reviewed how the stock market experiences bull and bear market cycles. Within each cycle we reviewed how bear markets have periods of significant gains. Bear markets of 1906, 1937, and 1966 have exhibited the ability to trade in a range for almost 18 years. While in a bull market there can be periods of large losses.

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April 9th Meeting Notes

• Wells Fargo

The discussion regarding WFC was about how the stock could continue to go up despite the fact that bank, in general, are in such an unhealthy position. It is safest for us to assume that any and all bailout money that has gone to the banks is boosting the company's earnings. The improved earnings cannot be expected down the road unless accounting rules are changed or new government money is pumped into the system. Wells Fargo is one of the better run banks and should have a quicker improvement as things turn around.

• Cycle Analysis

The purpose of attempting to understand cycles is to put our current circumstance in perspective so that we do not over-react in our investing. It would seem that much of what goes on is new however the underlying principles are generally the same. For this reason we would not need to panic when stocks crash or boom.

• Bull Markets

The best way to describe a bull market is to look at a chart of the clearest bull market periods of 1921-1929, 1932-1937, 1949-1966 and 1982-2007. While there are periods when the stock market has had significant increases during period outside of the years mentioned above, it is important to keep in mind that the duration of market increases outside of these periods are within a bear market. Also of importance is the fact the "real" bull markets take a long time to achieve significant gains.

• Bear Markets

Bear market are characterized by the periods of 1906-1924, 1929-1932, 1929-1950, 1937-1955 and 1966-1982. The charts below should assist you in visualizing that a bear market doesn't necessarily mean a falling market. The periods of 1906-1924, 1937-1950 and 1966-1982 had the stock market trading in a range. The hardest part of these market periods is that inflation killed the investor more than market declines did. One dollar put in at the beginning of each period would have resulted in it being equal to $1 at the end of the period excluding inflation. If inflation was included then the $1 would be less at the end of the period.

• The Ten Times Ten (10x10) Approach

In the book "Crisis Investing" by Douglas Casey he describes an investment strategy where a person breaks up their investment into ten unrelated and highly speculative groups. Of the ten unrelated areas each investment should move in the opposite direction of another investment. For example, gold v. bonds, short selling a stock v. going long a stock. The gold position would be owning the actual gold not gold stocks. When going long a stock it should not be a gold stock if you're already holding the physical gold. Do you have questions about this concept? Post them on the blog and I'll do my best to answer.

• Investment Vocabulary

All investment terms will be linked to Investopedia for an explanation. If there is a word that isn't clear then be sure to visit Investopedia for more assistance.

Click here to ask questions or send comments.

Speculation Opportunities

Because the stock market is up so much today, I want everyone to consider shorting the following stocks for the SMS competition:

• Wynn Resorts, Limited (wynn)
• Ameristar Casinos, Inc. (asca)
• Monarch Casino & Resort, Inc. (mcri)
• Penn National Gaming, Inc. (penn)
• Isle of Capri Casinos, Inc. (isle)
• LaSalle Hotel Properties (LHO)
• RC2 Corp. (RCRC)
• CYOU
• Force Protection Inc. (FRPT)

These stocks were among those that were up today and likely to be the ones that will fall the most in the coming days or weeks. Keep in mind that you wouldn't place the short sell until you see that the stocks are moving in a downward direction. If you start to lose more than 10% on the trade then you should get out of your short sell. Do not expect to be in these short sell positions more than 2-3 days.

Stocks to consider buying are those that have lost the most today. The following stocks are potential buy candidates:

• ANGLOGOLD ASHANTI LT (au)
• DRDGOLD Limited (drooy)
• GOLD FIELDS LTD ADS (gfi)
• KINROSS GOLD CP (kgc)
• AGNICO EAGLE MINES (aem)
• YAMANA GOLD INC (auy)
• GOLDCORP INC (gg)

These stocks were among those that were down the most and have the greatest chance of going up. In this case, you would employ the opposite strategy as short selling. You would wait until you see the price move up before you start to buy the stock.

Finally, listen to or download the following interview "Anatomy of the Bear" on the Financial Sense website. After listening to the interview add your comments or questions to the blog comment section.

• Click here to ask questions or send comments.

Meeting Notes

• Dogs of the Dow investment strategy

In our discussion of the Dogs of the Dow strategy, we discussed that the goal is to buy either the top five or top ten highest yielding stocks of the Dow Jones Industrial Average. After holding these stocks for one year, you would then sell the stocks that are no longer among the top ten highest yielding stocks of the Dow and replace them with companies that are among the new high yielding stocks. The purpose of this exercise has multiple functions:

1. By using Dow stocks, you're getting the highest quality and widely followed companies.
2. The highest yielding stocks are generally considered to be at a lower relative price.
3. Selling after one year helps to avoid short-term tax consequences.
4. high yield implies low price, low price implies less downside risk with greater chance to compound income.

The current top 10 high yielding stocks are as follows:

1. General Electric (GE) at 12.5%
2. Pfizer (PFE) at 9.3%
3. DuPont (DD) at 7.5%
4. AT&T (T) at 6.3%
5. Caterpillar (CAT) at 6.1%
6. Verizon (VZ) at 6%
7. Merck (MRK) at 5.7%
8. American Express (AXP) at 5.6%
9. Kraft Foods (KFT) at 5.3%
10. Boeing (BA) at 4.7%

Let's see what the performance of these companies will be as time goes on. As was discussed before, taking the very highest yielding stock, GE, may have the most risk of eliminating their dividend, getting kicked off the index or even going out of business. Only time will tell.

• Cash in the Hand

So far we've been able to witness the gains and losses in Bank of America (BAC) week after week. Interestingly, in each discussion we've had I have encouraged that we either sell short after large gains in the stock price or go long (buy) BAC when the price has fallen by large amounts. The lesson that should be learned is that excessive moves up or down are never permanent. For this reason, if you happen to be on the right side of a trade then protect your profits. Otherwise you'll end up wishing you sold or bought the stock after the fact. Again, this is very important when you are trading. However, even as I have invested in companies that I thought I would hold for the long term performed better when I sold after a nice gain. As an investor I don't sell short.

• Companies thought to be around forever, won't be.

As we reviewed the companies that were among the top 10 highest yielding stocks we started to wonder why someone wouldn't by our nation's biggest, best, and most profitable companies. After all, they'll be around forever so what's the risk? As investors and employees, we should always take the perspective that no company is safe. Just look at what happen to Lehman, AIG (AIG), Fannie Mae (FNM), and Freddie Mac (FRE). Ask yourself this, two years ago would you have considered that Washington Mutual would no longer exist. This partially explains why investors need to take their profits and move on to the next best alternative.

• Setting up your own list of stocks on Yahoo!Finance

The question was asked, "How can a person keep track of all the companies that have reached a new 52-low?" My answer is that by setting up a Yahoo!Finance account, you can track almost any set of companies that interest you. While there are over 5000 traded stocks and mutual funds, I focus on those companies that have increased their dividend every year for at least 10 years in a row. This list of companies can be found online at the following link. The list contains about 300 companies and is built on the concept of quality first. Once a list of companies is set up, Yahoo!Finance let's me set up the type of information that I can have show up on the page. I always include the % change from 52-week low. This tells me which companies are closest to the most recent low. Any company at a new low is where my research begins.

• What is IBM's (IBM) strategy for buying Sun Microsystems (JAVA)?

IBM is doing what every investor should try to do and that is buy at the lowest possible price. IBM also knows that in August of 2000 JAVA was selling for $257 a share. Now, IBM can buy JAVA for less than $10 a share. But why JAVA and why now? JAVA has patents that are critical for the use of internet communications between many different operating systems. When I say operating systems don't forget that Windows, Mac OS and Linux aren't the only operating systems. New ones are being created everyday with the use of cell phones and portable gaming devices. All of these devices wouldn't work on the web if it wasn't for the java script language. I wouldn't buy JAVA in anticipation of this deal getting done. Instead, I would be interested in IBM once it becomes clear that they are going to purchase JAVA and IBM's price falls significantly.

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Market Perspective on Bank of America

Just a quick note before our meeting tomorrow. In our last meeting, at the very end, we were discussing the idea of what to do with Bank of America (BAC). After all, from Monday March 16, 2009, BAC went from $6.18 to a high of $7.80 on Monday March 23, 2009. This was a gain of 26% in 7 days. As we were leaving I suggested that the best action to take would be to sell or sell short.

Since March 23, 2009, BAC has fallen 23%. This would have meant a total gain of around 47% if bought and sold short without using any margin. The lesson in all this is that significant short-term gains or losses will be offset, over time, with equal or greater reactions in the opposite direction.

How can we determine what is a "significant" short term gain or loss? The best way to do this is to look at a comparable index of stocks in the same industry. For BAC, a comparable index is the financial stock Exchange Traded Fund known as the Financial Select Sector SPDR (XLF.) From March 16th to March 23rd, the XLF was up only 18% While BAC was up 26%. The amount of change on a percentage basis for BAC would need to come in-line with the other stocks in the financial sector index. Since BAC tends to over-react both up and down, we could expect that the stock would go down more than the index, on a percentage basis, as we've seen today.

Because BAC is down more than the index since March 23rd, it might be time to either get out of your short sell or buy the stock in anticipation of it going back to the where the index is. Again, this strategy is only for speculative purposes and not at all part of a reasonable investment approach.

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Monday Meeting Update

Today's meeting covered the following topics:

• How far will the market go up and when will it end?

We do not know how long the market will go up or down. However, not knowing the future doesn't mean we can't take an educated guess as to how far it will go using Dow's Theory. Dow Theory says that the market will likely go up at least 1/3 of the amount of the previous decline. In the most recent instance we're looking at a decline in the stock market from 14,164 down to 6547.05. By dividing the difference by 3 we get 2539.16 (1/3). Adding 2539.16 to 6547.05 gets us to the level of 9086.21.

We now have a tentative upside target of 9086.21. However, Dow Theory also says that both the Industrials and the Transports need to exceed each prior peak in order for the trend to be valid (in this case the trend is up). As of the close of the market today, the Industrials smashed through the prior peak of 7350.94 on February 24th. The Transports barely closed above the prior peak of 2709.90 on February 24th. So far the signs are good that both indices will get close to the next peak which is 3203 for the Transports and 8280 for the Industrials.

Because both indices have gone above prior peaks we should continue to believe the market will generally go higher with some declines to occur along the way.

• What is the good and bad of Dow's Theory?

The good of Dow's Theory is the fact that it attempts to tell investors what the general trend of the market will be. How does the theory do this, by using the movement of the Dow Industrials, Transports and Industrial Production index along with volume indications from the New York Stock Exchange. Also, Dow Theory relies upon historical valuations of the stock market like P/E, dividend yield, book value, earnings and other assorted ways to measure the overall value of the markets.

The bad of Dow's Theory, if it is correct to begin with, is the fact that it can give false and early indications especially at perceived market tops. An example is the top in 1961 was 5 years before the actual top in 1966. Likewise the top in 1999 was 8 years before the actual top in 2007. Also, Dow Theory doesn't tell us about the direction of the market within a long term trend. For this reason, it becomes difficult to "trade" the market using this approach.

• The more people follow a concept or theory the less effective it will be.

The point was made that Dow Theory has been relatively ignore because of its lack of predictive value. While this is open for debate, my research says that it is a reasonable approach as long as it keeps working for me. If it no longer works then I will still use it but I won't rely so heavily upon it. However, if the critics keep ignoring the relative value of Dow's Theory then it makes the use of it more valuable and effective.

Dow's Theory alone won't answer the question of which stocks I will actually buy and sell. It only tells a person the trend. This is the reason why I combine Dow's Theory with my dividend investing approach so that at least if I'm wrong because of my reliance on a theory then I'll be able to collect income until I'm right or sell out if I'm disastrously wrong.

• Bear markets last a very, very long time.

Many market commentators in the media might claim that since we have seen a rise of 20% or more in the stock market then we must be in a bull market. However, I like the conservative view that Dow Theory takes on this issue and that is, a bull market begins when both the Industrials and Transports have exceeded the high of prior peaks. That means a bull market only starts at the 14,164 and 5,492 levels for the Industrials and Transports. This essentially means that both indices could go up over 100% and still be in a bear market as has been demonstrated many time in history.

• Ride out the upside action unless proven otherwise.

Because we are in a Bear market rally, the market trend is up until or unless we go below the previous low of March 9th.

• Those with outsized gains are probably more lucky than smart.

As I have learned the hard way, it is far better to be lucky in the stock market competition than smart. However, don't worry about getting lucky. Instead, focus on being informed as much about the history of the market to prepare yourself for the next wave of opportunity without losing money. Our goal is to learn and be ready. The luck will come in due time.

• I project that this bear market will last a while.

History suggests that the bear market will last 1/3 as long as the previous increase from 1974 to 2007. This means that the market should trade in a wide range until 2018. Around the year 2010 to 2018 we should see rampant inflation.

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Today's Investment club meeting notes:

• Losses due to quick trades and short sells

Losses due to quick trades and short selling is acceptable when you're required to get the highest return possible in the shortest amount of time with money that does not belong to you. However, keep in mind that you're not investing but speculating.

• Percentage change of investment portfolio matters more than dollar change

When working in the professional investing arena the only real measure of performance is the amount of percentage change to the entire portfolio, including cash, and not the dollar amount of change.

• Dealing with a rally within a Bear Market

We're currently experiencing a bear market. As with previous bear market rallies ( 1906-1924, 1929-1933, 1966-1982) they are violent and fast. Bear market rallies tend to get a lot of participants who end up losing any money that they didn't already lose on the first, second or third wave down. Be ready to take advantage of the rally but also be ready to jump out as soon as possible.

• What's the deal with Citigroup (C) and Bank of America (BAC)

To deal with the reality of a bear market rally we need to adapt to the changes taking place. First, even though nothing has materially changed with Citigroup or Bank of America we should be going long (buying) both stocks and using as much leverage as possible. The next upside target for Citigroup is $4.21 while Bank of America is $7.39. Hold these positions unless or until the stocks fall below the $1.02 level for Citigroup or the $3.14 level for BAC. If you're not comfortable with losing money then stay away from these stocks. Other speculative stocks to consider are MS, GS, HIG, GE, HBC, PAY, WFC.

• My rational for speculating in Helmerich and Payne (HP)

The rational for my stock purchase of HP is that the company has fallen from the high of $77 and has consistently bounced above the $20 level since 2005. If the stock falls below $18 then I will consider selling the stock. However, I have already accounted for the possibility of the price declining to the $8 level. Successful investing requires that you prepare your mind to losing all that you invest. If you make money then you have a problem that most investors would like to have to figure out how to deal with.

• What happens when the Dow Theory indicators are divergent? What indicators do you use to gauge where the market or economy is going?

When the Dow Transports and Dow Industrials are not going in the same direction then there is the problem of determining what the trend is according to Dow Theory. In circumstances such as these the best thing to do is assume that if the prior trend is down then it is still going to go down until proven otherwise. If the trend was previously going up then it is safest to assume that the trend is still up until proven otherwise.

The next question is, "are there other ways to determine the health of the stock market and economy?" Please visit my blog and look at the indicators on the right hand column. What I have posted is probably 1 out of 100,000 ways to view the markets health and direction. The ones that I have are ones that I feel are reasonable indicators of the general direction of the market but their certainly not foolproof. Only time and more experience will tell if these indicators are of any practical value.

• Dealing with investor psychology

All stock market investing is dealing with investor psychology. For this reason it is helpful to read books that deal with behavioral finance, game theory, Dow theory, market history or stock market psychology. While these topics don't answer the question of which stocks to buy what they do give is insight as to what people are likely to do under conditions of a rising or falling market.

• Investing in stocks is a 50/50 proposition, dividends from a quality stock tips the scales in your favor to 51/49.

Because there is always the prospect that the stock market will either go up or down you have one of the rare opportunities to enter into a 50/50 transaction. Unlike buying a home for investment, you won't have to fix the plumbing, deal with bad tenants, insure against loss or worry about earthquakes. Unlike starting your own business you don't have worry about the location, the foot traffic, zoning laws, or marketing. The purpose of researching and buying stocks that have increased their dividend every year a minimum of 10 years in a row is so that you can have the income from the stock even if the price declines. Remember, don't worry about the yield of the stock being low like Helmerich and Payne's (HP) 0.90%. Instead, focus on the fact that their earnings could fall 90% and still be able to increase the dividend.

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What's the Deal with Short Selling?

Q: Our team has a question for you about short selling. We don't really understand the logic buying a stock and then selling it. Even if the price of the stock goes back down, you have to buy it back. In the end how does that make any money? Doesn't that actually lose money?


A:The way to look at how short selling works is this:

Let's say you think that the price of XYZ Company is too expensive and is going to fall soon. You call your broker (CSU East Bay) and say sell short 100 shares of XYZ Company at a price of $50 per share.

First, the broker doesn't require that you buy the stock to sell short, instead the broker is going to lend you the 100 shares temporarily. After the broker lends you the 100 shares the broker will also find someone who is interested in buying the same 100 shares.

After someone buys the 100 shares from the broker, you have the ability to buy back the 100 shares that the broker sold to someone else at any time you want. If the price goes up then you lose money. If the price goes down then you make money.

If the stock goes up to $51 then the short seller loses a total of $100 while the person who bought the stock made $100. If the stock goes down to $49 then the short seller makes $100 while the person who bought XYZ Company loses $100.

I can understand your confusion with this process since we never get to do exactly the same thing in real life. However, you could think of this process this way...Let's say you know that the newest iPhone is too expensive and will eventually go down in price. The store that bought the iPhones thought that everyone would want one.

When the store couldn't sell enough iPhones for a profit the store decided to get rid of the rest of the phones at a 50% discount. You then decide that at half off the regular price it is worth buying the phone. In this example, the store is the one that loses the money while you are the one who "makes" or saves the money when the price falls. If you bought the phone right away and paid top dollar then you would have been the one who lost money since you could have paid a lower price and used the rest of the money for something else. At the same time the store is the one that makes the money because you were willing to pay the higher price when the phone first came out.

Short selling is the opposite of buying a stock and works only if you think that a stock is going to fall in price. Please click on the link at Investopedia.com for more info on the basic concept of short selling. I highly recommend that you sell short a company that you think might fall so that you can get a better idea of how it works. Since the money isn't yours you get the benefit of learning without losing.

I hope my answer is useful. Good luck.

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Institutional buying/selling information

Q: Is there a way to track institutional investments of a particular stock? What I am looking for is the % owned by institutions and how that has changed over a 6, month, 12 month or 18 month period.

A: One source that is relatively easy to access is Morningstar.com. First, type in the the symbol of the company in question (near the top center of the page). After the company information is displayed select the insider trading tab on the left-hand side of the screen. Above the insider activity list and below the company name you can choose concentrated fund owners, funds buying, funds selling, and top fund owners. The sample company that I have used to demonstrate this information is GE.

The upside of all this information is that it can be arranged to go back as far as 2005. The downside is that it is only reflective of insiders of the company and mutual fund ownership and not other corporate holders of company stock.

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Finding Dividend Payment History...

Today we'll find out how to verify the history of dividend payments for a particular company. As I have mentioned in my presentations, the best way to find out if the company management is committed to shareholders is by the consistent increase of the dividend over time. Let's get started with how to verify if a company is well managed and cares about it's shareholders.

Using Yahoo!Finance as our starting point we first need to select the company that we're interested in. In the image below, I have selected Mine Safety Appliances (MSA). In the left hand column select the section that says HISTORICAL PRICES. (click on image)

Next, select the tab that says DIVIDENDS ONLY. This is where you'll be able to actually see all the dividend history for the stock that you're interested in. (click image below)

Next, look to see if the company that you have selected has a history of increasing its dividend either every year or every other year. At the very least, companies that haven't cut their dividend, even during tough economic times, are probably better suited to stay profitable or recover faster when the economy turns around. (click on image below)

Finally, in order to be sure that this information is accurate you now have to find at least one other source to confirm the information that is on Yahoo!Finance. I like to get my other source information from Morningstar.com, MergentOnline, or Valueline.com. If you only use one source for your information you might not find out that there is a mistake until it is too late.

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Ex Dividend Date Information...

The question for today is, "where can a person find the EX-DIVIDEND DATE information on a stock?"



Using Yahoo!Finance as a source, the ex-dividend date can be found on the KEY STATISTICS section near the bottom. A sample of ex-dividend date is circled in red of the following image (click on image).

Using Yahoo!Finance, can you find the ex-dividend date for MacDonald's? Post your answer by clicking the "comments" link below.

Warren Buffett said...

In the following quotes we get to understand why Warren Buffett is known as one of the world's best investors.

Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like--anything like--they've performed in the past 17 [years]. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate--repeat, aggregate--would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more.

Loomis, Carol. "Mr. Buffett on the Stock Market." Fortune, Nov 22, 1999. p212.

Investors who expect in aggregate, if they expect to get more than six or seven percent a year over the next ten or twenty years, I think they're likely to be disappointed.

Interview of Warren Buffett by Nightly Business Report executive editor Linda O'Bryon. April 28, 2001.

At the following link, can you find the compound annual growth rate (CAGR) of the S&P 500 Index from 1999 to 2008 and 2001 to 2008? Post your answers by clicking the "comments" link below.

Book Value, Balance Sheet and Valueline

Question From a Student

I was thinking about stocks over the weekend and something about book value bothered me. Assume you have a large company with a high book value relative to their stock price. Lets say its a company that owns real estate. Wouldn't it be very hard to extract the equity from the company assets because it is hard to sell property, especially in this type of economy? So, would this mean that, even though the company might look promising because of a high book value, it might not be a good buy?

Going on the same thread. When you look at a balance sheet, how can you tell what type of assets the company has? On the Yahoo Finance sheet, it has Property/Plant/Equipment, Long Term Investments, Goodwill, and other stuff. What type of assets go in which category?

Oh yeah, is there any way to read Valueline online? It's kind of hard for me to go to the library, so I wanted to see if there was a website or something that had the same info.

A Response in the Comment Section Below

Banks and Information Resources

Question From a Student:

I have a couple new questions. First, if banks like Citi and BoA are so horrible at managing assets, are they only afloat because the government has helped them out in the past several decades? Also, what would be the hypothetical situation if one or several of these banks collapsed because the government didn't bail them out? Finally, assuming that these banks fail, could the smaller, profitable, and efficient banks fill in the financial vacuum before the entire system collapsed like in the Great Depression?

About those small investment banks that don't pay as much and thrive. What are the names of some of those banks? Maybe we could have a look at them next Tuesday

Last question. How can a prospective investor find out a company's business model, strategies, and inside information? I'm sure that this information would be just as valuable as the key statistics that is published on Valueline and Yahoo.

A Response in the Comment Section Below

A Question of Executive Compensation

Question From A Student:

Today, I was watching a news report that stated that President Obama has placed salary caps of $500,000 on all of the executives working for companies that received bailout money. Apparently, the reason was that the general public felt that the executives were being lavishly paid for losing billions in the financial crisis. However, this type of financial justice seems more retributive than restorative. I feel that capping the salaries of executives will only cause them to flee a company like rats from a sinking ship. A perfect example of this is when Salomon collapsed in the early 1990's and nearly brought the financial world into chaos.

According to Buffet's experience managing Salomon after becoming interim chairman, when he tried to slash $110 million from their nearly $1 billion bonus pool, a large amount high level executives, bankers, traders, and lawyers as well as midlevel bond and stock salvesmen walked out the door after receiving their significantly reduced bonus (The Snowball, p610-611). The administration's argument to this "brain drain" is that there isn't anywhere to run because most of the large financial companies have already recieved bailout funds. Thus, if an executive didn't like it, too bad you have to stay.

Also, what will happen to the bondsmen and traders, who also earn a high salary, but have little to nothing to do with the financial crisis? Should they be punished just the same as the executives as well?Unfortunately, I believe that this is an extreme miscalculation on President Obama's part. Capping the salary of executives will not prevent financial mishaps from happening. On the contrary, it may worsen the current financial crisis. First, many of these executives have enough money to buy a mansion and live the rest of their lives in financial bliss. In addition, many of those same executives could jump ship and form a new company to do the same thing all over again.

Once again, I will use Salomon as an example. Meriwether, the arbitrage king of Salomon, was fired for neglecting to supervise an employee who frauded the Treasury out of billions in bonds. After being fired, he formed his own firm, Long Term Capital, with other people from Salomon to trade in lucrative but high risk stocks and bonds. Later, his firm crashed as well, bringing another financial crisis similar to the Salomon crisis.

A Response is in the Comment Section Below.