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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