More Investing Ideas

     Over the past 40 years or so, I have developed many strategies or "themes". Some have proved profitable, some were losers and many were forgotten. One that has produced proven results and will most likely continue to outperform is investing in Spin-offs. A spin-off is the creation of a whole new company by a large corporation. The new company was a division of the parent company that was determined to be better-off as a stand-alone company. The shares of the new company are usually distributed to the existing shareholders as of a certain date. The share price is determined based on the amount of assets and the valuation of other business in that sector. As soon as the independent new company starts to trade on a stock exchange, the market will determine what the share price will be.Why would a large company decide to spin off one of its divisions? One obvious answer is that an activist shareholder like Carl Icahn takes a large position in the parent company and demands that they unlock shareholder value by spinning-off divisions that are not related to the core business. Another example could be that the spun-off company just was not profitable enough. What often happens is that the newly independent company is freed from the constraints of the larger corporation which allows it to pursue more profitable businesses. One reason that this presents an investing opportunity is because the new shares often drop in price and offer an attractive valuation compared to other companies in the same sector. Just imagine the many large mutual funds that hold shares of the parent company because the parent fit the investment objective of these funds. Now they hold a smaller company that possibly is not in the same sector. Many funds will sell the new shares because this new company does not fit their stated investment objectives. The selling causes the new shares to fall in price temporarily creating a short term buying opportunity. One study done in 2012 compared spun-off companies over 1 billion dollars in size to the performance of the S&P 500 index over a seven year span. The spin-offs almost doubled the performance of the  index. Is this strategy a sure thing? Of course not, there are many spin-offs that won't outperform. Make sure that the new company wasn't saddled with a ton of debt by the parent just to clean-up its balance sheet. A google search of  "corporate spin-offs" will reveal many examples to review. There is also an ETF which just invests in spin-offs, if you want to take a safer more diversified approach.

When to Let Go

     One of the hardest things about investing is the decision of when to sell a particular position. It's important to not let emotions enter this decision. One thing I agree with Jim Cramer about is the notion that when a stock appreciates, the investor should sell a portion of his position gradually, until the whole position is gain. This is because your initial investment has been returned to you, resulting in you playing with "house money". The danger here is that if the stock continues up rapidly, you will have fewer shares to profit from. Maybe its just me but I think being conservative will win out in the long run. Another reason to sell is if the reasons that you bought the stock in the first place are no longer valid. Remember the "theme" investing strategy from a previous post? Well themes don't last forever. That is why I write a new forecast each year. Sometimes themes last for several years and sometimes they are very temporary. Last year I noticed that everywhere I went, I saw young mothers with babies. It seemed to me that the baby-boomer's children were starting families and even their grandchildren were starting families. The one thing that most parents will spend money on is their kids. I decided to invest in the struggling toy company Mattel. With an 8% dividend and increased demand for their products, I had a good year holding Mattel. However, they could not compete with industry leader Hasbro so I sold out and moved on. I will continue to watch Mattel in the future for another possible buying opportunity. Just yesterday, I placed about seven limit orders to sell some of my holdings.A limit order allows you to name the price you are willing to sell at. I always use limit orders for all buys and sells unless there is some special circumstance. Why am I selling some shares? Actually, I am concerned about several things: increasing interest rates, high valuations, political unrest, changes in trade relations with our trading partners, and so on. I still believe in stocks but it just seemed like a good time to lighten up on some positions, It is also a good idea to look at your portfolio for some losing positions to offset your gains. The tax code allows capital losses to offset capital gains entirely and even up to $3000 excess losses over gains. Any losses above $3k will have to be carried over to the following year. In conclusion, with today's low cost brokerage commissions, selling is not the costly move it once was. Just consider your tax consequences and the timing of dividend payments or distributions.

Executive Compensation

     This may be my most controversial post to date. I'm writing about it because of a telephone conversation with my daughter about the recent Snapchat IPO and who makes money from these Initial Public Offerings. The conversation soon morphed into the high pay of top executives and specifically the CEO. As a guy who punched a timeclock his whole working career, and who always held stocks for investments, I have a unique perspective on this subject. First, I am not envious of the folks who draw huge salaries. Some actually are worth the millions they receive each year. Need some examples? How about Steve Jobs. He returned to Apple Computer after a series of CEO's tried to return the company to profitability, only he knew how to resuscitate the company he founded. Even years after his death, his vision lives on for the future of the company which has one of the largest market caps of all stocks. Jobs returned to Apple in 1997 and worked for $1 a year but by 2010 his stock compensation amounted to $1.2 billion. I can also remember the outrage over Michael Eisner's salary at Disney, however, the wealth he created for shareholders during his tenure justified his pay. History is littered with high paid executives who proved their worth by navigating their company through difficult or challenging times. There are also many CEO's who have managed to destroy wealth at an amazing rate. Unfortunately, they were also highly compensated. The good news is that the Board of Directors would usually can the slacker after giving him a reasonable amount of time. It's important to remember the huge responsibility these top exec's have to employees, shareholders, customers, and affiliated businesses. One boneheaded move could destroy thousands of jobs and billions in stock value. My point here is that the person leading the company you invest in, is just as important as the business itself. Since you can't personally know all the CEO's in your portfolio, diversification is the key to keep one jerk from spoiling your retirement. One guy who does get to know all his CEO's is Ron Baron who founded Baron Asset Fund. The annual report of this fund reads like a "Who's Who"of the business world. Although Ron has turned over management to an employee, I know Ron still has personal relationships with his top exec's. Ron's philosophy is that he invests in people first and businesses second. It has served his fund well. I am not recommending this particular fund because it may not be suitable for all investors, mainly because of high management fees, but the investment style has been a valuable lesson.

Home Ownership, Inflation and Banker Relations

          Owning your own home can be a very rewarding experience, especially during inflationary times. Usually, home prices adjust to reflect inflation. Back in the 1970's home prices appreciated at the rate of 12% + per year. Some people bought and sold within one year and doubled their money. My belief is that housing should not be viewed as an investment. Everyone needs housing of some sort and owning a home satisfies that requirement. There are costs to owning a home that must be considered : Mortgage interest, taxes, maintenance, lawn mowing, water and sewer, capital improvements like a new roof, and so on. If you are the type of person who cannot do many of these things and does not have the extra income for the expenses, then maybe you should consider renting. President George W Bush decided that every American should own their own home. He established policies that made it easy to get a home loan with little or no money down. Bad idea! Within a few years, people were defaulting on mortgages by the millions. The abandoned homes became a blight in many neighborhoods, bringing down property values for neighbors. If you are a person who wants to own a home, can afford the taxes and repairs, go for it, try not to use your house as your ATM by borrowing any equity from it. It's ok to have equity in your house. You will find that your house offers a reasonable hedge against inflation. Speaking of inflation, I suspect that it will pick-up slightly in the coming years. Stocks also offer some inflation protection if the dividend is increasing and the business is strong. Gold has traditionally been a hedge against inflation also. I like to hold a small amount of gold just as speculation-about 5% of my assets or less. I have always believed that the best strategy against inflation is to control my spending. Inflation only hurts the buyer in a transaction. Finally, about Bankers, if you are considering buying a house, it is important to have a banker in your corner. Establishing a good relationship with your local banker can make the process of financing much easier. What I look for in a financial institution, whether its a Credit Union, S&L, or Bank is that they will service your mortgage. Some banks sell the mortgages and the servicing of it to other companies, which means that you may have to send payments to the new owners, wherever they may be. So stick with a reputable banker and make his bank your PFI (primary financial institution).

Building A Foundation

     Just like building a home, a portfolio must have a solid foundation. This means selecting a few solid stocks that pay a decent dividend and have a sustainable business model. Look for companies that have been in business for 50 years or more and have a record of increasing their dividend for most of that time. Be careful to not choose companies that are cyclical in nature. Choose companies that can sustain sales in good times and bad. Some would call these defensive stocks because consumers will continue to use their products no matter what the economy is doing. People will always take the medicine needed to keep chronic illness at bay, homemakers will always buy soap and cleaning supplies, millions of cars on the road will need gasoline, online merchants will need delivery services like UPS and FedX. Modern life demands these products. I don't see our society suddenly rejecting cell phones and the internet. These things have become what we consider necessities. The foundation of your portfolio should be in large-cap stocks that provide some of these products and services. Their size is a guarantee that they will survive competition from smaller companies. Many large technology companies simply buy out serious challengers. The dividend is important because after several years of holding one of these foundation stocks, your yield could top 10,20 or even 30%. How could that be? Remember, your yield is based on the price you paid for the stock, not the current price. If your stock has appreciated and the dividend has been steadily increased each year, the annual dividend divided by the price you paid for the stock is your yield. Eventually, you will enjoy hefty yields on solid companies that resist downturns. In a bear market, usually all stocks suffer, but defensive stocks should hold up better. This is also an opportunity to buy more of your favorite foundation stocks at fire sale prices. Once you have a solid foundation, then the more speculative issues can be added to round out the total portfolio. My next post will talk about home ownership,inflation and relationships with financial professionals.

Go With The Flow

     To every thing there is a season and a time to every purpose unto heaven. These words were written two thousand years ago but they are still relevant today. Just like farmers follow the seasons for planting and harvesting their crops, stocks follow predictable cycles also. Just like the tides in the ocean, money flows from one asset class to another based on the political, monetary, and fiscal climate. For example, right now we are entering a phase where the Federal Reserve is increasing interest rates. What does this mean to the investor? A lot of things! First understand that when rates go up, bond prices go down. Why is this? Imagine you own a bond that pays a coupon of 3% Suddenly new issue bonds of the same quality are paying 4% Who would want your bond that pays less? How do you get rid of it? The buyer of your bond will pay you less than par for your bond, creating a capital loss for you. The lower price that he paid you boosts his yield to the going rate of 4%. Increasing rates creates a toxic climate for bond investors. That is why the stock market is experiencing large inflows of cash. Even though Donald Trump is taking credit for the market's rise, there is more to the story than he is letting on. Stocks can only go so far on political rhetoric. The tidal wave of money flowing into stocks is a natural occurrence. Valuations are near record highs. Money is desperately looking for a home. One thing that works near the end of long bull markets is stocks of small companies. These small and mid cap names can go long periods without much investor interest but now they are red hot. How long can they outperform? The easy answer is until money stops chasing their performance. My experience is that these trends usually last longer than you would think. Once people invest their money into the small and mid cap mutual funds, they tend to hold for too long. This is not an asset class to buy and forget about. At the first sign of trouble, reduce your exposure. When interest rates near a top, safer investments like cd's start to attract the tidal flow of money. My next post will talk about why every portfolio should have some "core" holdings of  large cap stocks.

More on Strategies

     As I've stated before, my main strategy is "theme" investing. This is where I forecast trends then buy stocks of  companies which should benefit if my thesis is correct. But what if I am wrong about both the trend and my investments? It is always a good idea to hedge your bets with some other strategies. Think of your total portfolio as separate buckets of money where the buckets are different strategies. This will provide you with diversification among industries, company size and style, (growth vrs value). It's important for the strategy to fit the times. At this time, overall stock multiples as expressed by the P/E ratio are near record highs. My thought is that record low interest rates justified these lofty valuations. However, interest rates are on the rise and expected to go higher. This means that at some point lots of money will leave the market in favor of lower risk alternatives such as CD's (certificates of deposit), bank accounts, and money market accounts. I don't know what level of rates will cause this migration but I know it will happen. That's why I like a strategy that avoids the high valuation stocks. There is an old strategy called the "Dogs of the Dow" portfolio. This is where the highest dividend payers in the Dow Industrials index are bought at the first of the year and held until the first of the next year. Usually the high dividend is a result of the stock price declining over the past year or longer. If the dividend had not been cut or reduced, the yield soars. Companies are reluctant to reduce or cut the dividend because that may be the only reason the stock doesn't decline more. Typically, these dogs have low P/E ratios (valuation) because investor demand is low. I like high yields combined with low valuations. I am not recommending this strategy or any of its variants, which are many, to my readers.  I just think it is important to know about it and research it further to see if it is right for one of your "buckets" at this time. In my next post, I will talk further about fat dividend yields and my thoughts about saving for retirement.