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Monthly Archives: March 2011

What a long investor needs to know about short positions

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If you’re going long on a stock, then it is wise of you to see what the short position in the stock looks like.  As you know, shorts make money when a stock falls in price and longs make money when the stock price rises.  When you look to invest in a company, it is wise to look at the information typically provided about the stock’s short positions.

The process of short selling is different than buying a stock.  Short sellers do not own the shares they are buying.  Selling short places the short seller in a contract with another party (typically the broker) to be able to buy X stock at a specific price at a future point in time.  For example, if a stock is trading at $8 and I sell short, I am betting that the stock will decease in price.  If the stock falls to $5 then I will close my position and thus buy the stock for $5.  I will have a $3 profit.

To actually sell short you will need a margin account.  If the stock’s price rises, then short will eventually be subject to a margin call.  Margin calls happen when an accounts value depreciates to the point where the broker requires additional funds be deposited to maintain compliance.  In these case, short sells may close out their positions to satisfy the margin call.

When a stock with a heavy amount of short interest starts moving north, then margin calls will eventually occur.  If the stock’s price moves north fast, it can cause what is terms a short squeeze.  The short squeeze happens because of a lack of supply and an excess demand for a stock.  Part of this process is helped along by the fact that short sellers are having to buy the stock when they cover their position.  Therefore, you not only have regular traders demanding the stock, but you have short sellers adding to the fire.

If you’re looking to get a sense of how strong the short interest is in a stock, I would refer you to Yahoo! Finance’s Key Statistics section.  It can be found within the information presented per each stock.

Short Interest Ratio (Days to Cover) = Current short interest / Average Daily Volume

  • As you see in the example above the stock has a short interest ratio of 2.10 days.  Therefore, it would take over 2 days of trading, based on the stock’s average volume, to work through the shares held short.

Remember it’s not by accident that a stock has a high or low short interest.  If you find yourself being drawn toward a stock with a lot of short positions, make sure that you understand why so many investors are short in the stock.  A large short interest in a stock isn’t something that should automatically scare you away from an investment, but it should serve as a warning sign.

Creative Destruction 2000-2010

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Creative destruction is a concept I’ve discussed in theory on this site, but what are some current examples of creative destruction within our economy?  IBISWord has recently published a report that lists ten dying industries in the U.S.  The report looks at their decline from 2000-2010 and their projected losses in the next six years (’10-’16).

Click Here to read the report.

Most of the industries that are in decline do not surprise me.  Most people that are paying attention to their surroundings would not be surprised about half of the industries list.  The industry that I am surprised to see listed is video post production services.  For one, I don’t give much thought to the service.  I’d be interested to see why this has happened to cause this decline and what has filled the void.

I see the biggest take-away from this report as an investor is the fact that you’re able to say to yourself, “What’s filled or filling the void?”  For example, record stores are on the decline, but that does not mean people have stopped enjoying/buying music.  Digital distribution of music has overtaken the industry.  In the case of video post production, is it some type of software or other service that has changed the nature of the industry?  If so, it might be an investing opportunity.

Natural Gas Rises From A Nuclear Stumble

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The perception of nuclear power has taken another hit.  Americans, already leery over over the thought of nuclear power, have seen their fear reinforced by the events in Japan over the past week.  While fear may increase or decrease, it is almost certain that our power needs in the U.S. will grow in the near and distant future.  The question that ultimately matters to you the citizen and investor is how will our power needs be met?

Approaching the question above from the position of an investor would lead me to consider what flavors of energy are palatable to the U.S. citizen.  I would contend that the U.S. energy consumer is torn between 2 desires; cleanliness and price.  The U.S. consumer wants to receive energy from clean sources, while being cost effective.  Essentially, the best of both worlds is being asked for.

Fossil fuel based (coal and oil) are cost effective, but are not viewed as ‘clean’ sources of energy.  Nuclear, while being ‘clean’ in many ways as an energy source, is seen as ‘dirty’ by the fact of its potential problems (radiation leaks and nuclear meltdown).  Though fossil and nuclear fuel sources are not regarded as being clean, they are price competitive and tested sources of energy.  They fulfill the pragmatic side of the U.S. consumer, yet leave his/her ‘green’ desires unfulfilled.

Solar, wind and geothermal are seen as earth friendly and aesthetically pleasing energy sources (although I find hills covered with windmills quite un-aesthetically pleasing), yet typically come with higher costs and are limited in their actual application.  Solar and wind generation must overcome their variable nature and geothermal is limited to certain geographic regions.  These sources of energy may help meet our needs, but they will not be the main solution.

Natural gas is uniquely positioned (particularly within the U.S.) to emerge as a mainstay of energy production.  New drilling technologies and natural gas discoveries have increased the energy’s potential in the U.S.  The expansion in supply has also presented the hope that gas will be able to fulfill more roles, while not jumping significantly in price.  The U.S. has a lot of natural gas and natural gas is viewed by the U.S. energy consumer as a ‘clean’ source of energy.  This is the match the U.S. consumer is looking for – the collision of economic realism and green energy.

As I’ve written about in a previous posting, the shift to natural gas will not happen over night.  This shift will take years.  Changing a factory’s energy delivery mechanism takes time and doing so for a city, state or nation will take even longer.  Yet, you must remember that the market is forward looking.  Thus, it is not when the plants are built that you will see investors swarm natural gas producers, drillers, providers and distributors.  Investors will swarm when they know that the direction has been set have natural gas play a much more significant role in the country’s future.

Here are 4 plays on natural gas growth that you can consider when starting your research:

  • Weatherford International (WFT) provides equipment and services used in the drilling, evaluation, completion, production, and intervention of oil and natural gas wells to independent oil and natural gas producing companies worldwide.
  • Dorchester Minerals (DMLP) engages in the acquisition, ownership, and administration of producing and non-producing natural gas and crude oil royalty, net profits, and leasehold interests in the United States.
  • Nicor (GAS) through its subsidiaries, engages in natural gas distribution business in the United States. The company distributes natural gas to approximately 2.2 million residential, commercial, and industrial customers in northern Illinois. It also provides natural gas storage and transmission-related services to marketers and other gas distribution companies.
  • Schlumberger Limited (SLB) and its subsidiaries supply technology, integrated project management, and information solutions to the oil and gas industry worldwide.

Disclosure: Long WFT

Cut Out the Noise

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I go back in forth in my mind about the value of looking at the news on a daily basis and scrutinizing it against your investments.  A lot of what you hear can be classified as noise.  By noise I mean non-material information that is more likely to distract or scare you rather than actually help you.

One of the worst things you can do as a long-term investor is to accumulate a basket of stocks that you are not comfortable with.  In such a case, the noise you hear becomes a force that will cause you to make hasty decisions and no longer stay on the path of long-term results.

To avoid such a situation, you need to pick stocks (or funds) that you feel comfortable with.  For instance, if you hold stocks that are from an industry that you expect to take off within the next 2-5 years, then swings in price should not really shake you all that much.  Yes, no one wants to see their stocks go down, but if you are convinced that the future is bright for the industry, then you have some certainly to rest against in times of uncertainty.

It’s easy to say you’re a long-term investor, but to actually walk to the talk is another story.  Our fears, passions and emotions can overrule or planning sometimes very easily.  Being comfortable with your investments will help you in preventing such erratic decision making.

The Fiscal Risk Index & Demographic Investing

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According to a new ranking of 163 countries, Europe’s big economies, including France, Germany, Italy, Sweden and the United Kingdom, are the most exposed to fiscal risk due to their ageing populations, substantial levels of debt and high public spending on health and pensions…READ MORE.

My Take:  As you might be aware, I am a very big fan of what I like to refer to as ‘demographic investing.’  As the name indicates, demographic investing is the use of demographic trends to help direct/guide your investing decisions.

A lot of what the article above states is well know by most.  Europe has a big problem; a lot of older people and a lot of government programs.  Their pyramid of social support is upside-down.  While knowing this may not drive you to invest in any one particular stock, it may shine some light on an area that you probably don’t want to flock towards, if you’re thinking of long-term investments.

Markets do price in known information, but information that is known, but will not be realized for 10-20 years is not information that people wrap their minds around easily.  The writing is on the wall, but the paint isn’t dry.  I don’t think the information in the article justifies staying away from Europe totally, but it should be a flashing red light in your mind when you’re thinking about long-term portfolio positioning.

Lastly, the situation Europe is in should not mean that investors should stay away from anything European.  This is specially true for those companies that have operations in and outside the continent.  Many successful companies are based in Europe with a significant amount of operations outside the country.  Thus, they’ll benefit from growth prospects outside their home base.  (Reference Telefonica)

Why I sold my nuclear holdings

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I’m not a nuclear energy expert, but I do understand human psychology.  Therefore, I sold my entire position in Cameco Corp (CCJ) this week.  I entered the position in CCJ as a medium risk bet on the increasing demands for energy, particularly nuclear energy.  Over the weekend I saw that this medium risk investment was growing into something much more risky.  People are already freaked out about nuclear power, the problems in Japan just reinforce these pre-existing fears.

The fears of people do impact the value of a commodity, such as uranium.  Fewer nuclear power plants mean less demand for uranium.  More fear = less nuclear.  A year or so ago I went through a similar situation with Diamond Offshore (DO).  What was once a smart play in deep-water drilling became a constant back-slide as the Gulf oil spill became worse by the day.  What I saw this weekend was possibly the beginning of such a problem.

Yes, I understand that the media hypes stories and this might be the case in Japan.  If so, that’s fine, I can always come back to uranium mining companies.  If that is not the case, my money parts from me and I’m out of luck.

I’ve learned not to bet against a freaked-out public.  I see this being the case with the use of nuclear technology.   Therefore, I am out of uranium.

To close, I often speak of long-term investing and not becoming a ‘trader’ while you’re a long-term investor.  In a case such as the Japanese quake and tsunami where a very dangerous situation is taking place with nuclear power, I do think it is wise to take a serious look at how your investments are going to be impacted by such events.  If you can make a clear connection (nuclear power blows up = bad for uranium demand), then I believe it’s wise for the long-term investor to trade as necessary.

I’m on the sidelines for now.

A Sound Argument for Investing in Trees

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It is my expectation that timber from the Pacific Northwest will help rebuild Japan in the coming months and years.  Plum Creek (PLC) and Weyerhaeuser (WY) are two companies that have the timber to rebuild Japan…READ MORE.

My Take: A huge earthquake and a tsunami can do a lot of damage…yes, that might be an understatement.  As Japan recovers from one of their largest natural disasters on record, they will require a significant amount of timber to rebuild.  Timber has been out of favor since the house market went bust around 07-08, yet with Japan and the re-emergence of many countries around the world, growth may spur demand in the not too distant future.

If you’re looking for a conservative growth play with a dividend payment, then why not give Plum and Weyerhaeuser a look?  Natural resources do count for something these days.  I’ll leave it to the CEO of Weyerhaeuser to talk more about future prospects.


Natural Gas, Depressed Prices & An Investing Opportunity

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If you keep up on natural gas prices you know that they are not anywhere near their 5 year highs of $14/mmBTU.  Today natural gas trades around the high $3 – low $4 range.  Prices are low and have remained so for a few years now.  A lot has to do with increasing natural gas discoveries around the world and more advanced extraction technology.  As other costs of energy increase, natural gas will be a more compelling alternative for energy production.

The market is currently bearish on natural gas.  Thus, it’s not expecting any significant rise in the price in the near-term.  Though, if you’re a long-term investor, you must remember the best time to get into a stock, sector or commodity is when the market is overly bearish.  I believe this is the case for natural gas in terms of its long-term potential.

Natural gas is a relatively clean form of energy, it is in abundant supply and it is relatively easy to transport.  Taking the assumption that crude oil prices remain high for at least the coming year, many industries that are energy intensive are going to seriously consider switching to natural gas as the source of their energy.  Many of them will make the switch.

On the government side, many states (I believe 34, if not at least 20) have enacted legislation that requires the reduction of green house emissions by a certain date.  Assuming the legislation stands, how will these states meet their requirements?  Most of the trendy green technologies for producing energy are quite expensive (wind & solar).  Most governments are strapped for cash and are looking to cut anywhere they can.  Subsidies are increasingly scarce.

Many states will look to natural gas to be their solution for their green house emissions requirements.  Whether it be power plants or vehicles, natural gas offers an affordable way to leverage the power of a clean energy source. States are at the point where implementing legislation is going to become very utilitarian in nature.  The cost, dependability and availability of natural gas speaks to this reality.

The market for energy from specific sources is inelastic.  By this I mean that people and organizations that use specific types of energy typically cannot switch from one source to another easily.  A power plant may be built to burn coal and therefore to switch to another source would involve building a new plant.  An industrial business might have equipment that specifically use one type of energy.  Replacing the equipment to support another form of energy would be necessary to switch energy sources.

From the examples above it is obvious that it will take industries and other organizations time to switch to natural gas.  Therefore, it will take time for the market to meet the increase in natural gas supply.  If you are a long-term investor, then consider this information and start researching companies producing, exploring and distributing natural gas and/or funds that invest in natural gas futures.

Long-Term Investing & Day-To-Day Market Movements

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Being an investor with a long-term (multiple year) investing horizon can be a difficult strategy to adhere to. The news headlines, pundits and anyone else with an opinion are heavily weighted towards the here and now.  When the market goes up elation fills the collective mood and when the market goes down anxiety (or worse) takes hold.

How does an investor with a long-term investing orientation prevent oneself from having his/her decisions influenced by the market’s manic behavior?  No one answer will suffice for every investor.  You must learn to understand how you react to good or bad news and how your own mind works to sabotage its own investing strategy.

The illustration above shows a range of emotions – remorse, anger, sorrow and happiness.  In a period of minutes, hours or days impulsive market swings can easily stir such a reaction from any investor.  Any investor that thinks the ticket to prosperity is allowing their emotions to guide them through a kaleidoscope of investments is in need of serious help.

When I think of what it takes to rise above the day to day sifts in emotion that ‘Mr. Market’ brings, I turn to Rudyard Kipling’s poem If.  In the poem Kipling states, “If you can keep your head when all about you are losing theirs…If you can trust yourself when all men doubt you, but make allowance for their doubting too.”  In the poem Kipling is speaking about being a man, but many of the words of wisdom espoused are relevant to what it takes to be a successful investor.

Consider this…If you are investing based on demographic trends, most people will not be investing with your same strategy.  They may be playing a certain market cap sector that is ‘hot’ or running towards another trendy asset class.  Money will flow from one area to another.  The rhyme or reason may not be clear, but to the individual controlling their funds the rational is crystal clear…for the moment.

Whatever your strategy is, it is all but certain that you are going to encounter a market in which investors turn against your strategic positioning.  In such times long-term investors are tested.  Do you have the resolve to stick to your game plan or will you panic?

My advice to long-term investors is to identify a sound strategy that you feel very confident in and then identify the companies or industries/sectors (via funds) that mesh with your strategy.

For example, if I think that healthcare companies are going to experience significant growth in the next 5-20 years because of an aging baby-boomer population, I will want to invest in companies that provide healthcare products and/or services.  In selecting my investments I will want to put the bulk of my portfolio’s weight in companies that are financially sound, have a well developed position in the market and are not unreasonably priced.   Selecting good companies will enable you to have less anxiety when the market goes through a bad period, plus they’ll fare better.  You may want to invest in some more speculative positions, but you won’t want to make these positions the majority of your portfolio.  If you do, you are likely to see dramatic swings in the value of your portfolio, which is likely to cause you to panic, destroy your long-term approach, and undermine your entire strategy.

Each individual investor is different and we psychologically handle market shifts differently.  Do your best to understand how you react to market shifts (positive or negative) and then consider how to best manage these psychological predispositions while maintaining your investment strategy.

Saving For College – The 529 & Beyond

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Note: The subject matter below is subject to changes in state and federal tax laws.  Please consult your state and federal tax regulations for specific information.

In a society that has come to believe that everyone should go to college, it’s no wonder the cost of higher education continues to climb.  Increased demand, reduced public funds and a relatively inelastic supply of established private institutions offering 4-year degrees and you’ve got yourself a head-ache as a parent thinking about how will you be able to support your child(ren) through college.

If you are a parent that is planning ahead and wants to ensure your child will have some financial support when they start on their 4 year journey (or more…), then you need to get comfortable with the 529 college savings account and your own IRA.  These two plans will help provide you tax-sheltered alternatives when saving for your child’s college education.

When people talk about tax-sheltered college savings, the conversation usually turns to the 529. The difficulty that comes when talking about such plans to a geographically diverse audience is that the specifics of the 529 plan vary by state, since they are actually state sponsored higher-ed savings accounts.  Since I’m in California, I will focus on the nuances of the California 529 account.

Who can contribute to your child’s 529 account? Anyone.  You don’t even need to be related; you can open a 529 account in the name of relative or friend’s child.  I hold a 529 account for my godchild Jack and we’re 2nd cousins.

What about the tax savings? Typically states offer tax exemptions for contributions to 529 plans.  In California that is the case; contribute the the plan and avoid state income taxes.  The contribution is also exempt from federal IRS taxes.

How much can I contribute? Cumulatively you can contribute up to $300k.  On an annual basis, gifts eligible for tax deducation stop at $50k for singles and $100k for married couples per child, per year.

What can I invest in? Again this is something that is going to vary by state.  California uses Fideiltiy Investments to define the scope of funds available for 529 account holders.  There are a handful of funds that range from aggressive to conservative.  Yes, you will be subject to annual management fees.

What can the money be spent on? You can use funds from a 529 account tax free on tuition, books, and other required school supplies and equipment.  It doesn’t stop with the basics though!  In ’09 and ’10 Internet connection fees were included (I’m not sure if that carried over into ’11?).  As long as you’re a half-time student you’ll be able to use the money for room and board.  If you’re on campus, then the entire cost is eligible, but if you’re off-campus then you would have to consult what dollar level the college quotes in its cost of attendance guidelines.  See this IRS document for more information.

What other routes should you consider? Look at your Roth or traditional IRA.

In piece by Robert Brokamp, he takes the position that parent’s should consider hedging their bets when saving for college.  Brokamp takes the approach of looking at college savings and retirement as two competing sources of your savings.  In this dialectical view, Brokamp finds resolution through the utilization of the IRA account.  With an IRA you have a chance to have your cake and eat it too – Save for retirement while being able to allocate savings for education, if needed.

If you’re having to compromise your retirement savings (IRA) for the 529 plan, then you should consider the fact that IRA funds can be used prior to retirement on qualified education expenses.  Thus, you can save  for retirement and not be penalized if you end up using the funds to support your child’s education.  Caution -When you withdraw funds from a traditional IRA you’re going to find these funds subject to Federal and state income tax.  Roth IRAs will not have this problem, if you do not withdraw funds beyond your original contribution level.

Another benefit to using your IRA for the cost of education is the fact that your IRA fund is not going to be counted with most financial aid calculations.  This is not always the case with 529 plans, since a beneficiary is defined.

IRA accounts are not subject to limited amounts of investment choices.  You can invest in individual stocks for better or worse.  This is not the case with 529 accounts.

I find the strongest argument for using IRA accounts in place of a 529 account would be the situation in which the parent’s do not know whether or not they will have enough to live on in retirement.  To summarize Brokamp’s argument; many options are available for students to pay for college (loans, grants, scholarships…), these options are not available for a person looking to retire.

As Waren Buffett is attributed with saying,”Someone’s sitting in the shade today because someone planted a tree a long time ago.”  Your actions that you take today will impact the actions you’re able to take tomorrow.  If saving for your child’s education is a priority for you, then understand that the journey you start on now will pay-off in the future.