Tag Archives: alternative

An Alternative To Buying Glamour Stocks

Summary Investors tend to overreact to the glamorous growth companies, and expectation can lead to disappointments. Return and value exists where nobody is looking. Micro capitalization, and value companies are common places where excess returns exist. My Investment Philosophy The road to successful investing often contradicts with our tendency to act in a collective manner. Ever since the beginning of my investing career, I have always avoided the glamour stocks, the public’s picks, and the ones that your neighbor is buying. In the short run, the market is a voting machine but in the long run, it is a weighing machine. -Ben Graham Like Ben Graham said, winning in the stock market isn’t like winning the election. Popularity will be weighed out in the long run by actual performance of the company. Large Cap Growth Stocks Tesla (NASDAQ: TSLA ): (click to enlarge) Netflix (NASDAQ: NFLX ) Source: Google Finance As TSLA and NFLX illustrate, large cap growth stocks have generated tremendous returns for their shareholders in the past few years. This Time is Different These words are often uttered before the collapse of the bull market. Investors use these words to justify elevated valuations and unsustainable growth trends. The legendary investor John Templeton once said “this time is different” are the four most dangerous words in finance. I would like to bring up an example that Warren Buffett used in his 1999 presentation before the collapse of the Dot-Com bubble: Well, I thought it would be instructive to go back and look at a couple of industries that transformed this country much earlier in this century: automobiles and aviation. Take automobiles first: I have here one page, out of 70 in total, of car and truck manufacturers that have operated in this country. At one time, there was a Berkshire car and an Omaha car. Naturally I noticed those. But there was also a telephone book of others. All told, there appear to have been at least 2,000 car makes, in an industry that had an incredible impact on people’s lives. If you had foreseen in the early days of cars how this industry would develop, you would have said, “Here is the road to riches.” So what did we progress to by the 1990s? After corporate carnage that never let up, we came down to three U.S. car companies–themselves no lollapaloozas for investors. So here is an industry that had an enormous impact on America–and also an enormous impact, though not the anticipated one, on investors. It is critically important for us as investors to realize that a revolutionary company might not be an economical one, and a great company might not be a good investment. Popular stocks are often overvalued and dangerous because of their nature to invoke high expectations. As NASDAQ is heading toward all-time highs again with these companies leading the charge, maybe it is time for us to take a step back and think independently about the intrinsic value of these companies before blindly following the herd. Micro-Cap Value Stocks On the other end of the spectrum, we have micro-cap stocks, which have under-performed the market since 2012. PowerShares Zacks Micro Cap ETF (NYSEARCA: PZI ) (click to enlarge) Source: Google Finance Empirical Proof In the study done by Ibbotson Associates, they divided stocks into different sizes and styles and measured their returns from 1969 to 2002. The research showed that the small caps outperformed the big caps and value stocks outperformed growth stocks during the same period. Geometric Arithmetic Standard Sharpe Mean (%) Mean (%) Deviation (%) Ratio All Growth 8.79 10.72 20.25 0.21 All Value 10.99 12.31 17.08 0.34 Large-Cap Growth 8.9 10.91 20.75 0.21 Large-Cap Value 10.43 11.75 17 0.31 Mid-Cap Growth 8.88 11.09 21.88 0.21 Mid-Cap Value 13.03 14.66 19.37 0.42 Small-Cap Growth 8.2 11.04 24.77 0.18 Small-Cap Value 14.35 16.41 21.69 0.46 Micro-Cap Growth 6.47 10.2 28.66 0.13 Micro-Cap Value 14.66 17.44 24.69 0.44 The statistics show that the micro-cap value stocks outperformed the large cap growth by a stunning 5.76% a year. But why do these market segments have by far the highest returns? Reasons for out-performance These micro-cap value companies tend to have the least coverage by analysts and the least institutional ownership. They are usually companies that are very small and no one has ever heard of. Institutions and analysts do not have incentives to research the companies, and because of their hidden nature, their values are buried with their size. Moreover, most institutions are not allowed to own these small to micro caps, and if they happen to own these companies due to a spin-off, they are forced to sell the position. Another reason why these stocks tend to out perform growth stocks is that investors overreact to growth, while not paying enough attention to the boring and less liquid companies. These asset classes are a great place to start looking for enterprise investors seeking to beat the market over the long term. Source: Fama and French Research portfolios If you are not comfortable picking stocks on your own, buying a small-to-micro capitalization value ETF will enhance your returns over the long run. For example, in the past 30 years, a 10% asset allocation to small caps will increase your return of over 1%, while having a lower standard deviation. Here are some ETFs tracking other small cap value equities: iShares Russell 2000 Value ETF (NYSEARCA: IWN ) , Small-Cap Value ETF (NYSEARCA: VBR ), iShares S&P Small-Cap 600 Value ETF (NYSEARCA: IJS ). (click to enlarge) Source: Money Chimp Conclusion I am not a market timer, nor do I suggest it is currently a good time to switch from popular growth stocks to micro-cap value stocks or that there is currently a bubble in the above companies. My point is that investing is a long-term game of discovering hidden gems, as opposed to following the herd. Micro-cap value stocks have outperformed the markets in the past for a reason; allocating a portion of the portfolio to these companies may be wiser than buying popular household names during the present-day lofty valuation era.

VEU: Now Might Be A Good Time To Add Foreign Equity Exposure To Your Retirement Portfolio

Summary Investing for retirement can be as simple or as complex as you want to make it. One well diversified global ETF with a low expense ratio is a good start. Given the relative under-performance of foreign equities over the last five years, now might be a good time to add exposure to foreign equities to your retirement portfolio. This article reviews VEU, an ETF that can be added effectively to the core portion of most investors’ portfolios to increase exposure to foreign equities. Simply Investing – Philosophy Whether you are just starting to invest for yourself or your kids or are taking back control of your investments from an investment advisor, keep investing simple, consistent, diversified and low cost and you will significantly increase your chance of success. One well diversified global ETF with a low expense ratio is all that is required for many people starting to invest in equities, and an ETF that meets these criteria is the Vanguard Total World Stock ETF (NYSEARCA: VT ). As an investor’s experience, time dedicated to investing activities and desired risk, increases, investors can add ETFs to the core of their portfolio to gain exposure to new areas or increase exposure to areas that the investor believes will outperform. The next step for many investors is to allocate a percentage of their portfolio to “edge” positions, which offer additional risk and opportunity. Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) This article reviews VEU, an ETF that can be added effectively to the core portion of many investors’ portfolios to increase exposure to foreign equities. VEU – Regional allocation and investment synopsis Source: Vanguard (allocation as of 10/31/2015) VEU seeks to track the performance of the FTSE All-World ex US Index. It has holdings in approximately 2,500 stocks with broad exposure across developed and emerging non-US equity markets around the world. VEU’s broad global diversification helps to minimize volatility that any one region may experience. As can be seen above, VEU’s heaviest weighting is in European stocks. Investors looking to increase their exposure to foreign stocks should consider whether they want a heavy concentration of European stocks in their foreign stock ETF, when adding this ETF to their portfolio. VEU performance compared to the S&P 500 (click to enlarge) Source: Yahoo Finance (11/29/2015) As the chart above shows, the S&P 500 has significantly outperformed VEU over the last five years. There are a number of reasons for this including the relative strength of the US economy and the US dollar compared to foreign economies and currencies. While the out-performance of the US market may continue for some time, after such an extreme period of under-performance by foreign stocks, now might be a good time to start building or add to a core position in foreign stocks in anticipation that this under-performance will, at some point, at least partially reverse itself. VEU -Equity characteristics Source: Vanguard (as of 10/31/2015) As the table above indicates, VEU is very well diversified, holding 2,508 stocks. The median market cap is quite large at $28.5 billion. VEU’s current price/earnings ratio at 17.4 is high compared to historical levels for global markets. The high current price/earnings ratio is not unique to VEU. The price/earnings ratios for US markets and many global markets are currently higher than historical norms. These high price/earnings ratios are likely due to the low returns that alternative investments, such as fixed income, currently offer. Investing for retirement should be done on a consistent basis. A simple investment plan, makes consistent investment that much more likely to happen. The relatively high current price/earnings ratio of stocks suggests that if you have a large amount of capital to invest today, it is advisable to dollar cost average this investment into the market over a period of time. VEU – Top 10 holdings Source: Vanguard (as of 10/31/2015) VEU’s top ten holdings are dominated by European companies, with eight out of the ten holdings European. As previously indicated, European stocks make up 47% of VEU’s holdings, so they are somewhat over-represented in this list of VEU’s top ten holdings, but these top ten holdings make up only 8.9% of total net assets. VEU – Expense ratio and dividend yield VEU’s expense ratio is 0.14%, this is well below the average expense ratio of similar funds at 1.16%. Given the relatively high price of the market today, it is likely that future returns may be lower than those recently experienced. In this environment, it is important that the core of your portfolio is allocated to funds with low expense ratios like VEU. The forward looking dividend yield is 2.95% based on the last four quarters distributions. Conclusion Your chance of long term investment success increases significantly by keeping your investing simple, consistent and well diversified. Most investors can benefit by building a core position in a well diversified global ETF with a low expense ratio like the Vanguard Total World Stock ETF. After establishing an initial core position in a global ETF, then additional low cost, well diversified ETFs can be added to the core portion of your portfolio to gain exposure to areas under-represented or which the investor believes will out-perform. With the relative under-performance of foreign stocks compared to the US market over the last five years, now might be a good time to increase your exposure to foreign stocks by to adding a low cost, well-diversified foreign stock fund like VEU to the core portion of your portfolio.

Dynegy: Too Early To Buy

Summary Dynegy shares have been cut in half in 2015 as investors run for the exits. While metrics are improving, the company still doesn’t generate significant operational cash flow. Additionally, I have concerns over whether cash flow problems have impacted the company’s ability to properly maintain its assets. It’s still to early to buy. If you really want a piece of this company, buy the preferred shares instead. Dynegy (NYSE: DYN ) is a holding company that owns a large portfolio of power generation assets throughout the United States, with a heavy concentration of these assets located in the Northeast and Midwest. The company operates regulated utility operations while also competing in the wholesale electric business, where it provides electricity to utilities, power marketers, and industrial customers. Unlike traditional regulated utilities that are the sole source of power for their customers, the wholesale market pits many players against each other in the name of driving down costs. Dynegy operates approximately 26GW of generation assets, with the vast majority of production evenly split between modern combined cycle natural gas plants and legacy coal plants. In acquiring and developing these assets, the company has had both an interesting and volatile past. Dynegy emerged from bankruptcy in 2012 with a little help from the renowned Carl Icahn , only to make a $6.25B acquisition (12.4GW) of coal and gas-fired assets from Duke Energy (NYSE: DUK ) and Energy Capital Partners just a few short years later in 2014. While the debt load may appear large given the company’s size and recent bankruptcy, the acquisition was viewed favorably by most ratings agencies in regards to improving earnings by acquiring some retail regulated business. However, this debt didn’t come cheap – weighted average interest rate of the debt was 7.18%, quite high given our current position in the interest rate cycle. Operating Results (click to enlarge) As one of the largest merchant energy providers using natural gas, you might expect operating results to have been a little bit more favorable than this post-bankruptcy. There are some sparks of improvement for investors to grab on to, such as improving gross margins. The retail Duke Energy/Energy Capital Partner assets have improved the company’s margin profile, and spark spread improvements due to collapsing natural gas prices have also boosted margins. SG&A expenses have also grown quite slowly, indicative of the scale that is present in many utilities. Bigger is generally better in this sector. Like the income statement, cash flow generation hasn’t been much better. Dynegy generated negative operational cash flow in 2013 and 2012, and was only generated marginal cash flow in 2014. 2015 is set to be a better year, but the company still struggles to generate enough cash to sustain itself. Through this point in 2015, the company has barely spent any money at all on capital expenditures ($500M over three and a half years). Even after taking into account the change in the business from the acquisition, this still seems woefully low. Great Plains Energy (NYSE: GXP ), another company with heavy coal exposure and nearly identical enterprise value, has averaged $600-800M in annual capital expenditures. I’m not sure I buy into just $130M in capex to support the company’s 16 power plants in 2014. This company is a long way away from supporting itself from a cash flow perspective, never mind instituting a dividend that can be healthily supported. I do like the company’s natural gas operations. Citing industry trends, management itself notes that it expects ~50GW of coal power plants to be phased out of markets that Dynegy competes in due to a variety of factors, such as falling natural gas prices, increased capital expenditure requirements, and burdensome regulatory costs. However, I can’t help but feel this leads to a negative in and of itself as well. This bullishness on natural gas generation seems to run contrary to the assets picked up from the Duke Energy deal, as a sizeable (roughly 40%) portion of those assets were coal-fired. Duke Energy has been reluctant and slow to shift generation away from coal, and while these were non-core assets for Duke Energy (the company has decided to focus on its East Coast operations), Duke Energy management wouldn’t have taken a poor deal just to dispose of these assets. Conclusion Dynegy is too early in the turnaround stage for me to recommend it, and it is too early to go bottom fishing, despite the stock getting halved in price in 2015. While I’m not going to call it a short (I would have six months ago), the company is still years away from being what investors want in a utility: consistent cash flows, a healthy dividend, and a fair valuation. The preferred issue is probably the better play here if you’re deeply interested in the company. The preferred currently yields 8.49%, and is convertible into 2.58 shares of Dynegy if you choose to later on. At $59.22/preferred share at this point, if this thing ever does recover, you’ll be sitting pretty and will have been paid a healthy dividend to boot while you wait.