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How To Increase The Dynamic Energy Of Your Portfolio

In physics, the dynamic energy of an object is a measure of how much energy the object can release under favorable conditions. In a similar way, a stock portfolio has higher dynamic energy when it consists of stocks with great upside potential thanks to a headwind and its resultant sell-off. The article suggests replacing some stalwarts, whose growth has stumbled but still trade at elevated P/E, with some oil stocks that have been extremely punished due to the oil plunge. In physics, the dynamic energy of an object is a measure of how much energy the object can release under favorable conditions. To clarify this through an example, two objects that are still, with the one at the sea level and the other one on the top of a hill, both have zero kinetic energy. However, the one on the top of the hill possesses much greater dynamic energy because a minimal push can make it start moving at an increasing speed, whereas the other one will remain still under any conditions. Given this definition, investors should try to build a portfolio that has high dynamic energy, i.e., its stocks will greatly appreciate under favorable conditions. Of course this does not involve purchasing extremely high-risk stocks that will return great profits under extremely specific conditions, which have minimal chance of prevailing. Instead this strategy involves purchasing stocks that have asymmetrical reward to risk, as they have been beaten to the extreme due to a temporary headwind despite their strong fundamentals. In the past, it was much easier to build a portfolio with high growth potential. More specifically, all an investor needed to do was to purchase some stalwarts, such as Coca-Cola (NYSE: KO ), PepsiCo (NYSE: PEP ), McDonald’s (NYSE: MCD ), Wal-Mart (NYSE: WMT ), General Mills (NYSE: GIS ), Philip Morris (NYSE: PM ) and Procter & Gamble (NYSE: PG ), and hold them forever without even checking on them. As these companies have historically grown their earnings per share [EPS] at a rate higher than 10%, they have historically offered excellent returns to their shareholders. However, as these stalwarts have now expanded to almost every country, further growth has become much harder to accomplish and hence their EPS growth has stumbled in the last 2 years, as shown in the table (data from morningstar.com for 2013-2014 and finance.yahoo.com for 2015): KO PEP MCD WMT GIS PM PG 2013 growth -4% 10% 4% -3% 19% 2% 6% 2014 growth -2% 5% -8% -2% 1% -5% 4% 2015 growth [Exp.] 0% 4% 5% 5% 0% -10% -2% P/E TTM 21 21 19 17 22 16 21 Given the low growth rate of the above stalwarts, their high market cap and their relatively high P/E, investors should realize that a portfolio consisting largely of such stocks possesses limited upside (fortunately it also has limited downside, as these stocks greatly outperform the market during a downturn). Therefore, investors should add some stocks that have been unfairly beaten to the extreme due to a temporary headwind. At the moment, there are some off-shore drillers and oilfield service companies that possess strong balance sheets and great managements but have been sold off to the extreme due to the sell-off of their entire sector. Investors should realize that oil is very cyclical in nature and hence it will not remain for many years at its current level, which is half of the level that prevailed in the last 4 years. To be sure, the number of oil rigs has consistently decreased in the last 10 weeks, reaching the level of March-2010, and will keep declining if oil remains pressured. Moreover, all oil companies have significantly curtailed their capital expenses for future growth, which will ultimately result in lower production levels in the future. Thus it is a question of time before oil returns to a more reasonable range, which will render more rigs profitable than the current price does. The table below includes some stocks with strong earnings and low amounts of debt, which will strongly recover when oil returns to a more reasonable level, around $70-$80. The table depicts the decline of these stocks off their peak in the summer, the upside from their current price to their peak and the upside from their current price to half way till their peak, which will correspond to an oil price within $70-$80. NOV HAL ESV NOV Decline off peak 41% 42% 46% 40% Upside to peak 69% 72% 85% 67% Upside if oil rises to $70-$80 35% 36% 43% 33% P/E TTM 9 11 5 6 Given the extremely low P/E of Ensco (NYSE: ESV ), its low debt and its high dividend yield (10%), it is the stock with the greatest upside potential if oil rises to $70-$80. Noble Energy (NYSE: NE ) has a very low current P/E but its forward P/E is higher, around 9, while the company also carries a much higher relative amount of net debt ($7 B) than Ensco, standing at about 9 years’ earnings. National Oilwell Varco (NYSE: NOV ) has a low P/E and high backlog, which can fully protect its profitability for at least one more year, while its balance sheet is essentially debt-free, as its net debt ($2 B) is worth only one year’s earnings. Halliburton (NYSE: HAL ) has a low P/E but its earnings are expected to plunge almost 50% this year so it is a riskier choice. To sum up, investors should always look for stocks that have strong fundamentals but have been punished due to a temporary headwind, thus possessing great upside potential. As the market always overreacts to headwinds and any factor of uncertainty, it is only natural that asymmetric reward to risk shows up whenever an unforeseen headwind emerges. Of course this does not mean that an entire portfolio should consist of such stocks, particularly in the case of defensive investors. Nevertheless, when a stock of a portfolio reaches an overvalued level that leaves very limited further upside, it is prudent for investors to exchange that stock with another one as shown above so that their portfolio maintains high dynamic energy. Disclosure: The author is long ESV, NOV. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Beware Of Industries About To Be Upended

Ratios are great, but incomplete. To be a great investor, you have to predict the future. But remember your predictions will be imperfect. I’m an analyst at heart, so I love metrics and ratios and data visualizations that show how one investment will work and another will not. When I scour Google finance for the next big idea, I look for low price/book ratios, or low P/E ratios, or high dividend yields. But before you get caught up in all the numbers, think about this from an article on BBC News : “The average lifespan of a company listed in the S&P 500 index of leading US companies has decreased by more than 50 years in the last century, from 67 years in the 1920s to just 15 years today, according to Professor Richard Foster from Yale University.” This information should terrify you, or at least make you think twice about stocks you think of as being “value” investments. It means that our conception of value isn’t just looking for “cheap” but rather do as Warren Buffett does: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” What does this mean? Let’s take two companies: Intel (NASDAQ: INTC ) & Coca-Cola (NYSE: KO ). Which is more over (under) valued? Based purely on an analysis of the most-used ratios: Forward P/E ratio: INTC: 13.5 KO: 19.6 Price to cash flow: INTC: 9.0 KO: 17.9 Price to book: INTC: 3.1 KO: 5.7 By every valuation metric, Intel is cheaper than Coca-Cola. If you treated each stock as a bond, you’d earn 11% in cash on Intel vs. only 5.6% on Coca-Cola. Plus, Intel is a tech stock (ignore recent problems in personal computers). Technology has higher growth rates, so that 11% will likely be far more than Coca-Cola’s 5.6% in 10 years, right? Of course I primed you, so you know that logic is faulty. If I imagine a world 20 or 30 years from now, I can still see myself sipping a Coke Zero (or Coke 100 or some Coke brand). There’s not much that can replace my physical and mental relationship with the Coca-Cola brand. Could someone come up with a better formula? Maybe. Could they market it better? Perhaps. Could they secure my loyalty. Could happen. What about incorporating an addictive drug in their drink? Yeah, sure. What about all of the above? Not bloody likely. Because of the amount of change in the technology landscape within my lifetime, I can easily imagine a world without Intel in 20 years (maybe even 10). That doesn’t mean Intel will go away. In fact, Intel may be a good buy, but there’s an added risk. I don’t have the same relationship with my computer chips that I have with Coke. If the processing is fast, and I can do it anywhere, and it’s not crazy expensive, I don’t care if it’s Intel or AMD or the next new thing. Project this outward. If I want to know the total value/price of Coca-Cola vs. the total value/price of Intel, I should take the current market cap of each, the return in cash flow on each compared with the total future cash flows due to me as an owner over the lifetime of the company (discounted by inflation year over year). Intel $176.2 billion market cap $10 billion free cash flow Expected lifetime? 15 years (this is a wild guess, by the way) Coca-Cola $189.7 billion market cap $8 billion free cash flow Expected lifetime? 50 years (again, a wild guess) Ignoring the discount rate (because cash flows will likely grow), we get a rough return from Intel of -15% vs. a rough return of 111% for Coca-Cola. Notice how the least knowable bit of information becomes the most important. This is the essence of Buffett’s philosophy for not getting stuck in value traps. As an analyst, I like to have perfect data. I’m tempted to ignore imperfect data because they’re based on a hunch or a guess or something completely unknowable. But a stock investment is a bet on the future. You cannot ignore the most important piece of information just because it’s imperfect. It’s better to conduct a valid analysis on imperfect data than an irrelevant analysis on perfect data. So if you buy a company based on a ratio, take a little time to think about whether that company would have existed 50 years ago, and will still exist 50 years from today. Disclosure: The author is long KO. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Investing Lessons And Portfolio Update

Never go “all-in”, no matter how tempting it may be. Many forex traders got wiped out by using too much leverage trading the Swiss franc last week. “Protect the downside” and “regular re-balancing” have kept my portfolio from big drawdowns and losses. We have added multiple equity positions and precious metal positions to our 1% income portfolio. First thing, let’s go through what happened with the Swiss franc last Friday. The currency’s value had been pegged to the euro since 2011. The pegged price was “1.2:1”, which meant 1.2 Swiss francs bought you 1 euro. Last Friday, the Swiss National Bank announced that it was going to break the peg and allow its currency to trade freely. The franc rallied strongly on the news, and at one point last Friday, the franc was worth 0.85 euro cents, before finishing at practically parity with the euro. The Swiss stock markets fell sharply, but when you factored in the added strength of the franc, the losses in real terms were much less than reported. So why did the Swiss bank announce such a measure? Well, I believe there could be 2 answers. Firstly, the franc has lost a lot of purchasing power since the middle of last year, as the dollar has made massive gains against the euro. Also, secondly, is the Swiss central bank sniffing our quantitative easing in the near future by the European central bank? If QE gets the go-ahead in Europe, then all currencies that are pegged to the euro will also have to undergo devaluation. However, the Swiss franc is seen as a safe haven internationally, so it would have definitely lost its prestige if the currency continued its devaluation against other currencies such as the dollar. The Swiss economy may hurt for a while, but the right decision was made, in my opinion. The purchasing power of the franc has been prioritised, and this is excellent news for its citizens. So what’s the lesson to be learned here? Well, many currency traders got their portfolios wiped out because of last Friday’s action. An investor or trader can never go “all-in”, no matter how tempting the investment or trade may be. I spoke about this in one of my previous articles . Greed can destroy a portfolio overnight, if it is allowed to. The dollar has been rallying strongly since the middle of last year. Moreover, many currency traders thought that the impending QE in Europe would strengthen the dollar even more against the euro and the Swiss franc. Some shorted the Swiss franc en masse in the hope of making a killing. Unfortunately, all that was “killed” was their portfolios. Re-balancing your portfolio is one of the best techniques out there for controlling greed and keeping your portfolio fresh. If you are holding US stocks, the US dollar or US bonds in your portfolio, I would recommend that you rebalance your portfolio. These 3 sectors have risen a lot in the last 12-18 months. Smart investors would take some money off the table in these sectors and deploy extra capital in more depressed sectors. I am not advocating withdrawing all your capital from these sectors, as there may be many more months of upside, but now may be the time to lighten up instead of doubling down. We are living in volatile times, where any move by a country or central bank could have devastating effects on your portfolio if it is not set up correctly. I say all of the above because the sentiment on the US dollar at the moment is extremely bullish. Everyone expects the dollar rally to continue (and it may very well continue) as Europe tries to get a grip on deflation. Nevertheless, surprises can happen in any market, as we witnessed last week. Could China, for example, break its currency’s peg against the US dollar? Many would say this is highly improbable, as China owns huge amounts of dollar reserves. What if the US announced QE4 in the coming months? Would the Chinese let their currency weaken alongside the dollar? These scenarios may never happen, but position sizing and diversification in your portfolio would protect you from all possible outcomes. Another valuable lesson in investing which ties in well with my last point is “protecting the downside”. Professional investors are far more concerned with the downside (risk) than the upside. Losing money is not an option for them. So let’s look at what an investor can do when he or she is sitting on some nice profits. Let’s take a look at the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), for example. This ETF has gained 80% over the last 5 years, which is a fantastic return for an ETF. How do we protect the downside? (click to enlarge) 1. We take some money off the table and deploy it into a depressed sector, such as the gold mining sector. 2. We buy a put option (like insurance). If the ETF drops, our put option will go up in value. The net result is that we will lose less if the market falls sharply. If the market continues to rise, we will only lose what we paid for the put option. 3. We place a stop loss under the present price of the ETF (the 200-day moving average is used often by professionals). The problem with a stop loss is that it is less effective when there is volatility in the market (violent swings both ways). Protecting the downside and rebalancing my portfolio every once in a while has not only protected my portfolio, but also has grown it. Finally, we added many positions to our 1% portfolio last Thursday and Friday (see screenshot below). We now have in the region of $130k invested in stocks, but will not be investing more into this asset class for the moment, as we feel other asset classes can give us higher returns going forward (rebalancing). We will fill up our Precious Metals & Commodities asset classes with the full $180k each soon enough, as we have unearthed depressed companies in these sectors and low-cost indexes. Stay tuned. (click to enlarge) Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.