Monday, October 18, 2010

16 October 2010 Guaranteed 5% Return On Your Investment

16 October 2010 Guaranteed 5% Return On Your Investment


16 October 2010 Guaranteed 5% Return On Your Investment

What would say if I offered you a guarantee of a 5% annually (or twice the going yield of the 10 Year Treasury Bond which ever is higher) return on your principal as well as a 100% protection of that principal? What if I told you I could make that offer if you only answer 10 questions on each stock in your portfolio four times a year (immediately after the quarterly earnings report) as long as you had at least 5 stocks in your portfolio?

Well I can’t make that offer. I think it might be illegal and I am not a qualified financial advisor. In fact the information in this blog is worth the cost of the paper it is printed on assuming you don’t print off the blog to read it.

However, if you answer the ten questions I am about to pose, you can make that guarantee to yourself and feel pretty confident you will not owe yourself any money. Here are the 10 questions.

1. How does your company (stock) try to make sales and profit? Explain in three sentences or less.

That wasn’t too painful. If you can’t answer that question or they are not making a profit, you better have some really good answers for the other 9 questions.

2. What is this company doing to increase its shareholder’s yield over the next 12-36 months? Uh oh, you need to know the definition of share holder’s yield. Not too worry. It is an easy definition. It is the difference between what the stock is worth at some future date (including the future price gain or loss and any dividends received) and its current value expressed as a percentage. Here are some examples of what the answers might look like. They have a rising free cash flow (found in the financials) and they are using it to pay down long term debt (found in the balance sheet) and issue or increase a dividend (found in company press releases, SEC filings, or by calling investor relations at the company) and buy back shares (found in company press releases, SEC filings, or by calling investor relations at the company), and they are acquiring a strategic partner (found in company press releases, SEC filings, or by calling investor relations at the company).

3. What is their current (last trailing quarter) price to earnings ratio aka “The Multiple” and what is their forward looking (next fiscals estimated profit per share divided by its current price) multiple. Almost all decent stock websites have this information available on regularly traded equities. If not you have to find at least three analysts who have calculated next years earnings, average the next year earnings and divide them into the current price. Once you have the current and forward looking multiples, compare them to the top three performers in that industry segment.

4. What three things are the bullish followers of the stock saying and what are the three things that the bears of the stock saying. FinViz is invaluable for this exercise as they show a running discourse of news and press releases about the company and there are always both side of the coin represented. Sometimes by the same publication on the same day. You might think some stocks are all bad or all good, like maybe AAPL right now. You don’t have to look too far to find bearish statements about the stock such as they are too US focused and missing out on emerging market growth, or it can’t keep coming out with the next new best thing, or GOOG Android phone is available to a much larger network stifling AAPL’s iPhone growth. (Yes they just announced for sure an agreement with Verizon so you can check that BEAR mark off the list).

5. What is the average tenure of the Chairman, CEO, CFO, and COO at the company and how much of the shares of the company, as a percentage of outstanding shares, do they own? You also might want to know how many shares have they bought or sold over the last three months. All of this information is available on the SEC website.

And look for filings about employee compensation and options. Much of this is disclosed in their 10Q sec filings as well. Knowing how long the executive suite has been at the job and how much “skin” they have in the game helps you determine if they are making decisions on behalf of the shareholder’s or their paycheck.

6. What price did you (or are you, if it is a new position) want to pay for this stock and at what downward price would you end your losses and at what upward price would you consider taking all or part of the profits. (Hey that sounded a lot like three questions. Not really.) You should answer that question as presented before ever buying a stock.

7. What is the difference (up or down) between the current price of the stock and the analysts average target price. This is a real important one because it helps define your margin of safety which in turn defines your margin of risk. Remember analysts get paid and notoriety for accuracy not good news. If ten analysts all say GOOG Google is going to report 6.50 a share earnings and one outlier analyst says 9 dollars a share earnings and the quarterly report comes into at $8.57, that analyst becomes the Ax or analyst in the know. (For further reading hunt down a 2000 article by Adam Lashinsky called “What a Research Analyst Is, (And What IT Is Not). I would cut and paste it for you, but Uncle Jim –Cramer- might not appreciate it. With a little Google action you can find it.

8. How much above 20% is the return on equity of the company? ROE can be found on almost any stock financial website. As a reminder, ROE is an important ratio that tells investors how effectively the management uses the investor’s money and is calculated by dividing annual net income by shareholder’s equity. But again it is a common metric on most websites so you don’t need to do the calculations. The more above 20%, usually (assuming no accounting gimmickry) the better run the company and the better the results. If the ROE is under 20% compare it to its peers or industry averages as it might be in the downward swing of a cyclical adjustment. (Wow that sounded like I know what I was talking about-scary.)

9. What three tools do you use to keep abreast of sudden changes in the fundamentals of the company? They might be stock alerts on your smart phone, subscriptions to industry specific newsletters or websites or industry specific blogs to name a few.

10. Name three reasons why you should continue to hold this stock for three more months?

Ok there you have it. All you have to do is answer those 10 questions about each one of the stocks in your balanced portfolio. (Remember we asked you to have at least 5 stocks because that way you can have a balanced portfolio such as Banking, Oil, Aerospace, Tech and some speculative and put 20% of your portfolio into each sector.) You will notice I did not put a max on how many stocks you can have. Because if you answer all ten questions every three months, you can’t do an effective job on many more than 10 stocks unless you have no job and no life.

Here is how you rate the stocks. If you are only able to answer 1 or 2 questions, get out of the market and take the money and put it on the don’t pass line on the craps table in Las Vegas or your local neighborhood casino. You see the don’t pass line is the best statistical odds for the player in a casino. If you don’t understand statistics, just look at how much real estate the casino provides to the don’t pass players of craps. In a three hundred thousand square foot casino (Think Mirage or Encore) they devote about 11 square feet to the Don’t Pass line. Insider’s tip, if the point is 4 or 10 on the come out take the maximum odds of the house when you are on the don’t pass line. But I digress.

If you are only able or willing to answer 3-5 questions, pat yourself on the back, but you are still sailing without a rudder. Stay in port a while till you get that rudder ready. Don’t buy any stocks if you can’t or don’t want to answer at least 6 or 8 of these questions.

If you can answer 6-8 of these questions and by now you will know what are favorable answers versus unfavorable. Take a disciplined approach to acquiring the stocks. Get in slowly, use limit orders, buy on dips and most importantly, three months form now ask those 10 questions all over again.

If you can answer 8-10 questions favorably, call me immediately. I will have the checkbook ready.

Next time your broker or buddy has a stock tip (Tips are for waiters), for fun ask them these 10 questions. If your broker or financial advisor cannot answer at least 6-8 of these questions, I’d find a new advisor.

Salve Lucrum

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