Mar 11

Getting Stock Tips From Your Bartender

The stock market moves cyclically.  The market rises and falls with the business cycles and cannot be simply timed by getting in or getting out by a calendar.  Business cycles can last anywhere from a few years to a decade or more.

Successful investors pay close attention to the cycles and adjust their holdings accordingly.  For example, when the business cycle is at a low point investors will start moving into industrial stocks as they will provide the most upside an a recovery.  Conversely, when the business cycle is flying high investors will start taking profits and will start building positions in more defensive stocks or even move out of the stock market and into bonds or cash.

Look around.  Where are we now?  This is not rocket science and is very obvious.  How is business doing?  How is the market?  It looks like business is slowly recovering here in early 2011, but the market as a whole has jumped up drastically since its lows of 2009.  I am making these observations by simply watching Squawk Box on CNBC every morning, reading a myriad of articles from The Wall Street Journal to CNN Money and all bloggers I can get my eyes on and a few earnings calls I listened in on with my largest holdings.  What is most important is knowing not just where we are, but where we are going from here.

When I am worried about a market that feels “toppy” (a very high-brow investing term), I go have a drink.  No, the cocktail doesn’t clear my mind so that I can see into the future.  I am actually doing investment research.  I am trying to see if the bartender will offer up any great stock tips.

Although they are wise, I know bartenders aren’t usually known for their investing prowess necessarily.  In fact they will not even know how valuable their stock tips are.  I want to know “who” is in interested in the market.  If bartenders, retail sales people, my barber or any other “retail investors” (non-professional investors) are excited enough about the market and I can see dollar signs protruding from their eyes as they run off a list of “sure thing” stocks – the bull market is dead.

After I gladly accept all the stock picks from my informant, I will check some economic indicators to see how much time I have.  Because the stock market and the business cycle don’t move at exactly the same time, I can watch for a hint of bad news to come out.  Then more bad news.  Then more bad than good.  All those retail investors will freak out and sell – starting the market on its inevitable bear run.

The stock market is a leading indicator of the business cycle.  In 2011 the stock market seems to be leading the business cycle greatly.  Even though the market may be over-valued as a whole, we are on the right side of the business cycle to be in stocks.  On a side note, with interest rates near zero and being on the recovery side of the business cycle, bonds are a bad place to be.  You have to pay attention to everything going on around you to invest successfully.  By the way, when I asked the bartender for his recommendations, he said he feels like I should put everything in a gin and tonic… so our portfolios are good.


Feb 11

Invest Successfully by Being a Contrarian

Knowing things that other investors do not will set you apart from the pack of investors. This knowledge can also unlock immense wealth in the stock markets and even in other areas of investment. The easy way to receive this knowledge is to cheat. Having insider information is the sure bet to beat the markets – it’s also the sure bet to land you in the slammer. Fortunately for those of us who wish to live life on the straight and narrow there are other legal methods to gain insight into the future.

Learning to properly analyze a stock and a company will set you ahead of only those people that are not professionals. Any student of investing – whether formally trained or informally trained – will know at least as much as you do and the smartest guys will know more. One will argue that assumptions play a major role in the outcome of one’s analysis, but this is an argument that will continue indefinitely. Every analyst will come to a different conclusion – this is one point I would bet on.

Listening to the earnings release calls and reading annual reports are also well known and pretty much standard methods of gaining information on your company and therefore your stock. Again, every analyst will hear the exact same information as you hear it. Trading on publically available information is not going to cut it. I don’t care how fast you can get your order in after a merger breaks on CNBC; you aren’t going to get it in. Believe me I have done it and I have given up on trying. If news hits the wire, it’s too late to trade on it. You have to know what’s going to happen before it happens. You have to see the future. Sound possible? It is.

I prefer to shift holdings around based on what everyone else is doing. As everyone and their mothers were selling everything in 2008 and 2009, I was borrowing money to buy more. It made me sick every day, but I knew that there were stocks on sale and they would bottom out at some point. Being sick to your stomach is part of being a contrarian. When you flip through every single channel and hear about the pending end of the financial world and even your grandmother tells you its time to sell everything. When the four horsemen of the apocalypse are circling your brokerage account and all you want to do is take your remaining cash and curl up with it in the fetal position on your floor. It will make you slightly sick to your stomach to buy. As a contrarian, this is just part of the game.

Being a contrarian works both ways. John Paulson of Paulson & Co. famously shorted the mortgage backed securities (MBS) markets when everyone knew he was crazy. Essentially, Paulson bet that the U.S. housing market was in a bubble and it would burst – something unprecedented in U.S. history. The benefit of hindsight shows us how prophetic Paulson was. As people took out 100% plus mortgages on properties they could not afford, Paulson was a contrarian and bet the opposite.

I am sure Paulson was sick with every news story of the booming housing market hit the air, just as I was buying long positions in stocks that I had just heard were going bust along with the rest of the market. That’s just part of the fun. Spotting bubbles and acting with conviction takes foresight and a strong stomach, but this is a great way to beat the market. Buying stocks when the four horsemen of the apocalypse were the only guys whispering in my ear what a great choice I am making made me sick also, but two years later, those positions are up over 100%. Moral of the story is keep plenty of cash in your portfolio that you can use to buy more stock during a crash.

Pay attention to what “everyone” is doing. Be a contrarian. Make yourself some money!  



Feb 11

How to Develop a High-Speed Rail Plan

In his first act as governor of Ohio, John Kasich commits political suicide.  Or perhaps not accepting the Federal Government’s $400M check for high-speed rail was he just crazy enough to be considered genius?  Now two more governors are on-board (pun intended) with Kasich essentially validating his sentiments and breathing life back into the Ohio governor’s political life.

The truth is that there has yet to be a compelling argument for the latest passenger rail project in the US – at least not in Ohio, Wisconsin or Florida. I am personally excited about the idea of hopping on a train and hopping off wherever I want to go. I have taken the Amtrak and Acela trains up and down the east coast many times – and it is absolutely wonderful! No airport security. No desolate drives to an airport far away from the city. I would jump in the middle of DC and jump of in the middle of Manhattan. It comes down to the numbers.

The numbers work on the east coast. The rail lines up and down the east coast are much faster than flying or driving. Figure in traffic and ridiculous security delays at all the airports; it is not inconceivable for a 50 minute flight to take a good 4 hours. You can take the regular Amtrak trains in just over 3 hours. If you opted for the Acela Express, your trip would be under 3 hours – all for less expense than flying. The rail lines are faster and cheaper than their main competitor on the east coast – flying.

The numbers don’t work in Ohio. The proposed rail lines would be much slower than just driving between Cleveland and Columbus for example. Once you figure in the time spent driving to the train station and parking, the slow speeds of the trains (topping out around 55 mph I believe) and then the cab ride to your destination because the stations are not centrally located you would have almost doubled the time spent had you just driven. In Ohio and Wisconsin the proposed high-speed rail lines would be relegated to shuffling college kids back to school after Thanksgiving – and that will cause the states to subsidize the failing projects.

In Ohio the passenger rail lines need to be faster and comparably priced than driving. A true high-speed rail which traveled over 150 mph would be a huge success and an important investment in the future of our country. Ideally, linking regional hubs such as Cleveland and Indianapolis to International hubs like Chicago and New York via true high-speed rail is much better use of this money – even if the first phase was only able to link Pittsburgh to New York. It’s the quality of the investment and not quantity of rail miles developed.


Feb 11

Value and Share Price

The notion of using value to determine utility is commonplace for all people as they perform their normal daily activities. “I am not paying $6.00 for a cup of coffee” is actually a value-driven decision as much as it is a price-driven decision. I am sure if you dug deeply you could come up with $6.00 – even in a recession. However, you don’t see $6.00 of value in the coffee. In fact, value is the underlying element to all buy or don’t buy decisions we make. Do we find at least enough value in the product to pry our cash out of our hand for the utility derived from the product?


Value is most easily derived through a relative analysis. You might not see $6.00 of value in a cup of coffee at Starbucks, but then you next door to Caribou and the same cup of coffee is offered for $8.00. Now what? The value calculation in your brain is all out of whack. Through relative analysis, the $6.00 cup of coffee all of a sudden seems like it might be a good deal. You now “value” that cup of coffee at $6.00. Of course, this analysis only works when you are dealing with exactly the same product. Commodities are the perfect example of this. I am generalizing that all cups of coffee are exactly the same or a commodity in the example above – I know there are a lot of connoisseurs out there that will take offense.

Now we come to investing. Many times people will mistakenly value shares of stock based on a crude relative analysis using the prices of all shares in the universe. They assume a share of Borders Group is the same as a share of Apple. Borders Group is now trading at $.37/share and Apple is trading at $351.88/share. New investors will want to quickly discern that Borders Group is cheaper than Apple and conclude it to be a better deal. The conclusion could not be further from the truth. In reality, there are no two companies that are exactly the same. All shares are created differently.

As I write this, Borders Group is most likely preparing to file for Chapter 11 bankruptcy protection and being delisted by the New York Stock Exchange for non-compliance with listing standards. Anyone with a few business classes in college knows that there is a pecking order in a bankruptcy and the common shares are the last on that list. Even if Borders Group continues to operate the business the likelihood of an investor in common shares losing 100% of their investment is near 100%. Will Borders Group still be a good deal when you lose everything in the near future?


Apple is on the other end of the spectrum. They have a great product lineup with innovations unmatched in the industry. Apple has so much cash on their balance sheet that putting all that cash to work is very difficult and problematic – albeit a good problem to have! It is safe to assume that Apple is not going to go bankrupt anytime soon and probably not even in our lifetimes (though stranger things have happened.) There is a high probability that you will not lose all of your investment buying Apple shares. This is not to say that you won’t lose money based on the normal fluctuations in business cycles.

Using a relative analysis can still be used to determine relative worth, but price is only part of the equation – literally. The measure most commonly used to measure stocks is called the P/E ratio. The price per share is divided by the earnings per share yielding some number. The lower a stock’s P/E, the cheaper the stock is. There are many nuances that are also in play when comparing two companies based on P/E, but this is most commonly used ratio.   

Comparing companies by P/E within their own industry is most useful as many variables vary between industries. I have prepared a snapshot of the soft drink industry below. These numbers can be found directly in Yahoo! Finance.            

Based on earnings, Pepsi is currently the cheapest stock and should then provide the highest value. Notice that Pepsi is also the stock with the highest share price. This analysis is meant to show that share price is not a determinant of value for a stock. Only when used in concert with another measure, in this case earnings, can you attempt to draw a relationship between stocks in a similar industry.


Feb 11

Battle of the IRAs – Roth Vs. Traditional

For most of my life, I just knew that a Roth IRA was better than a Traditional IRA. It was a given, no work needed to be done on this one. That was until one afternoon during grad school when a professor challenged my belief, so I challenged his and he performed an exercise similar to the one I will work through later.

A Roth IRA is a retirement investment account in which the investor is not permitted by the IRS to deduct contributions to the account. That is to say, that this account is funded entirely with post-tax dollars – money you already earned and paid tax on similar to a savings account. The attribute that always piqued my interest was that you can let this account earn returns for the rest of your life and you never have to pay tax in those earnings. I made it a point to fund my Roth as much as I could (and I still do) because of that great tax benefit in the future. There are income restrictions limiting only people that have a modified adjusted gross income under $105,000 to participate. An investor is also limited to $5,000 per year for either a Roth IRA or a Traditional IRA (or both).

A Traditional IRA permits investors to contribute pre-tax dollars to fund the account. So you can take the amount you invested into the Traditional IRA off of your income for the year in which you contribute the cash – similar to a 401k plan. The investor will then have to pay a tax bill we he/she cashes in the account to retire.

The Exercise

The spreadsheet below details two scenarios with the same given parameters. The given parameters are:

  • A 25% tax rate for the entire 25 years of the exercise.
  • An average 8% return on the investments for the entire 25 years.
  • A steady $1,000 yearly contribution for the Traditional IRA as this is pre-tax.
  • A $750 yearly contribution for the Roth IRA as you need to first pay tax on it.

The Results

As you can see from the bottom line result, given the exact same parameters, you will realize the exact same result from either IRA. A draw. I was shocked at these results even though it made sense when it was all said and done. So what is the point of the Roth IRA anyway? Well, the key to deciding how to pick an IRA comes down to your current tax rate and the expected tax rate in the future.

It Comes Down to Taxes

You do not need to hire a CPA to figure out your current tax rate. You may want to hire a psychic to figure out your future tax rate – and the psychic may even be challenged to predict future congressional actions. Common wisdom may predict that your tax rate in retirement may be less than it is as a working professional. In this case it would be better to pay the tax at that time and at your lower rate – you would pick the Traditional IRA. Others may argue that the government will be raising tax rates to pay for a national debt that is spiraling out of control, underfunded social security and national healthcare system. A subscriber to this logical path should invest in a Roth IRA and pay the taxes now.

This article should be called “the tax rate now vs. the tax rate in the future” instead of “Roth vs. Traditional” because your prediction of the future tax rates should drive this decision. If you asked ten people what they thought, you would get ten different answers. The bottom line is that no one knows what the future holds. Just like all other aspects of investing, it is prudent to not put all your eggs in one basket and instead spread your bets around. I have a Roth IRA and a Traditional IRA. Contributions vary based on other retirement accounts I am contributing to at that time. I try to always be contributing to my Roth and a tax deferred account whether it be a Traditional IRA or a 401k and you should to.