For What It's Worth

Analyst Jeremy Grantham recently anaylzed stock market history and he divided it according to how cheap or expensive stocks were at the time - and then looked to see what happened next. Since 1929, if you bought stocks at times when they were among the cheapest 20% in terms of P/E ratios, you would have earned an average return of 10.6% over the following ten years. If you had purchased them when they were at their most expensive - the top 20% in terms of P/E ratios - you would have earned only 0.6% per year during the following 10 years.

Where are stocks now? In the most expensive quintile. So what can investors reasonably expect? If history and theory are any guide, they can look forward to less than a 1% annual rate of return. So the question every investor should be asking him or herself is this one: "Why would any forward thinking investor buy stocks under these conditions? And the answer of course is, he or she wouldn't!

Which goes to show how little investors actually think at all. Let's look at the facts: The Dow is at an all-time high; the Federal deficit came in lower than expected; and even housing starts showed new energy. So what's not to like?

Even though the Dow is setting records, investors' real returns are still negative. Inflation has taken nearly 20% off of nominal gains over the past six years. And the returns on gold have been much worse during the same period. So measured in gold, the typical stock market investor has lost more than half his/her money since 1999.

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Food For Thought

Henry David Thoreau taught us this: "Life is frittered away by detail, so we should simplify!" And likewise, fortunes are frittered away by complexity. Therefore, in order to be a more successful investor, you must simplify your approach to investing. And the best way to do that is by buying plain old stocks and bonds or the no-load funds that own them.

If you pick up 1,000 shares of General Electric (GE) or $50,000 worth of a Treasury bond, you can be highly confident that you are paying a fair price. But not confident that you will make money. Anything that is capable of providing a worthwhile gain is also capable of going down. But when you buy GE or the T-bond, you are buying on the same terms as Warren Buffett.

Acquire a wide enough assortment of securities over a long enough stretch of time and you should do just fine. You could even make your selections with a dart board and probably retire in better style than someone who buys complicated things. And your life will not be frittered away reading prospectuses!

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Hopscotching The Investment Media

We read in Kiplinger's Personal Finance that closed-end bond funds offer several advantages over regular bond funds. They may borrow money at short-term rates to invest in long-term securities. That adds risks but it usually pumps up a fund's income. Closed-end funds may trade at a discount to net asset value (NAV), effectively raising the yield to investors who buy at the right time. In addition, closed-end managers do not have to hold low-yield cash to meet redemptions, so they can invest all their money in higher-yielding bonds. Today, some closed-end muni funds yield over 5%, tax exempt, while taxable closed-ends yield as much as 8%.
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Forbes magazine reports that supply and demand might push oil prices down and result in $1.95-per-gallon in 2007. The recent four-year surge in oil prices has been due largely to one-time transient events from Venezuela to Iraq to China to Nigeria to hurricanes in the U.S.. During the price run-up, industry spending on exploration soared and new oil is now coming from many places around the world, from Argentina to the U.K.. On the demand side, growth has moderated because of higher oil prices and economic slowdowns. The increasing dividend payouts by ExxonMobil and BP indicate that they see less profit in exploration because prices will be falling.
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In Business Week, it talks about how investors are discovering innovative ways to use exchange-traded funds (ETFs). If you are concerned about falling real estate prices, for example, you might sell short the iShares Dow Jones U.S. Home Construction ETF. You'd make a profit if those shares were to fall in a weak housing market. In another tactic, suppose you are planning a trip to Italy next summer but think the dollar will fall against the euro in the interim. You might invest in the Euro Currency Trust ETF, which effectively lets you buy euros at today's prices.
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Smart Money magazine mentions that large companies often use spin-offs to shine light on an attractive piece of the business that's getting lost in the big picture. Typically, shareholders of the parent company are given shares of the spin-off as a dividend. Over the long haul, spin-offs generally perform well because the leaner structure of the newly formed company usually means more efficient management. Also, spin-offs can be under appreciated because professional investors need to sell shares that don't fit into their overall portfolio strategy.

It should be noted that a study of 25 years' worth of spin-offs found that shares of the new companies outperformed the market by 33% during their first three years of independence.
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Thoughts of Chairman Buffett

ON HOW TO VIEW STOCKS


"Look at stocks as businesses, look for businesses you understand, run by people you trust and are comfortable with, and leave them alone for a long time."

-Warren Buffett


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The Basics of REITs

I recently heard some very favorable comments concerning REITs as an investment and feel that we should review the most important facts to be aware of concerning this type of investment.

First and foremost, a REIT is a stock, pure and simple. REITs trade on stock exchanges just like all stocks. However, they differ in that they own virtually nothing but real estate. They also differ in how they are taxed.

For most corporations, every dollar of net earnings is taxed 34 cents, leaving 66 cents of potential dividends for the shareholders. One advantage of REITs is that they are given a pass on the corporate tax if they meet certain guidelines on the percentage of company assets made up of real estate, and the percentage of total income that is paid as dividends to the shareholders.

The net result of all this is that REITs pay lots and lots of cash relative to their typical stock cousin. And because they own real estate they have tenants. And because they have tenants, they raise the rents of said tenants and they then raise their dividends to the owners. This is a remarkably simple "food chain" - with the REIT holder on top!

Now REITs come in six main classifications. The broadest are equity REITs, where the company buys, manages, and eventually re-sells actual property. The second major type is a mortgage REIT, where the company is a glorified bank. As a rule of thumb, the equity REIT will provide you with more future growth and some income, while the mortgage REIT will provide you with more current income and some growth.

The next two classifications you need to know are geographic and industrial. Both of these are pretty much self-explanatory; you can get a California REIT, or a Florida REIT, a Southwestern U.S. or even a Washington, D.C. REIT. Industry classifications will fall into office building REITs, mall REITs, hotel REITs and even nursing home REITs. Geographic REITs and industrial REITs also can be equity or mortgage combos.

The last two classifications aren't really as much classifications as they are "packaging." A hybrid REIT invests in two or more classifications - typically part equity and part mortgage. A PREIT (a finite REIT) is simply a REIT that has a predetermined ending date. It could be five, ten, or twenty years. Like all the others, they too can be equity, income, geographic, or whatever.

Now before you run off to buy 100 shares of XYZ REIT, you need to consider the risks. First of all, stocks will be stocks. They go up and down. And occasionally out. So always stick with class when it comes to REITs.

Next, REITs, like real estate in general, are long-term investments. Speculators are not welcome.

Third and last of all, if you are thinking of investing in REITs, do your homework. Visit the library. Call your broker. Get some annual reports and most important, diversify. Spread your eggs around. Start with a couple of REITs, and add to them regularly.

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Words To The Wise

Nothing is ever accomplished by committee unless it consists of three members, one of whom happens to be sick, and the other absent.

-Hendrik Van Loon

The Game of Crisis Investing

You can hardly ever open a newspaper or catch the news on radio or TV without hearing about the latest crisis. So no matter what the latest dilemma may be, if we are to come out ahead of all our current crises and all of our future crises investment-wise, we need a game plan - a game plan that will see us through the upcoming trials we are guaranteed to face.

Like any game, we first have to know the strategy of the game and its rules.

The Strategy: Watch for and capitalize on the constant but varying crises of the future by buying when others are panicking, and selling when others are greedily buying.

The Rules: Just because your neighbor panics doesn't mean you have to. There's an old saying in investments: "Bulls make money, and bears make money, but pigs and sheep get eaten." When the markets go down it is not necessarily a signal of disaster. It can simply be a signsl that the "Sunday drivers" are out - not the professionals.

Remember...for every stock sold in "panic" someone else bought that very same stock!

A good rule to follow is always diversify. By this I mean more than just between stocks and bonds. Rather than investing and gambling on one stock in one industry, buy the whole industry. You can do this easily with ETFs.

Learn the "ins and outs" of dollar-cost-averaging. This strategy says simply that when an investment you own goes down in value, especially through no fault of its own (such as a political crisis) take a re-look at it. If it's still a solid stock, industry or country, then add to your portfolio and thereby reduce your average cost. Then the shares won't have to go back to where you bought them for you to break even or make a profit.

There's an old saying that makes good sense: "To be master, you must learn what the masters do - then do what the masters have learned." This means you learn the whats and whys of how institutions and "insiders" invest. The institutions can be tracked through Standard & Poor's and Value-Line, both of which you can find in any good library.

Monitoring insider trading activity can be easily learned by reading, "Investing In and Profiting from Legal Insider Transactions, by Edwin A Buck, and published by the New York Institute of Finance.

A good Rule of Thumb to follow: Don't invest in any stock without first knowing what the institutions and the company's insiders are doing with respect to the stock in question. All things being equal, when they buy, you buy; when they sell, you sell. Simple enough?

You may also want to set up a tracking system of current top industries and be a "grave watcher" so to speak, because sooner or later, they all get a black eye.

You can count on the fact that there will always be some crisis or another. The only difference among these is how we react. We can freeze up and wait for "it" to clear up - only to see a new crisis in the headlines predicting still gloomier doom!

So forget about waiting for a perfect investment at the perfect price and at the perfect time - because it's not going to come! Instead, all you need is a game plan that will allow you to decide in advance what you will do during the crisis. It can be likened to emergency services - our police, doctors, and firefighters all know what emergency actions to take before the emergency. They're prepared, and so should you be!

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