Wednesday, July 25, 2007

Holy cow batman

On a whim I just logged into Google AdSense and saw that I have actually made some money -- 36 cents! I'm not being sarcastic when I say that I never expected to make that much money with this blog.

The reason I put an ad on my blog was that I was intensely curious what sorts of ads would be shown. At first it was stuff like "Hot penny stocks!" and "This stock is poised to EXPLODE!" and I was rather disappointed. But the other day I saw an ad for a report on Warren Buffet's portfolio. Now we're talking.

Tuesday, July 24, 2007

Rough day in the market

I have to be honest and admit something: I would be perfectly okay with a market crash right about now. Since I only have a small amount of money invested, it wouldn't really have much of an impact on me, but it would be a great chance to get in low with my next few contributions. I would be sad that I can't put more into my IRA, but at least I have some of that in the AGG bond fund (for that very reason).

AAV has been down fairly significantly in the last few weeks and it fell about 5% more just today! That doesn't bother me because I'm still making a good return on it. When I get my next paycheck I'll pick up a few more shares.

I still think that, long term, AAV is a good investment. Canada is obviously going to play a bigger and bigger role in the world supply of oil and natural gas (for America in particular). AAV gets about 1/3 of their production from oil and the rest from natural gas. As it turns out, natural gas plays an important role in the extraction process of oil from Canada's oil sands, so it seems pretty safe to assume that demand for natural gas in Canada itself is going to go up dramatically in the next decade. Unless they decide to build some nuclear reactors to provide heat for the extraction process... but doesn't it take like 20 years to build a new plant anyway?

Well, I don't think the market is about to crash. Hopefully I'm not jinxing it!

Friday, July 20, 2007

Evaluating stocks to buy

In the past few months I've been making two kinds of purchases: very long-term, and mid-term. As such, I've got two ways to evaluate which stocks to buy.

Very long-term

For very long-term buys, like the kind that I honestly don't plan on selling for 40 years or more (if ever), the first thing to decide is what industry to invest in. This depends mostly on what I think is going to happen in the world over the next 20 years or so. Here are a few of my speculations (some of which are pretty obvious):

  • BRIC (Brazil, Russia, India, China) is going to grow. A lot. And a lot of it is going to be growth in infrastructure, simply because they are relatively undeveloped.

  • The dollar is going to start recovering.

  • Chinese stocks are going to fall significantly sometime in the next few years, at which point they will make great investments.

Those are the three I feel pretty sure about. The first one has made me interested in infrastructure companies like GE and ABB. Before I graduated, I had an internship at ABB and was struck by an anecdote told by the vice president of R&D during a meeting. He said they weren't doing too well in India because their equipment was too expensive and complicated. The Chinese, on the other hand, absolutely loved how complex it was and bought it like crazy. I can totally picture that.

Anyway, the second point makes me kind of sad. I want to invest in overseas companies (like ABB) but if the dollar begins recovering, that will eat into my returns. So I want to focus mostly on American companies that do no more than half of their business overseas.

The third point has an obvious strategy -- wait until Chinese stocks fall (if they ever do) and then buy the nice ones.

Aside from those strategies, I currently am a big subscriber to the dividend growth theory: Companies that have a history of paying dividends and consistently increasing those dividends make great long term investments. This is a pretty well-researched area and I feel pretty confident in it. One source of ideas for such companies is Standard & Poor's "Dividend Aristocrat" list. Or you can just think of big companies that have been around for 100+ years and you'll pretty much be right on track.

Only when I've narrowed down my list to a few companies (that match the criteria above) do I start looking at the financial details. The first thing to look at, of course, is the stock chart. You can get a quick overview of how the market has "liked" the company over the past 5 to 10 years. Sudden drops or spikes always require investigation, but the best thing (to me) is a relatively flat graph. To me, a successful company whose stock price isn't going up is like a spring gathering potential energy. Eventually, it will make up those flat years with strong growth years.

The metric associated with this, of course, is the P/E ratio. If earnings have been growing and the price has stayed flat, the P/E ratio will decrease. Companies with P/E ratios below that of their peers, and below their own historical P/E ratio average, are definitely something to look into.

While normally I agree that timing the market is very difficult, I think this strategy is pretty realistic. Since there are so many good companies to invest in, the chances of a few of them being in one of these lull states is fairly good. I think of it as an opportunity to time-travel back a few years and invest. If a company is trading in the same range it was 5 years ago, investing today is equivalent to investing back then.

This option is primarily for new investors, like me, because half the risk of market timing is selling too early. In other words, if you start thinking "Oh GE isn't going to move for the next 5 years, I better sell" then you have a good chance of missing out. Only a new investor can look at the chart and say "Heh I'm glad my money hasn't been sitting idle for 5 years." But since investors typically add new money into their positions periodically, you can still look out for the same things. It's just not as comprehensive since this plan doesn't speak to your existing investments.


The other evaluation method is for mid-term investments. These, to me, are investments that you want to hold for an unknown amount of time, but typically less than a year. I see them more as price goal investments. The main source of these ideas comes from reading about sudden drops in stock prices. Earnings misses, natural disasters, war, anything can cause them. Your job is to do some research and guess at how much of the price drop is legitimate versus investor overreaction. I feel like most sudden drops in otherwise good companies are overreactions and the price will recover in the short term.

For instance, look at Duke Energy. They seem to have been affected by two things in the past few months. First, the recent interest rate hikes, which (I've read) send utility stocks down because of competition with their dividends. Apparently a lot of people invest in utilities for the dividend with the bonus of slow growth, which will probably out-perform bonds. When interest rates go up, people ditch the utilities and go to bonds. Sounds crazy to me but I believe it.

Second, Duke Energy wants to build new plants. Nuclear plants. Investors seem rather terrified of this idea -- whenever news comes out of some environmental group trying to stop them, the stock price goes up a bit. When more news comes out that they were unsuccessful, I think it's fair to say the price plummets a bit. Even Duke Energy's requests for rate hikes don't allay investors fears. I guess it's somewhat sensible for short-term thinkers, given that interest rates may be going up and Duke Energy is going to acquire lots of debt in the next 10 years... but still. Utilities have to expand eventually or what good are they?

I see both of those things as overreactions. I think that when all is said and done, new plants (not just nuclear but natural gas and coal) will give Duke Energy more customers, more revenue, and more profit. Then their price will go up. It's currently hovering around $18, down from $21 earlier in the year. The price drop has pushed up their dividend yield to almost 5%, and I suspect the price will recover as they A) keep raising their dividend and B) get some sweet incentives from the government. Anyway, that's what I hope will happen. :)

Wednesday, July 11, 2007

New stock in my IRA

After writing that last post I decided to invest some of the cash that was just sitting around in my IRA. I added a bit to my GE position and then added Johnson & Johnson (JNJ).

I've been looking for another nice dividend investment for the last few weeks and there are an absolute TON to choose from. Some of the ones I looked at are Proctor & Gamble (PG), Colgate-Palmolive (CL), Pfizer (PFE), and Bank of America (BAC). All of them are nice, big, safe companies with good dividends, dividend growth, earnings growth, etc. Perfect for an initial investment in an IRA, to give it an anchor. I really wanted to invest in BAC but I don't like investing in financial companies. I feel like the economy (in the US and Europe) is too heavily weighted towards financials. When you look at the breakdown of the S&P 500, it's 21% financial services! That's almost twice as much as any other category.

Service economies are one thing (which I also don't really like) but financial services must be just about the worst kind. Is it sustainable if a quarter of your economy is just handling money for the other 75%?

The iShares Dividend Select Fund (DVY), which is a great fund, is over 40% financial services. These companies pay great dividends. I'll probably be adding it to my IRA at some point and that will give me plenty of exposure to financials.

Anyway, I could go on, but I won't. Any of the choices would have been good, but I chose JNJ because I wanted to get some health care exposure and I don't trust Pfizer.

Now I will be patient and not touch my IRA until January, 2008. Unless something bad happens or I see a reeeeally good deal in another company.

Gotta love free dividend reinvestments

Yesterday I noticed my first free dividend reinvestment in my TD Ameritrade IRA. My $2.10 dividend from AGG was converted to 0.021 shares and added to my position. Nice! I was surprised that the dividend was so much, considering I have less than $500 in it. If it keeps up, I'll get about 5.14% per year. Not too bad for a low risk investment. Of course, I'll lose almost all of the interest when I sell it. I'm going to really miss the introductory free trading period when it's over! Maybe by the time I need to pay commissions I'll transfer this account to Zecco.

I was thinking about an asset allocation strategy and I realized two things. First, I probably don't need to worry about it until I have a lot more money in the market. Second, I bet the performance of the strategy depends more on the length of time between re-balancing than anything else. Most of the things I've read say to pick a time period of half a year to a year. It makes sense to use a longish time period because if you re-balance too often you miss out on big moves in price.

For instance, say I have a huge $100k portfolio with 10% in bonds and 90% in stock. Every month for a year the stock goes down 5%, so after 1 year I've got 0.95^12 = 0.54, or 54% of my original investment in stocks (I lost 46%). We'll assume we have no dividends and that the bonds haven't changed. I don't know how realistic that is, because I've heard bonds usually go up if the stock market goes down a lot. Anyway, that leaves $10k bonds + $48k stock. Now the allocation is 20% bonds, 80% stock. Time to re-balance! So I sell $5k of bonds and put that money into my stocks.

Now in a few years, who knows how long, the stocks slowly climb back up to their original position. Maybe they went down even more in the meantime, or bounced around a lot, but we can assume that eventually they get back up there. We still have $5k in bonds, but how much stock do we have? Well at this price level we used to have $90k in stocks, but we added 5/48 = 10.4% to our position while it was low. So now we have $90k * 1.104 = $99k! Yay. This is why asset allocation is good. It forces you to buy low and sell high (we had to sell bonds and buy stocks while they were low to get them back into proportion).

If we had re-balanced too quickly and too often, we would have had a smaller overall return, because the money we took out of bonds would have fallen along with the original stocks. But if the downturn had been shorter, say only 6 months, we would have missed out on the low stock prices. What to do?

I guess the best solution is to ignore time-spans and establish numeric rules for re-balancing. For instance, rather than say you have a 10% bond allocation, you could say you have 5% to 20% bonds with a 10% target (so the limits are half and double, not a fixed number either direction). You only re-balance your bonds if they fall under 5% or rise to over 20% of your portfolio. If it happens in 2 months you do it then. If it takes 2 years, you wait until then.

That range might be too big since basically your stocks would have to fall by half or double to get out of balance. Maybe 7% to 14% would be better? I don't know. It's definitely an art, not a science.