- Pink Slime, Panics, Taxes, Profits and Pebbles
- The Fashion of Financial Information: Facebook
- Umbrella Insurance Policy – Why You May Need One
- Investment Spotlight
By: Paul Sutherland, CFP ®
Volatility and Panics and Recessions, Oh My!
Volatility, panics, crashes, recessions, lower earnings and sales, taxes, dividend cuts, deficits, debts, currency crises, fraud, greed and management screw-ups are all part of the reality of investing. It’s just like the pink slime in sausage – knowing it’s there can make you opt for a nice, crisp salad. The fact is, with investing there is no such avoidance of the rough-and-tumble world that affects investing. Some advisers, brokers and insurance companies advertise their products by obscuring the messy (i.e., pink slime) part of investing with trusts, mutual funds, selling losers, holding winners and incomplete reporting, and instead just show clients the finished “sausage.” Ultimately, this is a costly way to invest as it reduces transparency, oversight and performance. At FIM Group we do not obscure anything. In fact, most of the feedback we get from our clients is that we over-communicate the “sausage-making” part of a portfolio. As we learned in Investing 101 – Risks can be minimized, avoided, retained and reduced, but they exist; and a portfolio manager’s job is to manage the risks.
Twenty-two of Facebook’s 160-plus page securities IPO filing deal with risk. I would vote that in a fair world they should have an equal amount of pages devoted to rewards. Obviously the $16 billion of investors’ dollars devoted to Facebook on May 12 hoped to benefit from the reward side of the investing equation with their hard-earned cash. Saying “no” to Facebook as FIM Group did was guided by our rigorous risk-management discipline that weighs the risks/rewards and margin of safety in each investment we make. We would love to own Facebook – but only at the right price. The price you pay for an investment is a key attribute to risk management (see Figure 1 on page 2).
Psychology drives prices on the short term around the stock’s real or intrinsic value. Figure 1 illustrates this concept. It is time to sell when optimism is peaking, and it is time to buy when optimism is at the bottom and pessimism is rampant. In Facebook’s case – the sellers of the company are its founders and early investors, so they are selling at a price for personal financial gain. The people who buy Facebook are either optimistic about the company’s future, or are just naïve about value and price. When I was much younger (age 19-20)and selling insurance, I was given a copy of Sell the Sizzle (Not the Steak), a popular book on sales techniques. The main point was that people buy on emotion, so don’t bog them down with details. Facebook’s (and Wall Street’s) new billionaires got rich by naïve investors who felt the sizzle. I do not wish to pick on Facebook, as it is a real, innovative business. In fact, at the right price, we would have bought shares – but we do not like to pay $2 for a $1 worth of goods.
What's Stock Worth?
So how do you value a company? It’s part science and part art. The science looks at the tangible - products, financial ratios, management and the art looks at future prospects and the softer side of the company. Figure 2 demonstrates in a simplified way the stock market math and the tension between what is and what could be. In the last issue of Current Observations we stood in the future together as part of an investment analysis. We will not repeat the entire article except to say: Our job at FIM Group is to “stand in the future” and make sure that we are structuring our client portfolios thoroughly and consistently, and base our research on facts rather than hearsay, emotion or the fad du jour.
Be Early or You're Late
I was recently in Africa and before that in Haiti, and I am writing this from Hawaii. Contrary to my “if you’re early, you’re on time; if you’re on time, you’re late” Midwestern upbringing, all these cultures believe that “if you’re late, you’re on time; if you’re on time, you’re compulsive, overly diligent and a perfectionist.” In the culture of investing it pays to be early both from the risk-management and maximizing-profit points of view. Based on statistical evidence, most investors tend to sell at the bottom and buy at the top, somehow believing that the time to invest is when things are stabilized. As figure 3 illustrates, waiting for things to stabilize, even for six months, can be extremely expensive. As we have said over and over, markets are cyclical and the key to performance is buying when things are priced at bargain levels.
We Will Be Too Early?
John Templeton, the greatest investor of all time (at least I think so), said something along the lines of: Even the best investor is going to be wrong about one-third of the time, but it’s how you handle the onethird that makes the difference. FIM Group does not obscure anything. We send confirmations to clients after investments are bought or sold, as well as monthly reports and appraisals, because we believe that our clients should know what we are doing and how we are investing. Naturally, when a stock or investment sinks to below its purchase price, we look “wrong.” However, one thing we are sure of when we buy is that we are buying an investment at a good value, settled in the knowledge that with patience our analysis will pay off. Whether or not a stock’s value is above or below its purchase price, we have the same three options: 1) We can sell it; 2) We can hold it; or 3) We can buy more of it. If it is a taxable account we can “double up to sell” 31 days later to save taxes while still keeping the investment exposure. If we don’t like an investment because we feel that its fundamental value (not price) has eroded, or we find something we like better, we sell. If we still like the investment but its price has gone down, we can buy more. There is truth in the statement that the “value investor” gets more excited about his investment when the price drops and less excited about his investment when the price increases. When a price drops (all things equal) the patient and disciplined value investor gobbles up more. If we double up and sell we can capture the tax loss on the investment and still retain the benefits of ownership as long as: 1) We buy more; and 2) We sell the original high-price shares at least 31 days after we bought the double-up shares. The advantage here is that we remain exposed to an investment we like and get to share (hopefully) the short-term loss with the government in less taxes. We also use other tax-saving strategies like pushing a long-term gain into the next tax year and swapping an investment for another with similar characteristics to capture the tax loss. Of course we’ve had very tough markets to invest in lately, which allows us to tax manage effectively. And investor psychology is mired in seeing the glass half empty, which creates huge opportunities to buy great investments at great prices. During times like these we like to emphasize three important things: 1) FIM Group looks for investments that should do well regardless of the economy and psychology of the markets; 2) We strive to own investments with good cash yields to generate current income returns; and There is a story about three Arabian horsemen who were riding through the night when a voice from above boomed, “Jump from your horses and fill your pockets with pebbles, and in the morning you can look at the contents of your pockets and you will be both sad and glad.” Full of fear the men did as instructed and rode off. That morning they hesitantly pulled out the contents of their pockets and were glad to find the pebbles had turned to diamonds, rubies and emeralds, but they were sad that their fear prevented them from filling their pockets even more. In investing, it feels like we always wish we owned less of what is going down and a lot more of what is going up. 3) We invest in companies going through buyouts, reorganizations or mergers, or that have characteristics that we feel could cause buyouts or mergers. In times like today, with near zero-percent interest rates on CDs and money markets, patience, maturity and diligence are key in maintaining focus and discipline to make the right investment decisions.
By: Jeff Lokken, CFP®, ChFC
Keeping a clear head and making good financial decisions is difficult, especially with the cloudy financial thoughts and conversations prevalent in what has become a very fast-paced and competitive financial news environment. Financial marketing, as most marketing, has become a race for eyes and ears and eventually our pocketbooks. Consequently, financial marketing plays mostly to emotions, the short term and the sensational. Thus, the daily financial news headlines tantalize us with stories of fear, greed, intraday stock price volatility and bizarre activity
Consider this news headline (that I made up): “Facebook Co-Founder Loses $2 Billion.”
If my calculations are correct, the total value of Mark Zuckerberg’s Facebook stock dropped $2 billion from intraday highs on Friday, May 18, the day of its initial public offering, to noon on Monday, May 21. In only its second day of trading as a publically held company, how could Zuckerberg be so stupid as to lose $2 billion?
Of course, Zuckerberg is not stupid. In fact, all the evidence shows he is quite intelligent. He did, however, lose $2 billion in the value of his Facebook stock in a very short period of time. But like all sensational headlines, deeper analysis quickly reveals how ridiculous this headline reads. In creating Facebook, Zuckerberg and friends created a phenomenally interesting company. For the valuetype investor, Facebook’s $38/share IPO valuation was excessive and overly hyped by news media. Vitaliy Katsenelson, Chief Investment Officer at Investment Management Associates and author of The Little Book of Sideways Markets: How to Make Money in Markets that Go Nowhere (John Wiley and Sons, 2011), perfectly summarized the Facebook scenario in a recent article, “Why Facebook’s IPO Valuation is Insane,” that appeared in Institutional Investor magazine:
“I believe [Facebook’s valuation] is priced for out-of-this-world perfection. The easiest way to assess the insanity of Facebook’s valuation is by comparing it to Google’s. Facebook is set to go public at a sweet valuation of $100 billion, and it has estimated revenue for 2012 of about $4 billion.
However, investors are not buying Facebook today because they believe it is fairly valued, so what is the point of the comparison? Bear with me for a moment. Let’s say Facebook investors want to receive 15 percent a year over the next five years. In that case, Facebook’s market capitalization has to double in five years, to $200 billion. Conveniently, $200 billion happens to be Google’s valuation today. Since both companies are in the advertising business and have very similar cost structures, all Facebook has to do over the next five years is achieve Google’s current sales level, which is a meager $40 billion (for purposes of this discussion, we’ll ignore Google’s $40 billion pile of cash, or about $100 a share, compared with Facebook’s few billion, though that would only further make my point here). For an investor to double his or her money over the next five years, all Facebook has to do is increase its revenues tenfold.”
This revenue growth target is possible, but in the world of high-tech there is no certainty. The real test for Zuckerberg will be his ability to grow Facebook as the IPO priced his shares. Should this be executed than it will not matter that he lost $2 billion over the first weekend. In the end, Facebook’s success isn’t about hype, news stories of new billionaires, or minute-by-minute news coverage. It’s all about the business of selling stuff and making a profit. Investors should ignore the headlines and watch the financial details. Most of us won’t win the lottery or have a Facebook IPO to bank on. We will need to invest wisely, minimize risk while achieving the return necessary to maintain our long-term standard of living goals. We shouldn’t waste our time with the hype. Price matters, so we won’t overpay for your investments no matter how much hype. Therefore we did not participate in the Facebook IPO for our clients.
By: Alice McDermott, CFP®
An umbrella policy (aka, “personal liability” policy) may protect your net worth in the event of a catastrophic incident. Umbrella policies protect an individual by covering costs incurred after your other insurance policies cap out. You may typically purchase in increments of $1 million, and you may need to increase coverage on your other policies before an insurer will cover you.
Many clients ask why they need this coverage, and I typically give a “worsecase scenario” to explain why it makes sense for those with “at-risk” assets.
You’re traveling down the road, coming home from the grocery store and you hit a driver with a van full of school kids. Based on the evidence, the judge rules in favor of the plaintiff and determines you were personally negligent and must pay out a multimillion- dollar settlement to cover various injuries and damage, or worse, death. Since your auto coverage caps out at a maximum of $500,000 (if you have that much coverage) you are now personally responsible for paying the rest of the lawsuit. Unless you happen to have this kind of cash on hand, and/ or have substantial assets you can sell, you may find yourself in a financial pickle! The judge can force you to empty your bank accounts, sell your house and garnish wages to cover the lawsuit. The umbrella policy will step in after your auto insurance caps out and may cover remaining legal fees and additional settlement costs up to the umbrella coverage. Most attorneys want to settle, and the insurance company, obviously, will not pay a penny more than absolutely necessary. A scenario such as this is not likely to happen, but the risk is there.
Auto accidents aren’t the only type of insurable incidents. There are a number of other factors where you may be vulnerable. Do you drive more than the average person? Does your family have a dog? A swimming pool? Teenage drivers? Do you frequently have visitors or host parties at your home? Other factors that help you decide on an umbrella policy include your tolerance for risk and the amount of assets you want to protect. In addition to supplemental liability coverage, these policies may protect you from incidents where you may be accused of slander, libel, defamation of character or invasion of privacy.
Keep in mind, an umbrella policy will typically not cover small-business owners or those who are self-employed. You may need a business insurance policy for this.
Surprisingly, umbrella policies are fairly inexpensive – approximately $150-$500 per year depending on the amount of coverage and the driving record of those covered. This is a fraction of the cost of your homeowners and auto insurance. I suggest you start with your homeowners insurance company and then shop around. You may also find your insurer requires you to have all polices with them so they may monitor the amount of coverage. Many insurers give a multi-policy discount, so in the end you may find you get the extra coverage with little to no more dollars out of your pocket!
So … how much is enough? Everyone’s needs are different, so when considering the amount of coverage, it is important to know your current financial situation. Knowing the value of your investments, the equity in your home, and the market value of autos and other possessions is critical. If in doubt, talk with one of our Certified Financial Planners and they can assist you in determining the appropriate amount not only based on your “atrisk” assets, but also your personal risk tolerance. Be well and live Pono (for those of you not on Maui “live Pono” is to live your life by doing what is right)!
There is no Spotlight for this issue.