Personal Investing

How do you know if a stock that has underperformed the market is still a good place to invest?

I wish we could invest in winning stocks all the time, but that just doesn’t happen because of the “unknown” factors. An unknown factor can be a tragedy from Mother Nature, impact from a shift in the global economy or an earnings miss, just to mention a few. The bottom line is that any unknown factor can be a negative surprise to a company, reflecting in a price decline. What an investor needs to look at is why they liked the stock in the beginning and what has changed, if anything, their conviction on the stock. Consider what led to the decline and determine how long will it take for the company to recover.

If the decline was caused from a one-time event, then perhaps you should hold on to the stock or add to your existing position at the undervalued price. As an example; back in 2009 Caterpillar missed their earnings and laid-off employees paying them a very nice severance package that hurt their profit. The stock declined from $40.00 to around $30.00 during that time and is now worth over $100 per share. Looking into the factor that caused the decline reiterated my conviction on the management of the company. The payoff was worth the wait.

If you don’t already own a stock that tumbled should you look at buying it in hopes that it can turnaround? What we don’t want to do is chase a stock hoping it will turn around and become profitable. If we “hope” then we should remain cautious because hope does not belong in one of the factors that increase a company’s earnings.

Look to see if management is buying back shares of the company. This is a good sign of the company being truly undervalued and growth may have stalled due to temporary issues. Look for a company that shows continued improvement in sales as this is a solid sign that a higher price may be ahead. Is the company investing into a new product? If so, how well have they done in the past with their products. Some companies can develop new products and implement into their strategy, such as Apple, where other companies cannot.

If the company rewards investors with a dividend, it may be worth buying to hold and collect the dividend while waiting for stock to appreciate.

Last, you don’t need to own at the beginning of a turnaround to make a profit.

Good Luck and Know what you are invested in.

Diversification is a general rule for successful investing.    The common phrase “Don’t put all your eggs in one basket” describes diversification strategy.  This strategy involves distributing your investment holdings among different asset classes in order to manage investment risk and reduce market value loss in your portfolio.

Remember my Asset Allocation blog identifying three common asset categories; cash, equities and fixed income.  Well, diversification goes beyond those categories.  Equities for example can be broken down into its sub classes:  large cap stocks, mid cap stocks, small cap stocks and international stocks.    These asset classes help manage investment risk by allocating different percentages of your money to each class.   Risk is managed as certain classes offer different levels of return, meaning some investment classes will lose money, while other classes will grow.

Another level of diversification is sectors.  Sectors are subsets of an industry, which describes the company’s business.    Equities are grouped into ten sectors in the S&P 500 which are;  Consumer Staples, Consumer Discretion, Energy, Financials, Healthcare, Industrials, Technology, Materials, Utilities and Telecommunications.  Each sector performs differently based on the current market conditions.  For example, if we are currently in a slow growth recovery market with a very low GDP expectation then consumers will most likely not be spending a lot of their money on unnecessary items which belong in the Consumer Discretion sector (Restaurants, Retail stores or Hotels).  This sector of the market should have less exposure compared to say the Healthcare sector.  A good way of investing in specific sectors is through Exchange Traded Funds (ETF’S).  See my blog on ETF’s.

Now, most people think of diversification just for their equity allocation but you should also carry this over into the fixed income component of your asset allocation.  Fixed Income (aka bonds) also has different classes:  Treasury/Government bonds, corporate bonds, Preferred Stocks or Municipal bonds to mention a few.  Similar to equities, bonds fluctuate in level of risk and return.  A portfolio should hold the appropriate bond percentages based on current market conditions and your risk tolerance.  Bonds have credit ratings that make them either a safe investment or higher risk investment known as junk bonds.   

Diversification is important and will allow your investments to grow as your money is spread out globally and not invested in just one part of the market.

Rebalancing

Rebalancing is bringing your portfolio back to the original asset allocation weightings you selected for your investment goal.   You may need to rebalance because an asset category has increased too much due to high returns, therefore you would trim the winners and reallocate the proceeds to asset categories that have underperformed.   

 Another way to rebalance your portfolio is if you make contributions.  The new contributions will need to be invested based on your asset allocation and more of the contributions may go towards the underweighted categories to bring your portfolio back into balance. 

It is important to remain disciplined and take action on rebalancing.  You should consider doing this once a year and you will pick up additional return in your portfolio over time. 

Good luck and know what you are invested in.

The term, Asset Allocation is used often in the financial world but what does it exactly mean?   First, you must understand that you will have an asset allocation within an investment portfolio/account.  This investment portfolio/account will have money you saved and set aside for a specific financial goal, whether that goal is saving to purchase a home, college funding or most commonly for your retirement.  You may already have an investment portfolio if you are contributing to a 401k plan.

Asset Allocation is an investment strategy that involves different asset categories, such as cash, equities and fixed income.   The mixture of these asset categories will assist in managing the risk and performance of an investment portfolio.  This is important because the asset allocation will have an impact on meeting your financial goal you established.    I have outlined some points below that you will need to decide in order to select your asset allocation.

When do you need to begin using the money in the portfolio?  This is known as a time horizon.    If the money is not to be used for a long time typically longer than 10 years then the portfolio may be able to take on riskier asset categories and handle market volatility.   In contrast, if the time horizon is less than 5 years, less risky asset categories should be considered.

What is your risk tolerance for this money?    Each asset category has a level of risk associated with it and every person has a different risk tolerance level.  You will need to determine how much risk you are willing to take to increase your portfolio’s performance.  Riskier assets provide growth or the potential to increase your portfolio value, while experiencing some volatility along the way.  Less risky assets may just provide you with some income but no growth.  This is a more conservative approach.

Fact:  91.5% of your portfolio’s return (performance) comes from asset allocation!

Asset categories mentioned above, cash, equities and fixed income are the most common and each has their own level of risk.  Cash has the least amount of risk while fixed income has some risk but much less volatile and typically produces income like a Certificate of Deposit.   Equities hold the trophy for being the riskiest and most volatile asset.   Remember, the higher the risk the more potential for growth/performance.  Once you determine your time horizon and risk tolerance then choosing how much you should have in each asset category is next step.   These three asset categories typically do not move in the same direction therefore a portfolio can protect itself against major movements, either in losses or gains, by choosing an asset allocation that contains all three.

For an example:  I have a friend who is 35 years old and has a portfolio she contributes to every month towards her retirement, which is at least 25 years away.  My friend’s time horizon is longer than 10 years.  What should her risk tolerance be?    This can only be determined by my friend as she has to be comfortable with her decision.  She feels that because she has a long term horizon she should be invested for Growth but also wants some comfort of conservativeness.   Her asset allocation is 65% equities and 30% fixed income with 5% cash.  However, the same aged person may not want any equities and have a 100% fixed income asset allocation for their portfolio.  That too is fine, because it is what works for them.    The difference between the two allocations may mean that one will meet their goal and the other may not.    Equities provide the growth in a portfolio while fixed income only provides income earned but no growth.

Now, there are two more steps to be discussed and they are Diversification and Rebalancing.   I will discuss both steps in my next blog.  Stay tuned and……  

Good Luck and know what you are invested in.

What do you do when the volatility in the stock market acts like a roller coaster?  Where do you invest your money? 

The stock market is on a wild ride and the bond market remains expensive with extremely low yields.  The 10 year Treasury bond is yielding 2%.   The S&P 500 Index is yielding 2%. 

2011 is still a recovery year for the economy.  We started out with high unemployment and excessive residential homes for sale in a low interest rate environment.  All of those factors do not improve at the same time but there have been other factors that have improved.  Corporate earnings for 2^nd quarter came in with double digit year over year growth along with corporate sales growth.  If corporations are growing and making money someone has to be spending.   Retail sales have been improving including auto sales rebounding from Japan’s earthquake disruption.  Personal Income is climbing albeit slowly and consumers have begun to deleverage in a healthy way.  So why is the market down year to date and moving like a roller coaster?  Fear of the unknown!  Trust is an issue in both Europe and the US political divisions and there is presumption of a recession.   Investors want resolution and all the economic indicators do not show we have resolution so the unknown arouses panic and sell offs take place.  Traders are making quick money with today’s technology of electronic trading and margin trading, day traders are active.  This is a short term strategy.  Panic selling tends to lead to underperform in ones portfolio because who knows when to buy back in.  Once the rally holds and takes off, being out of the market misses the first round of price upswings.  Just a hint of a better economic outlook and the equity market will have a bounce to the upside.  Remember, your asset allocation should complement your overall objective.

I believe we are in a stock buyers market. The S&P 500 Index pays you 2% plus appreciation while the 10 year Treasury bond will pay you 2% and only 2% for 10 years.  I would rather own the Index and reap some appreciation along with income.   Individual stock names can pay two times higher dividends than most bonds.   Emerging Markets Index also pays 2% with higher growth expectations than the US market.  As always, remain disciplined and lock in some profits along the way. 

Fear is an emotional reaction that should be taken out of the equation when investing.  Details behind the announcements especially in wild roller coaster rides are most important in today’s investment environment.   The economic weakness does not mean all the fundamentals have a negative sentiment.

Good luck and know what you are invested in.

The media discusses several topics and one frequently mentioned is the earnings report or earnings season.   We hear Company XYZ beat their earnings or Company ABC missed their earnings.  These are corporate earnings which simply indicate how much a company has made or lost during a specific period.   Earning season begins one or two weeks after the last month of each quarter and are important in determining whether the company has sustainable growth and reasonable outlook for the long term. 

Earnings are provided in a per share form (known as EPS) and distributed most commonly on a quarterly basis.  EPS means earnings per share and each quarterly earnings distributed is added together to calculate the annual EPS.  This annual EPS provides the full year outlook.  These quarterly and annual EPS numbers are compared to previous year numbers so investors know how well the company is performing.     For example, if Nike Inc. earned 17% more per share in recent quarter than a year ago (and they really did), you would think that Nike has potential for growth. 

EPS is calculated by taking the revenue generated by the company and subtracting all expenses to get your net earnings.  Take the net earnings and divide by the number of outstanding shares.  If Nike’s net earnings were $500 million and they have 486 million outstanding shares, their EPS would be $1.02.     The outline below shows a sample of quarterly and annual earnings history with expectations for 2011 and 2012.  This is only one guideline reviewed when researching a company for sustainability and growth.

How do Corporate Earnings impact the market?  Great question.  Let me begin by saying that just because a company “missed” their earnings projection does not make them a bad investment.  Companies may miss their earnings, meaning they expected to earn $1.02 per share and instead they earned $0.95 per share.  It is well known in the investment world that companies get punished if earnings are not met, their stock price declines quite a bit. This can provide an opportunity to purchase the stock at a lower price knowing the earnings miss may recover during the full year.  This being said, corporate earnings are a big factor in the health of the stock market and during earnings season the market becomes very active from all participants; investors, traders and analyst as they review their positions and take action where necessary based on the new data.  Let’s take a look at 2011’s first quarter results for the S&P 500 below. 

The ten sectors above identify the net results of all the company’s earnings.  The overall growth for the S&P 500 was 39.83% with 386 companies reporting positive earnings and 99 companies reporting negative earnings.  The Surprise column shows the combined companies all reported 5.73% better than expected with 359 companies reported to the upside and 135 companies missed their earnings expectations.  Take a look at the financial sector showing 828.21% growth.  Remember, this is year over year comparisons and the financials were coming out of the financial crisis last year so any improvement to the stocks would be a huge difference to the upside.  The first quarter earnings for 2011 were strong and the S&P 500 returned 9.05% for the first four months on this year!  There you go.

Where do earnings expectations come from?  The management of the individual company reports their own expectations along with many analysts.  Analysts do their own research to come up with their opinion for recommending a company.   An analyst will have a Buy, Hold or Sell on each company they want to follow.  Various expectations should be evaluated to form your own opinion or view.   All these opinions come into play when earnings are reported as the results may lead to the analysts downgrading or upgrading their recommendation.   These recommendations often have an impact on the stock price and sometimes the whole industry that the particular stock belongs to because investors may believe other stocks in that industry may report similar results.  That is a short term view and keeping your long term view on companies is one of the keys to successful investing.

The media captures a brief detail on the corporate earnings results.  And while the whole story may not get full coverage it is important to know what made up the company’s performance.

Good luck and know what you are invested in.

REITs  are Real Estate Investment Trusts which hold either real estate property or mortgages.  REITs are known for their high dividend payout with capital appreciation secondary.  The safest way to invest in a REIT is through an Exchange Traded Fund (ETF) as your investment is liquid through an ETF.  Some REITs purchased are like owing joint ventures and you may be locked in for a specific time frame while only able to collect dividend payout through dividend reinvestment plans.  This is not the same as an ETF.

A REIT ETF trades on the exchange like a stock and invests directly in the type of properties you are investing in such as for commercial real estate; shopping malls, office buildings, hotels or apartments when using residential real estate.  REITs also offer the opportunity to invest in specific sectors like Health care where consumer demand is less sensitive to the economy.  Health care REITs can include skilled nursing homes or medical office buildings where the expected demand from aging baby boomers is growing.

REITs pay out 90% of their taxable income to shareholders each year and you will have to pay Uncle Sam at your ordinary income tax rate.  A good rule may be to hold high dividend paying investments in an IRA so you will not owe taxes until you begin withdrawing from your IRA.

An investor looking to increase their income may want to add a small allocation to your portfolio for diversification.  Just like any investment you make, understand what you are purchasing by researching the asset.

Good luck and know what you are invested in.

Planning for retirement is not easy.   Saving for retirement is a function of attitude and past experience.    Attitude meaning, you understand the importance of savings and past experience identifies the discipline in continuing the savings while watching your investments grow.  Start young as the longer horizon you have the better off you will be.

How much do you need to retire?  That is truly the question and is entirely up to you.  There are many factors to consider and the fundamentals may change, such as:  the amount you will need, how long you’ll live, what are the tax rates when you retire, cost of living and of course, what kind of returns will your investments earn.

The most common retirement plans are Social Security, pensions/401k plans and personal savings.  The personal savings is most often left out.  This money is what you set aside and invest differently than your deferred investments.  There are no mandatory requirements on your personal savings.

Did you know 2011 is the year Baby Boomers turn 65!  Congratulations to all you Baby Boomers.  I too, am a Baby Boomer but at the end of the generation.  Some of these Baby Boomers will have pensions while others will not as traditional pension plans have gone out of style and replaced with 401k plans.  Social Security will then have to provide the extra income needed.

In one survey I read, 3 out of 4 Americans claim their Social Security benefits at age 62.  This locks them into a much lower amount than if they would have waited three years longer.  This should also be part of your plan.

Plan now or review your plan by using Retirement Calculations found on the Internet.     Assumptions you can use in the calculation are 8% annual return and 3% inflation. This will provide realistic numbers to assist in what it will take to retire.  Don’t let the large annual amount needed to save scare you away. The key is to begin saving and the size does not matter as long as you have the proper attitude.

Good luck and know what you are invested in.

There has recently been a list of reasons why we have market fears:  Middle East turmoil, gas and food prices are rising, QEII Program in question of being necessary and unfortunately Japans earthquake and tsunami .

These fears bring uncertainty into the picture and then you start second guessing your actions.  Should I get out of the market now and wait until everything settles down?  We start paying more attention to the potential risks and headline news than understanding all the facts and benefits.  This is called emotional trading and we should ignore this part of investing.  I admit it is tough at times to ignore the emotions but the outcome will pay off.

If there are no changes to the fundamentals then the market fear should correct in a shorter time frame than why we are investing to begin with, commonly for the long term.  These market fears can provide buying opportunities as it is sometimes beneficial to invest against the uncertainty.

With this said, you need to know that market fears do happen and that you should understand your comfort level of risk tolerance.  This will help with emotional side of investing/trading.

Good luck and know what you are invested in.

It is the time of year that some are excited about while others fear.  Do I owe money or do I get a refund?

Let’s go with a refund.   Next, you need to ask yourself, what should I do with it?

If you lived all year without it then you could just invest it.  Let me provide some guidance as to why investing would be a good option.

The street view of the S&P 500 is to return somewhere north of 10% for all of 2011.   If you have loans and are paying less than 10% for those loans, it makes more sense to invest and receive greater than 10% on your return.

If you contribute to college savings plan add the tax refund to the investments as an additional savings.  The compound interest adds up fast. 

Do you have a Roth IRA?  If yes, add the refund.   If no, use the refund to open one.  Just getting started is the hard part.

Remember Christmas club savings accounts?   Open a new savings account and deposit this to use towards your Christmas shopping.  It may not be much now but when you need it, watch out, you will be so happy you saved it.

We can always come up with ideas on how to spend money but to save extra money is more difficult.    This difficult process will be the most rewarding in the long term.

Good luck and know what you are invested in.

Bonds in a portfolio are meant to generate income and provide some safety.  Fears of recession send investors to the bond market and this ultimately sends yields, which move inversely to the price of bonds, down.

 This happened in 2010, where bonds were seriously overvalued and now that economic data is improving and the stock market returned double digits for all of 2010, yields are now recovering and this may be the end of bond market rally.

Many bond mutual funds had massive inflows in 2010 and this is beginning to reverse.  The 10-year Treasury yield is an indicator used for determining bond spreads to show how expensive or cheap the bond market is.  The 10-year yield has climbed from 2.4% in October to 3.4% today.   As investors change strategy towards equities, the bond market will suffer some losses.

One cannot deny the fact that the Federal Reserve will keep interest rates low for some time and inflation is not currently an issue.  This only implies a more volatile bond market than safe bond market.

 Good luck and know what you are invested in.