Affiliate Post: China and the holy trinity of growth stock criteria

 

When it comes to stocks, buying the best – at the right price – is worth it… especially in Asia.

There are a lot of ways to make (and lose) money as an investor. Some strategies are very complex. Others are common sense and simple to understand – but not always easy to implement… like the one I’m about to explain.

As a rule of thumb, if you invest in the best company in a dying industry, you’ll probably lose money. You’re fighting the tide and will probably wind up out at sea. And if you invest in an average company in a growing sector, things could go either way. (Of course, valuations matter here as well.)

But for the biggest gains, look to exploit the holy trinity of investing:

  • Find a sector that is showing exceptional, ongoing growth
  • Identify the leading company in this major growth industry
  • Buy the leading company when it’s cheap

Here are two examples to show how this works.

Apple blossoms

Apple shares (NASDAQ; ticker: AAPL) were trading for US$18 in the spring of 2009. And it just so happens that Apple met all three of the investment trifecta at that time:

1) Top Sector: Smartphone use was on the verge of exploding

2) Leading Company: There was no product like the iPhone, not to mention Apple’s other products

3) Cheap Valuation: Despite its growth rate and outlook, Apple stock carried a price-to-earnings (P/E) multiple nearly the same as the S&P 500 – in other words, it was valued the same as an average stock on the S&P 500, even though it was a leading company in a high-growth sector

If you’d bought Apple shares in the spring of 2009 when it met the three growth criteria, you would have made nearly 400 percent over the next three years (compared to the return of the S&P 500 of about 50 percent). And if you held on to the shares until today, you’d be up over 500 percent.

(Of course, “if only” is not a valid investment strategy (as in, “if only I bought Apple shares when they were just US$18”). We all have perfect hindsight – and if these decisions were always obvious and easy we’d all be rich.)

100 degrees of Baidu

Another example of exploiting these three growth factors is Chinese search engine giant Baidu (NASDAQ; ticker: BIDU). It’s like the Google of China – and the name in Chinese literally means 100 (bai百) degrees (du度).

In early 2013, Baidu was already China’s top search engine and shares were trading for US$90 each.

But even then, Baidu still met the three top growth criteria:

1) Top Sector: Internet search had been growing steadily for years and forecasts called for more of the same

2) Leading Company: Baidu had long before overtaken Google in China, the world’s fastest growing economy at the time

3) Cheap Valuation: Baidu stock’s P/E (price-to-earnings) ratio had pulled back to 20, a small premium to the market, despite its long growth history and positive outlook

Over the next year and a half, Baidu shares moved up nearly 200 percent.

At the time, Apple and Baidu were not undiscovered gems. They were already giant, successful companies.

While it appeared that their success would continue, at the time their stories felt stale to many investors – some of whom no doubt felt the need to discover new emerging companies to earn a big return. But ignoring the well-run market leaders trading at a reasonable valuation was a mistake.

This easy-to-understand strategy – identify a leading sector, find the leading company in the sector, buy when the stock valuations are cheap – isn’t so easy to execute. Is a high-growth sector slowing down? Has the leading company in the sector lost its way with a misguided strategy or management mistakes? Is the apparently attractive valuation accurately pricing in a slowdown in growth?

How to find big growth companies

The good news is, there are a lot of companies that meet these criteria in Asia at the moment.

To help you find them, our friends at Truewealth Publishing are launching a new research service focused on finding these kinds of sectors and companies in Asia. They’ve prepared a report outlining three of the best investment opportunities in Asia right now. What’s more, part of their (very affordable) package includes an exclusive interview with one of the world’s biggest investment legends – who is himself a huge proponent of Asia.

To find out more, and to sign up for this incredible opportunity, please click here.

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My Fiverr Gigs

In the spirit of income generation, I created a couple of Fiverr gigs a while back and when no one ever purchased either gave up on them ever being used.

Now that I juicing up the website and my subscriber count is increasing about 10% weekly (note, 10% of 20 is 2), I’ve decided to get back on the Fiverr bandwagon and try to make some of that nice freelance cash.

I talked a little about Fiverr in my second book and the strategies to making money on the site.  The basics are to create some quick consulting gig, like designing a book cover, editing or transcribing, etc.  and then adding gig extras to up the price.

The two gigs are both stock related and are useful for anyone wanting a quick summary of a stock to reference.  The first is a  one-page report with stats, a stock price chart, financials, business description and key executives.  This is great to collect for each company in your portfolio to keep them in line.

The second is a comparable valuation analysis.  In this I select several multiples and compare the subject’s to comparable companies and project out what the stock price would be if it traded at those multiples.

Both have ultra fun add-ons for me to do even more analysis for even more straight cash.  Nice.

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Fitbit is Oversold

In writing my weekly newsletter this week, I realized that adding in pictures of charts was more work than it was worth and that many people would skip over that party anyway.  So, here is a glimpse into the fun thought process behind my trades that you would typically only get in the newsletter.

Before we start, go read this article to learn about how I trade and what the different things in these charts mean.

This first chart has a cluster of overbought/oversold measures on it.  Fitbit is just 17 cents above the lower Bollinger Band and both the RSI and Stochastics show over sold levels.  It is worth noting that each of these have shown oversold since the stock’s massive drop in November.

This chart shows all the important moving averages.  Fitbit’s price is the black and red line on the bottom, up from that is the 20 day ema, 50 dma and 200 dma.  It’s obviously bad for the trend that the price is below all three.  However, the MACD on the bottom has crossed over the signal line and has diverged from the stock price – both of these are buy signals.  When the MACD crosses over zero and/or the stock price crosses over the 20 day ema look for it to jump.

 

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Christmas List for Someone Who Wants to be Rich

In a completely transparent attempt to earn some affiliate cash, I have pulled together a bunch of recommendations for Christmas presents to get for people who want to be rich.  And, really, outside of Jill Stein supporters, who doesn’t?  I’ve suggested four books (one for each of the site’s pillars) and two courses.  If you enjoy the site, try to buy the expensive courses; if not, still buy all of the books.

Books

I Will Teach You to be Rich by Ramit Sethi is my favorite personal finance book.  Most personal finance books feel like going to confession – you just feel guilty and empty after.  Ramit tells readers to get credit cards, to spend money on Starbucks if they want and even how to ask for a raise.  If you only get one of these books, make it this one.

One Up on Wall St. by Peter Lynch.  I struggled for a few minutes to decide what investment book to recommend.  Many of my favorites would fly well over the head of beginning investors.  Lynch’s book is simple and written well enough to hook even the staunchest anti-vaccer (going with a Jill Stein joke again there if you didn’t catch it) and has enough wisdom to be worth countless re-reads.

Economics for Real People by Gene Callahan was the first book I read that really made me feel like I ‘got’ Austrian Economics.  Before this book, I sort of understood supply and demand, minimum wage stuff and even bits of the Austrian Business Cycle Theory – but I didn’t have the all-encompassing “start with a lone man on a desert island (in this case Richard Hatch from Survivor) and build all of economics from that” grasp  on it that I had after reading this book.

How to Start a Successful Blog in One Hour by Steve Scott is self-explanatory.  Anyone wanting to earn money online needs to get past this step.  The book’s also really cheap.

Courses

Tom Woods’s Liberty Classroom is my go-to at work anytime I need to do some mindless data entry type stuff for a while and want to learn about interest rate theory, why some president from 1860 was terrible or why the Robber Barons were good. Nothing on the internet will teach you Austrian Economics or libertarianism better.

Top Business Courses- How To Become a Bestselling Author on Amazon Kindle  is also a go-to for me, whenever I publish or start work on a new eBook.  The course has tons of sections, showing how to format Microsoft Word correctly, actually brainstorm good ideas and write consistently, upload your book to get an electronic and paperback version and how to market it effectively.

BONUS PRESENTS

I can’t ever dodge the chance to add my own books to any of these lists:

How to Hack Wall St. Four Steps to Retiring a Millionaire

 

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Book Notes: Trade Like Warren Buffett

For whatever reason self-help guru James Altucher has disavowed his older trading/investing books, including one of my favorite Buffett books: Trade Like Warren Buffett.

In a sea of bland-same-old-conservative-value-Buffett-books, Altucher’s evaluates the out of the ordinary strategies Buffett pursued and ends the book with interviews of two of my favorites hedge fund managers: Mohnish Pabrai and Zeke Ashton.

I have devoured this book at least seven separate times and much of it led to the techniques I wrote about in my first book.

The strategies Altucher describes include: Merger Arbitrage, Relative Value arbitrage, Junk Bonds, Closed-end fund arbitrage, PE ratios and market timing and disasters.  My notes on each will follow.

Merger Arb

Merger arbitrage is the technique of purchasing the stock of a to-be-acquired security when it trades for lower than the price of the announced merger, while shorting the acquirer to hedge, to gain the difference.

Risks involved in the arbitrage include:

  • Due Diligence risk – risk that the acquirer will back out of the deal when it finds something bad during the due diligence phase.
  • Regulatory risk – risk that governments will block the deal.
  • Another acquirer showing up – this would kill the short hedge.
  • Interest rate risk – risk that the amount of time it takes for the deal to close will push the return below the risk-free rate.

To calculate the potential return in the deal, use the formula: V = P((D-T)/T); where v = the value of the deal; p = the probability of the deal completing; d = the deal price; t = the price we pay for the target stock.

Relative Value Arb

In relative value arbitrage investors find a company where the sum-of-the-parts value is great than the current market value of the company, purchase the company and then short the parts.

For example, if Price Industries had holdings worth $150mm in Kelsey Farm Corp, $100mm in Packers Are Just Alright, Inc and $50mm in Not as Interesting of a name, LLC the sum of the parts valuation would be $350mm.

If the market value of Price Industries was $300mm there is an obvious gap to be arbitraged away through investors purchasing shares in Price.

Of course, it is also possible the value of the holdings could fall, therefore arbitrageurs short the holdings and then hold both positions simultaneously until the gap is closed.

Junk Bonds

Junk bonds, or distressed debt, is the publicly traded debt of companies given a poor rating by credit rating agencies.  Because the agency gives the company a material chance of bankruptcy before the debt can be repaid, the interest rate of the debt is higher than typical corporate debt to attract investors willing to take on the risk.

Per Altucher, in junk bond situations Buffett does not go through the typical rigmarole of evaluating the quality of the business or is sustainable competitive advantages; he simply evaluates the business’s ability to pay back the debt.

With distressed debt, it is important to keep in mind that the day-to-day, even year-to-year, volatility of the debt is, in the end, irrelevant.  The debt will do one of two things: make its payments and pay back lenders or default.

Closed-End Fund Arbitrage

Find the site’s closed-end fund strategy here.

Market Timing

Despite Buffett’s constant statements that he does not attempt to time the market he had, at the time of this book’s publishing, made market calls in 1969, 1974, 1979, 1986, 1992, 1999 and 2001.

Altucher tries to tie these market calls to value ratios like P/E and P/Book and to the so-called Fed Model where investors buy stocks when the earnings yield (E/P) is higher than bond yields, but fails to establish a successful trading system using either.

It seems Buffett’s market calls are valuation based but are more based on his personal feel than on a direct ratio.

If you’re interested in learning about market timing, I devoted the final chapter in my most recent book to various value based indicators.

Disaster

Every time some sort of disaster happens (e.g. 9/11 or the housing crisis) Buffett is on TV soon after declaring the stock market will return.

Altucher finds that, for the most part, when there is a disaster and the market panics in the short-term it bounces back fairly strongly over the next month and six months.

Altucher even shows a trading system where traders purchase any stock that falls 10% in a day and it outperforms buy and hold by a factor of over 5.

You can buy the book here.

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Filling out the Special Situations Portfolio

Earlier this year I put out a special report to add several positions to the Hack Wall St. portfolio and dismiss a few.  The report left about 25% of the portfolio in cash, which is where we stand today.  To access this report, which discusses the addition of several country ETFs as well as Ferrari, subscribe to my newsletter.

Even earlier this year, my now fiancée and I managed to save a down payment for a new house in just six months partly by using closed-end municipal bond funds.  Our strategy was to pay $1,500/month to ourselves in rent and send it all into a brokerage account where it would be invested.

The savings part was easy enough – we just had to commit to it.  The hard part was deciding how to invest the money.

We could pick blue-chip stocks paying dividends, but even the least volatile blue chips could lose 20% suddenly with little or no warning.

We could just keep the money in a savings account or use short-term CDs, but the people who do that don’t run personal finance websites.

We could sell puts on blue chip stocks using the cash as collateral, but again there is an, albeit slim, potential for a huge loss.

Our selection was Closed-end funds (CEFs) holding municipal bonds that trade at a discount.  We get conservatism with the municipal bonds – if they defaulted we probably wouldn’t be looking to buy a new house either way.  We also got an alright return with a 4-5% non-taxable yield; this converts to about 6% for a taxable asset.  Finally, we picked closed-end funds that traded for a discount to their net asset value (NAV).

Here’s how that works.  The net asset value is the actual value of the holdings in the fund – in our case it would be the value of the municipal bonds and any cash in the fund.  The fund trades on the open market, so depending on the feelings of the market it can trade below (discount) or above (premium) to its net asset value.

Many closed-end funds will trade at discounts their entire life – or at least until an activist gets a controlling share and riles up management.  With municipal bond funds, the asset value has so little certainty that it is very likely that at some point the fund will trade at a premium or at the NAV.

This worked out for us.  Including the yield and the reversion to the mean, we earned about 8% in just six months holding the CEFs.  All in all, the return subtracted about a month from the amount of time it took to save.

I’ve written about the mechanics of this strategy before and how to find and evaluate funds and what types of portfolios this strategy works in. You can find that article here. 

In the past couple of months, these CEF opportunities dried up.  The strategy obviously works, so investors were piling into it.  However, following election day, the market became convinced that interest rates would rise – which pushes bond prices down – and many muni bond CEFs fell in price and now trade at a discount.

Using the method described in the article linked above I found three good opportunities: NXP, AKP and VPV.  We will put 5% in each and sell if they hit a 5% premium or we find a better opportunity for the portfolio.

For the current portfolio, visit this page. 

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Debuting the Market Timing Portfolio

In 4 Steps to Retiring a Millionaire I talked about some ways to use valuation to time markets.  I thought it would be useful to follow a portfolio on the site with some market timing trades.

Before we start, I’ll hedge with the fact that I don’t expect this portfolio to wallop the market.  In fact, I wouldn’t be surprised if it does poorly.  To start I won’t be using any trend or momentum indicators and deeply undervalued assets tend to get even more deeply undervalued for a while.

The From-the-Book-Ones

ProShares Short High Yield

Interest rates are at near a generational low, as they go up bond prices will go down – especially junk bonds.

Platinum & Palladium

Historically, platinum has traded at a premium or slight discount to its precious metal cousin, gold.  Right now, gold trades for $1,208/oz and platinum trades for just $925.50.

Uranium

The Uranium price has fallen 80% since Fukushima five years ago.  In the mean-time nuclear power sources have turned to secondary sources to purchase uranium.  Eventually the secondary sources will run out and the price will necessarily go up to allow producers to earn a profit.  We will use Cameco.

Coal

The price of Coal has fallen 64% in the past five years and 76% since July 2011.  Much of this is due to the attempted creation of alternative energy sources and the increased regulations on the industry.  Regardless, of how this works out, it is likely the price of coal is too low.

Some CAPErs

CAPE stands for cyclically adjusted price to earnings ratio.  The ratio is calculated by dividing the current price by the average earnings over the past ten years.  Averaging out ten years of earnings smooths any cycles that are either artificially inflating or deflating earnings at the current time.  We’ll include all countries with current CAPEs below 10x.

The current countries are: Russia, Brazil, Czech Republic, Poland and Turkey.  Unfortunately, there isn’t a good option for investing in the Czech Republic.

As always, the portfolio will be tracked on the portfolio page.

 

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Book Notes: DIY Financial Advisor

I loved Wes Gray’s book with Tobias Carlyle: Quantitative Value. I have been thinking about becoming a financial advisor and have been fooling around with different asset allocation models.  Imagine my surprise and delight when I found out he had another book (with Jack Vogel and David Foulke) combining the three.

The book is a very easy read (especially when you skip over the all the studies/back testing) and the authors do a great job simplifying complex strategies and creating solutions for investors at various skill and risk levels.

While this post will serve as notes for me to return to, I always recommend reading the book yourself, which you can do here.

Problems with The Experts

  • Successful experts must constantly acknowledge the potential for them to be wrong – this is very hard to do in practice.
  • Experts typically focus on short-term results and complexity when they should focus on long-term results and simplicity.
  • Simple models will typically defeat experts who are slaves to emotional issues.  Human decisions are instinctual and heuristic-based whereas processes are calculated and analytical.
    • The three main reasons experts fail in this way are: coming to different decisions with the same facts as the model, being overconfident and using story-based and not evidence-based decisions.
  • Anchoring – Humans tend to rely too heavily on an eventually irrelevant piece of information, which is referred to as an anchor.
  • Framing – The way information is presented (or framed) can evoke emotional responses that lead to different decisions.
  • Availability Bias – The mind overvalues recent or easily recalled information.
  • Physical State – Physical factors like if the expert is a morning or night person (or if they’ve had their coffee) affect decisions.
  • Overconfidence – self-explanatory, this leads to experts using far more leverage or participating in far more risk than is appropriate.

How to Choose an Expert if you Must

Use FACTS:

  • Fees – Find the effective all-in fee number and assure it is based on a percent of assets managed – not commissions on investment products purchased. Don’t pay more than 1% per year and lean toward not paying for investing prowess. Instead, pay for things like insurance, wealth planning and other bonus features.
  • Access – Find out what the liquidity provisions are with the investment (is there a lock-up period, are there fees to get your money back) and lean toward more liquidity.
  • Complexity – The more complex, the more opportunities to potentially screw up.
  • Taxes – Look for advisers and instruments that are good at tax efficiency.
  • Search – Consider the time and cost of identifying and monitoring managers.

Asset Allocation

Asset Allocation allows investors to gain exposure to different asset classes and reduce volatility and drawdowns.  The book covers three different approaches and recommends the third:

  1. Yale Endowment model from David Swensen’s book Unconventional Success: 30% US stocks, 20% foreign stocks, 20% real estate, 15% inflation-protected bonds and 15% treasury bonds.
  2. William Bernstein’s portfolio from The Intelligent Asset Allocator: 25% domestic equity, 25% foreign equity, 25% small caps and 25% bonds.
  3. Meb Faber and Eric Richardson’s Ivy Portfolio: 20% US stocks, 20% foreign stocks, 20% real estate, 20% commodities and 20% treasuries.

Risk Management

There are five main buckets of techniques for risk management:

  1. Fundamentals
  2. Technicals
  3. Sentiment
  4. Volatility
  5. Combo

The book recommends using a simple moving average (buy when the price is higher than it has averaged over the past one year) and time series momentum (buy when the asset’s 12-month return is higher than a risk-free asset’s).

Security Selection

There are two simple models to pick securities: value and momentum.  For value, pick stocks with a high EBIT/TEV yield (EBIT is earnings before interest and taxes, TEV is the amount it would take to purchase the entire company).  For momentum, buy the top decile of stocks based on the past 6 or 12 months of returns.

To combine the two, either buy the top decile of high EBIT/TEV firms each month or split a stock portfolio 50/50 between the two strategies.

The DIY Solution

Start with the Ivy Portfolio, use the security selection tools for the stock portions and apply the risk management tools to each portion, holding cash when necessary.

Last note: Wes’s site Alpha Architect assists with all components of the strategy and is great for both financial advisors and individual investors.   

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4 Books to Become Wealthier than a Game of Thrones House with a Cool Animal Sigil

Before you can choose an asset allocation strategy or start actively trading or even start earning money online you need to get your financial situation in order, start saving and figure out how you’re going to save enough money to forsake your grandchildren in retirement.

I Will Teach You to be Rich

Ramit Sethi wrote the most effective personal finance book I’ve read.  Seas of the typical personal finance tomes begging readers to never use debt for any reason and to hoard all their cash in CDs to save it from the evil stock market probably have a net negative on society.  Ramit’s book takes the opposite approach.

He tells readers not to budget, tells them to use credit cards and shows how a beginner can get involved in the stock market.

Rich Dad, Poor Dad

Where I Will Teach You to be Rich establishes a mindset for managing your finances, Rich Dad, Poor Dad establishes a mindset for creating wealth.  Employees rarely become wealthy and Robert Kiyosaki reinforces this time and time again.

Money: Master the Game

Though Money: Master the Game has the typical number of worn platitudes, the sections on how to live like a millionaire without being a millionaire and risk parity portfolios are worth the read.

Seven Years to Seven Figures

Michael Masterson has a mixed reputation on first Google.  As a long-time marketer, this is to be expected.  His book is second to none as far as introductions to motivation, strategies for getting promoted and getting raises at work, starting a business and investing in real estate.

Bonus: Four Steps to Retiring a Millionaire

How could I do this list without my own book (which is only $2.99, what a deal!) which, as far as I know, invented a savings concept called forced savings.  How could you not read a book that created a new concept?

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11 Books to Rewire Your Online Business Instincts

For whatever reason, most people who read these books will feel enlightened, be filled with plans for future success, come up with tons of ideas to make money online and never do anything about it.

There innumerable ways to make money online regardless of your individual talents and niche knowledge, and these books will explain how, but the most important step is not what email provider you use, how much time you spend on SEO or even who your target audience us but just sitting in front of a computer and doing the work.

Will it Fly

This site is modeled on Pat Flynn’s, so his most recent book must be included in the list.  Flynn teaches entrepreneurs how to not only come up with successful product idea for their business but test it to make sure they won’t be wasting hours and dollars on a dud.

How to Start a Successful Blog in One Hour, Your first $1,000, Email Marketing Blueprint and Authority Affiliate Marketing

This list is mostly going to be a Mike’s internet-business-role-models books.  The first is Steve Scott.  Scott has built two simultaneous eBook based empires.  One with habit books and one with online business books, mostly on how to sell eBooks.  These are my favorite online business ones by him.

The Side Hustle Path Vol 1, Vol 2, Vol 3 & Vol 4

The next is Nick Loper.  Loper’s site, Side Hustle Nation is more about ways to add income on the side of your normal day job.  He details the side hustles he experiments with on his site and has interviewed experts at many more on his podcast as well.  These four volumes introduce readers to the most successful ideas.

The Fire Path & Podcast Launch

John Lee Dumas and his wife Kate Ericson run one of the best online business resource sites, with monthly income often in excess of $1mm.  In The Fire Path, Kate tells the story of how they started their business and draws the map for you to follow.  Podcast Launch is self-explanatory.

Bonus: The Altucher Report

James Altucher is one of the leading entrepreneurship and self-improvement authorities.  His monthly newsletter introduces passive income opportunities, interviews with leading entrepreneurs and analysis of the most important technological trends.  Plus (!) if you do a lifetime subscription you get a bunch of monthly book recommendations.

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