HealthyWealthyWiseProject

An Investment In Knowledge Always Pays The Best Interest

Main Menu

post

Warren Buffett’s stock market Valuation model says stocks are going nowhere fast

by Leave a Comment

In a 2001 Fortune magazine article, Warren Buffett commented that the ratio of stock market capitalization to GDP is “probably the single best measure of where valuations stand at any given moment.”

The present ratio of MarketCap/GDP is about 1.2, which translates to nominal total returns (including dividends) in the S&P 500 of about 2% annually over the coming 12 years.  Unfortunately, this just reflects objective evidence that has remained reliable over a century of market cycles.

Individual investors can fight back against these abysmal returns in two ways:

  1. Individual stock selection: see the HWWP Portfolio Page
  2. Value-weighted Asset Allocation:  see Optimal Asset Allocation

 

Source for Graphic: Hussman Funds – Weekly Market Comment: Run-Of-The-Mill Outcomes vs. Worst-Case Scenarios

aside

Annuities – A Rotten Deal for Investors

by Leave a Comment

Let’s use the housing market to put a typical annuity commission structure into perspective. This would be like adding $50,000 in price to home worth $500,000 to compensate the selling agent. On top of that, if the buyers decided to move after six months, they would owe the real estate broker who sold them the house an additional $60,000! This doesn’t include the potential additional fees that can be accrued by the signing agent if the homeowner opts into a refinansiering program, like the one made by Sambla in Norway.

I doubt many consumers would go for this. Unfortunately in the world of annuities, this is the norm.

These numbers are astonishing. The story gets worse. As Scott states, ” Keep in mind this is just the standard commission schedule, it doesn’t include any perks, trips, deferred compensation or compensation that the company may pay their employees for inducing them to recommend their products.”

The chart below shows the total value of an investment after 35 years, assuming $250 contributed monthly with an 8% annual return. The effects of these charges are devastating.

Source: A Sales Model that Makes Revenue Sharing Look Investor Friendly

post

Investing versus Flipping

by Leave a Comment

In his October, 2015, article Investing versus Flipping, Chris Brightman of Research Affiliates, Inc. compares the economics of rental property investments in Atlanta, Georgia, versus flipping homes in Orange County, California.

Relative Value of Houses

Let’s compare the housing market here, where we live in the OC [Orange County], to Atlanta. The best bargain we can find in the OC is a three-bedroom, two-bath house that sells for $500,000. Yep, for those of you unaccustomed to California real estate prices, the cheapest houses in OC fetch half a million dollars. We could rent one of these houses for $2,000 a month.

 As shown in Table 1, the prices in the OC are—to anyone who doesn’t live here—insane. If we were to invest in a house today as a rental property in the OC, our net annual rental yield (annual rent minus taxes, insurance, and property management) would be about 3% before tax. Of course, we can reasonably assume that home prices rise with inflation, so this is a real yield. Not bad. But California and the IRS tax even the inflation portion of the return.  This yield is then mostly taxed away, at higher rates than in Atlanta, to deliver less than 1% real return, after income and capital gains taxes. I don’t like this investment. House prices can go down as well as up. The high prices in the OC seem risky to me.

 Instead, we buy houses in Atlanta. Today, we buy renovated “three/two” houses (three bedrooms and two bathrooms, in the parlance of the trade) for $80,000, and then rent them out for $850 a month. As shown in Table 1, our net pre-tax rental yield is 9%, and approximately 5% after tax. I have strong conviction that buying rental properties in Atlanta at a 5% real after-tax yield is a far more sensible and safer way to accumulate wealth for our retirement than buying rental properties in the OC with an after-tax yield of 1%.

Flip That House?

Now, to some of my house-flipper friends in Newport Beach, the OC seems the better bet. The OC is local, prosperous, and safe. House prices have been rising rapidly for many years; they’ve even recovered the full damage wrought from the 2008 global financial crisis. Atlanta, in contrast, seems far away and scary. They have a point; the urban neighborhoods of Atlanta have a very different socioeconomic profile than Newport Beach and must deal with the corresponding issues of a less educated renter base, a less prosperous population, and a higher crime rate. I can confirm that Donna and I don’t feel quite as safe when wandering the streets of the neighborhoods in Atlanta where we search for houses as we do during evening strolls through our quiet neighborhood in Newport Beach. That’s, in part, why a comparable house costs $500,000 in the OC, but only $80,000 in parts of Atlanta.

 When my local house-flipper friends ask how I can be sure that house price appreciation in Atlanta will outpace house price appreciation in the OC over the coming year, I respond that I have no clue about the prospects for short-term price changes. If I had to guess, I would pick the OC as the hotter market. But I am not flipping houses, I explain. I am investing to build long-term wealth.

We can help you buy Rental Property or Flip Houses in any Market:

  1. Rental Income Property Analysis – Excel Spreadsheet Program;
  2. Fix-N-Flip Rehab Analysis Program for Excel.
aside

This Year, I’m Focusing on Rentals Over Flips: Here’s Why

by Leave a Comment

There are different perks to the varied avenues of real estate investing, so how do you choose? Learn why this investor is deciding to focus on rentals.

Which type of Real Estate Investing are you interested in?

Rental Property Income Cash Flow Analysis, or

Fix-n-Flip Home Flipping Profit Analysis

Source: This Year, I’m Focusing on Rentals Over Flips: Here’s Why

aside

Hussman Funds – Weekly Market Comment

by Leave a Comment

The chart below places MarketCap/GVA on an inverted log scale (blue line, left scale), along with the actual S&P 500 nominal annual total return over the following 12-year period (red line, right scale). Note that current valuations imply a 12-year total return of only about 1% annually. Given that all of this return is likely to come from dividends, current valuations also support the expectation that the S&P 500 Index will be lower 12 years from now than it is today. While that outcome may seem preposterous, recall that the same outcome was also realized in the 12-year period following the 2000 peak.

Source: Hussman Funds – Weekly Market Comment

post

Caterpillar has downbeat China outlook

by Leave a Comment

Caterpillar, one of the icons of American industrial might and a “bellwether” for the global economy, has been having a hard time. It forecast that sales would drop 5% in 2016, an IBM-like fourth year in a row of declining sales, the worst such spell in its history.Now Caterpillar threw in the towel on its formerly most promising market, China. Not for the current year, or even next year – those are already toast. But for future years. And for the entire industry.

It isn’t just CAT’s problem; the industry as a whole is getting whacked in China because of China’s economy. That’s Tom Pellette, Group President of Caterpillar Inc., with administrative responsibility for Construction Industries, told the Financial Times in an interview.

He cited some terrible industry-wide numbers for China, without disclosing Caterpillar’s own: in 2015, sales of hydraulic excavators between 10-90 tons are expected to be in the “23,000 range,” he said. Back during the China heyday in 2010, the industry sold over five times as many: 120,000 excavators. This would include excavators from Japanese, German, and Chinese competitors. In March 2011, the industry sold 27,000 units – in just that month! – more than in the entire year 2015!Those were the good times when China’s huge stimulus program from the Financial Crisis was reaching corporate pockets.

“That shows how far off the peak we are,” Pellette said. The market might never get back to where it once had been, despite the official GDP growth rate in the third quarter of 6.9%, which would be considered a blistering hot pace in other major economies that have somewhat less opaque economic reporting.

On September 24, Caterpillar had already warned of another round of big trouble. Its statement – evocatively titled in perfect corporate speak, “Building for a Stronger Future, Caterpillar Announces Restructuring and Cost Reduction Plans” – announced “a total possible workforce reduction of more than 10,000 people…” and “the contemplated consolidation and closures of manufacturing facilities occurring through 2018.”

“At this point, we are experiencing continued weakness in key industries that we serve,” it said, with sales declining “in all three of our large segments,” namely Construction Industries, Energy & Transportation, and Resource Industries.

Shrinkage, shrinkage, shrinkage. Because of the global economy. Because of collapsing investment in mining and energy. Because of “a convergence of challenging marketplace conditions in key regions and industry sectors.” Because of China.

Source: Caterpillar has downbeat China outlook – Business Insider

post

Why Management Loves Share Buybacks – Bloomberg View

by Leave a Comment

When it comes to using stock buybacks for management to compensate itself, the crown might belong to Dell. From 1998 to 2006, according to the New York Times’ Floyd Norris, “Dell reported net income of $17.9 billion — and it spent $24.1 billion buying back stock.” The longer the time period you look at the worse it gets. From 1997 to 2012, Dell purchased $39 billion in shares — more than the company has reported in net income over the entire course of its existence.No wonder it went private.The timing of Dell’s buybacks was consistently terrible, but since the costs were paid by shareholders and the proceeds went to management, the C suite never seemed to care much. Harvard Business Review looked at the phenomena and called it “Profits Without Prosperity.” The runner up to Dell might be Qualcomm. As the Times’ Gretchen Morgenson noted this summer, during the past five fiscal years, Qualcomm repurchased 238 million shares at a cost of $13.6 billion.Despite that huge buyback program, the Times wrote, “Qualcomm’s average diluted share count has actually increased over the period by almost 41 million shares. That’s a 2 percent rise since 2010…because the company has been granting a treasure trove of stock and option awards to its executives.”Qualcomm paid an average of $56.14 a share for stock that now trades for about $4 less. In other words, it overpaid by almost $1 billion.This is a pattern we see over and over. Here’s another pattern: Although many companies seem to buy shares just before they start falling, managers tend to do much better at the timing game, selling their own shares right before the slide begins. Just a coincidence, I suppose. Given a choice between dividends or buybacks, I’ll take the quarterly check. But the bigger question is simply this: Why is management at so many companies bereft of better ideas and more productive uses for corporate cash?Maybe it’s because so much of the proceeds of buybacks end up in their own pockets.

Source: Why Management Loves Share Buybacks – Bloomberg View

post

The Investment Landscape

by Leave a Comment

As an addition to my Optimal Asset Allocation post yesterday, I thought I’d share this graph which helps explain how I view the current investment landscape.

Principle #1: The goal of investment is to beat inflation over the time period which the investment is held.  To paraphrase a Warren Buffett article from 2012 -” investing is the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power in the future.  More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.  From this definition there flows an important corollary: The riskiness of an investment should be measured by the probability — the reasoned probability — of that investment causing its owner a loss of purchasing power over his contemplated holding period.  Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.”

Principle #2: Again to paraphrase Buffett – investors should put more money into their best ideas – those which offer a higher risk-adjusted return.  And the corollary to this principle is “Wait for the fat pitch”, ie. be patient, ignore the daily market moves, and then load up when the market offers a bargain.

With these two principles in mind, the graph below presents my projected asset class returns compared against the expected future inflation rate.  Then I allocate among assets using 1) the Standard Deviation and Sharpe Ratio of returns – as risk measures, and 2) the Kelly Formula – to make sure the best ideas get more money applied to them.

Asset Allocation

The results of my calculations are displayed in the chart on the Optimal Asset Allocation page.

 

post

It’s Mid-October, Time To Optimize Your Portfolio Asset Allocation

by Leave a Comment

Mid-October is the perfect time to revisit and adjust your portfolio’s allocation to bonds, stocks, TIPS, REITs and Commodities.  On October 16th I recalculated the preferred allocation to these asset classes and keep an updated chart on the Optimal Asset Allocation page.  Most significantly, I am putting a little more money to work in international and emerging stocks.  Emerging stock indexes (I recommend Vanguards ‘VWO’ ETF) are trading near 6-year lows due to currency and commodity bear markets, and offer decent risk-adjusted returns – which is about all I can say, no asset class is particularly compelling right now.

For my IRA and 401(K) accounts, I update these allocations twice a year – in mid-October and mid-April.  This timing accords with the well-known seasonal timing strategy proven to beat the market with less risk.

Why focus on Asset Allocation?:  One study suggests that more than 91.5% of a portfolio’s return is attributable to its mix of asset classes.  Individual stock selection and market timing accounted for less than 7% of a diversified portfolio’s return.  William Bernstein says in his book The Four Pillars of Investing, that: “The ability to estimate the long-term future returns of the major asset classes is perhaps the most important investment skill that an individual can possess.”

See the Optimal Asset Allocation page for the percentages.