My High Dividend Stocks Blog

My High Dividend Stocks
This is my high dividend stocks site where I help site members find high dividend stocks with earning power and strong balance sheets.

TIP OF THE WEEK -

Reuters.com has easy to find earnings estimates
December 9th, 2011
Jason Brizic
 
Knowing a company's earning power should help you determine when the company's shares are relatively value priced.  Companies are value priced when they are trading at less than 12 times average adjusted earnings.
 
I like to factor the current year's earnings into my long term average adjusted earnings.  I use Morninstar.com's website to gather the earnings per share, net income, and number of shares for the past five years.  That usually gets me 2006-2010.  But I still need 2011.  I switch the view from annual to quarterly to get Q1, Q2, and Q3 of the current year.  That leaves Q4 as an unknown.
 
This is where Reuters.com comes in.  I use Reuters.com to get an estimate for the next quarter to complete the year.  Its okay if a company beats or misses this estimate because it has little effect on a five or six year average adjusted earnings calculation.
 
Let's do this for one of my favorite stocks, Safe Bulkers (SB).  This data comes from Morningstar.com's financials tab.
(Earnings adjusted for changes in capitalization - Safe Bulkers has issued shares in the past two years)
Year        EPS       Net inc.       Shares      Adj EPS
2006        $1.78     $97 M         55 M         $1.47
2007        $3.84     $209 M       55 M         $3.17
2008        $2.19     $119 M       55 M         $1.81
2009        $3.03     $165 M       55 M         $2.50
2010        $1.73     $110 M       63 M         $1.67
 
For some reason unknown to me Morningstar.com wouldn't show me the quarterly data for Safe Bulkers, so I used Google Finance to find the data I need for Q1-Q3 2011
 
Year        EPS       Net inc.      Shares       Adj EPS
2011 Q1  $0.41     $27.31 M   65.88 M     $0.41
2011 Q2  $0.47     $31.13 M   65.88 M     $0.47
2011 Q3  $0.33     $22.01 M   65.88 M     $0.33
 
Click on the Analysts tab
Scroll down to Consensus Recommendations
You will see Safe Bulkers next quarter consensus estimate of $0.35 per share
 
Now we can complete the estimated earnings for 2011
Year        EPS       Net inc.      Shares      Adj EPS
2011 Q4  $0.35 E  $23.06 M   65.88 M    $0.35
 
Total        $1.56 E  $103.5 M   65.88 M   $1.56 E
 
Compute the six year average adjusted earnings, which equals $2.03 per share @ 65.88 million shares.  Safe Bulkers is trading at $6.16 as I write this, so it is only trading at 3.03 times its six year average earnings.  What a value especially with the 9.79% dividend yield.  However, its stock price will decline in a global recession and a China hard landing so I think you can get it even cheaper in the $3 - $4 range.
 
 
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TIP OF THE WEEK - Create a budget and stick to it

Create a budget and stick to it

Jason Brizic

December 2nd, 2011

Sticking to a realistic budget will allow you to save for retirement or to create an inheritance.  You will need capital to start your side business or to start a new career that will fund your retirement.  Social Security and Medicare are the biggest ponzi schemes in the history of the world.  You can’t rely on them to fund your retirement at all if you are under age 55 right now.  So, you must budget for success later in life so you don’t end up a ward of a dying nation-state.

If you create a realistic budget and stick to it, then you will accumulate saving/capital to achieve your life and retirement goals.  You will reduce your stress levels when you stop living paycheck to paycheck.  Marriage is hard enough without the additional pressures of monthly money problems.  You will also be able to buy goods on sale for cash when you have accumulated savings.  People sell quality assets online (Ebay, Craigslist, the local classifieds) for pennies on the dollar when they get into financial troubles.  The role of the capitalist entrepreneur is to buy these assets cheap and to put them to profitable use by satisfying customers desires.

A generic goal should be to save at least 10% of your pretax monthly income for retirement.  Some people will need to save more and some will need to save less to fund their goals.  However, there are several tasks to complete first before you begin saving for retirement that some people skip.

1.     Use this money to pay down credit card and other high interest debts now (this doesn’t include your house mortgage).

2.     Once those debts are extinguished you can save this money each month to build up your 3-6 month emergency fund.  Let’s face it – there ain’t no job security in corporate America or in the government sector either.

3.     After the emergency fund is filled up you can begin saving for retirement.  I discourage the use of 401(k) plans, IRAs, and other schemes that limit your access to your own property and that the government can confiscate easily to shore up their ponzi schemes.  Here is a taste of things to come: http://www.sovereignman.com/expat/how-the-us-government-will-seize-your-retirement-account/

4.     Use your savings to capitalize your business, purchase precious metals, buy positive cash flow real estate, invest in safe high dividend stocks, and/or buy stable foreign currencies

Go to www.mint.com and create a free account.  You can easily create a budget there and monitor your progress.

P.S. Here is a link to budget for living in California on a $46,000 per year income (now that is some austerity, but considering the median household income in the USA as of 2009 was $50,221 about half of Americans are in this boat) http://www.mybudget360.com/the-perfect-46000-budget-learning-to-live-in-california-for-under-50000/ .

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TIP OF THE WEEK - It's Official: Wall Street Firms May Legally Steal From Their Customers

It’s Official: Wall Street Firms May Legally Steal From Their Customers

Jason Brizic

November 11th, 2011

Desperate people do desperate things.  Don’t make it easy for them to fleece you.

Don’t put all your financial eggs in one basket.  You should own:

·         Your own business (to generate income even in retirement)

·         Physical precious metals (gold and silver coins from you country’s mint)

·         Rental real estate (3 bedroom, 2 bath houses in neighborhoods with good schools)

·         Currencies (US dollars in printed cash, Yen in printed cash)

·         Goods (all the commercial goods you can store that you will consume anyways)

·         High dividend stocks with earning power and strong balance sheets

Wall Street firms and commodities futures firms can legally steal from their customers.  Examine your terms and conditions that you have with your brokerage firm (e.g E*Trade, ScottTrade, etc..).  Minimize your stock holdings as a percentage of your net worth.  I’m targeting only 5%-10% of my net worth for my high dividend stock portfolio.  There are great risks that are going unnoticed by most investors in the world’s bond and equity markets.

I offer this article as proof: http://www.zerohedge.com/contributed/it%E2%80%99s-official-wall-street-firms-may-legally-steal-their-customers

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TIP OF THE WEEK - There ain't no thing such as a free lunch. My tip will still cost you a small amount of time.

There ain’t no thing such as a free lunch.  My tip will still cost you a small amount of time.

Jason Brizic

November 4th, 2011

The Austrian school of economics offers a unified theory of economics.  You probably learned in high school or college the concept of “micro” and “macro” economics.  I’m here to tell you that there is no “micro” and “macro” economics.  There is only one economics based on various economic laws that can’t be overcome by politicians or central banks actions.  The price system, supply and demand, and marginal utility are few examples of economic laws that can be escaped.  There ain’t no thing as a free lunch.  In other words, resources are scarce and will be allocated by individuals who own them.  The dominant economics taught in schools is Keynesian economics.  It teaches that there is such as thing as a free lunch.  Their economics can be distilled down to the slogan, “Federal deficits overcome recessions.”

This video explains the battle between the Austrians and the Keynesians with clarity and humor.  It stars F.A. Hayek (Austrian) vs. John Maynard Keynes (Keynes himself):

Governments and central banks are everywhere in this world interfering with the markets.  Austrian economics offers a causal explanation of how these groups will effect capital and human actions.  Your investments are capital, so you have a vested interest in seeing that it is protected from the harmful actions of governments and central bankers.

You can’t beat something with nothing.  The ideas of Austrian economics can defeat the crackpot theories of Keynesian economics and the Ludwig von Mises institute is determined to do just that.

The Ludwig von Mises Institute offers for these for no money (it will cost you time):

  1. Daily articles
  2. An excellent and enlightening blog
  3. Full length books on economics and liberty (most books are in several formats: PDF, e-pubs, and HTML, etc.) Some must read books include the following:

·         Ludwig von Mises – The Theory of Money and Credit; Human Action (read Rothbard first)

·         F.A. Hayek – The Road to Serfdom

·         Murray Rothbard – Man, Economy, and State with Power and Markets

  1. Audio of articles, lectures, and full length audio books
  2. Videos of lectures, interviews, and audio books with supporting pictures

www.mises.org

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TIP OF THE WEEK - A Free Lesson on How to Read a Financial Report

A Free Lesson on How to Read a Financial Report

Jason Brizic

October 28, 2011

A proposed definition of INVESTMENT from “Security Analysis” 2nd ed. (1940) written by legendary investors Benjamin Graham and Christopher Dodd is particularly appropriate for this Tip of the Week.

An investment operation is one which, upon through analysis, promises safety of principal and a satisfactory return.  Operations not meeting these requirements are speculative.

The phrases thorough analysis, promises safety, and satisfactory return are all chargeable with indefiniteness, but the important point is that their meaning is clear enough to prevent serious misunderstanding.  By thorough analysis [Graham and Dodd] mean, of course, the study of the facts in the light of established standards of safety and value.  An “analysis” that recommended investment in General Electric common at a price forty times its highest earnings merely because of its excellent prospects would be clearly ruled out, as devoid of all quality of thoroughness.

The “facts” that Graham and Dodd are referring to are the financial results that are located in company’s quarterly and annual reports.  You should be able to understand how the company makes a profit, what its assets and liabilities are, and how much cash is flowing into the business.  In general, you should have a basic understanding of how to read a financial report.

Merrill Lynch has provided a short 52 page free report on “How to Read a Financial Report”  It is available for free in PDF format at this link http://tinyurl.com/63yr4qs .  I’ve read this document and it is a great introduction to the contents of the typical financial reports worldwide.

There are more free sources on how to read a financial report available from this Google search http://tinyurl.com/3dxe7xq

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TIP OF THE WEEK - Make Good Use of Your Drive Time

Make Good Use of Your Drive Time
October 21st, 2011

Make good use of your commute to work time. Turn off the radio. Most people have a 23 minute commute. That is enough time to listen to an article or two on your smart phone each way to work using some cool technology.

You can go to to some of your favorite financial websites like www.seekingalpha.com and copy the text of an article into a text-to-speech web app. Or you could copy portions of a quarterly financial statement to better understand how the company makes money. Threads from discussion boards make great audio articles. They are rife with pros and cons of a stock. You can begin listening to your article In about the time it would take to print the article.

I use a text to speech web app called SpokenText. It has a free trial that does not require a credit card. I pay $30.00 a year fee to use it. I use it extensively everyday.

www.spokentext.net

There a over a dozen natural sounding voices, but I use for consistently (Mike, Teagan, Charles, and Bob). These voices do not sound like the robotic voice of Stephen Hawking.

For more tips like this go to: www.myhighdividedstocks.com/tip-of-the-week

TIP OF THE WEEK - Gold is a crisis hedge. Own some before the next crisis.

Gold is a crisis hedge.  Own some before the next crisis.

Jason Brizic

October 14th, 2011

Gold is a crisis hedge.  Rich people buy gold when they are fearful.

There are several good reasons for the wealthy to be fearful right now.  They own more that 80% of all stocks and bonds.  The European sovereign debt crisis is real, the USA will be bankrupted by welfare and warfare programs, and the Chinese economic bubble is going to pop.  Bonds aren’t safe, stocks aren’t safe, and interest rates are at historic lows in many economies.  Gold is a refuge from these crisis events that will not be solved through political means.

The gold price will continue to go up so long as central bankers run their printing presses.  Central bankers such as Ben Bernanke believe in Keynesian economics.  Keynesian economics can be summed up in four words: “Deficit Spending Overcomes Recessions”.  It doesn’t work, but they is what they believe and they are in charge of governments and central banks.

The Federal Reserve under Ben Bernanke has tripled the monetary base since 2008.

Image001

Most of this money is being held by the large commercial banks as excess reserves.  It is not being loaned into the economy.

Image002

Despite gold’s price increases it has not increased in proportion with the inflation of the monetary base.  It has not risen as much because most of the money created by the Federal Reserve has not flowed into the economy to increase the prices of everything.  The newly created money is locked away in the excess reserves of the large commercial banks.  If they were to lend it out, then prices would rise more than the 300% increase in the monetary base due to fractional reserve banking process.  Basically, one dollar added to the monetary base could become 7-10 more dollars in the M1 money supply (depending on how profligate the bankers loans are).

These are the best gold prices since the July-August 2011 timeframe.  Take this opportunity to make your first purchases of some gold coins.  Politicians will announce solutions to the sovereign debt crisis, the FED will announce better economic numbers, and the Chinese will deny they are in a bubble until it obviously pops.  Don’t believe them.  Greece will default.  They are the first domino to fall.  Nobody talks about the Medicare and Social Security unfunded liabilities.  They are too huge.  They are dozens of trillions of dollars.  The Chinese mercantilists have been inflating they currency and their economy.  When they stop their will be a severe recession in China.

Go to www.apmex.com and take a look at the one ounce gold coins from your country’s mint.  Then buy one if you have none already.  I had a good experience with American Precious Metals Exchange in the past.  I get no commissions or anything from them.

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TIP OF THE WEEK - A Second Worldwide Financial Crisis is Coming

A Second Worldwide Financial Crisis is Coming

Jason Brizic

October 7, 2011

The Euro crisis is real and the Euro is doomed.  This will trigger the next global financial crisis and worldwide recession.

<a href=”http://lewrockwell.com/north/north1039.html”>Busted Euro, Busted Dream</a>

The Eurozone is just beginning to implode starting with the PIIGS.  Those governments made welfare promises that they can’t pay for (in Euros).

The PIIGS (Portugal, Italy, Ireland, Greece, and Spain) are running budget deficits above 3% of GDP. This violates EU rules.  But the European bureaucrats are powerless to stop the violators.  You can view this on the following graph. Only Estonia had a balanced budget as of last spring. Germany was slightly above the 3% limit.

http://www.bbc.co.uk/news/business-13366011

Greece will default first.  That is obvious because one year Greek government bonds are yielding over 100%.  Ireland will likely be next and then the rest of the PIIGS will tumble which have much bigger sovereign debts.

Do you want to see how small Greece is in the whole European debt crisis?  Look at <a href:http://www.nytimes.com/interactive/2010/05/02/weekinreview/02marsh.html>this</a> from the New York Times back in December 2010.

The northern European banks lent trillions to the PIIGS.  They will need massive bailouts that dwarf the previous bailouts.  The northern European banks bought default insurance from the American banks.  The US banks are exposed to the European soverign debt crisis also.  The yield curve is flattening and we are going into a second recession.  Plan accordingly.  Read this site to sidestep as much of the calamity as possible.

There will be a time to buy high dividend stocks with earning power and strong balance sheets down at the bottom like in March 2009.  But we aren’t there yet.

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Image001

TIP OF THE WEEK - My Advice for Young People

My Advice for Young People

Jason Brizic

September 16th, 2011

Austrian economist and entrepreneur Robert P. Murphy provides some great advice that I’m already following.

* * * * * * * * * *

Over the last few years I've been freely dispensing financial advice to young people. I usually preface my remarks by saying, "I feel funny telling you what to do with your life, but since I'm bald you know I'm older and that I worry a lot." In the present article I'll summarize my recommendations. I am comfortable reproducing them for wide distribution, because they are conservative tips that would be appropriate in any setting, but are particularly important given my dire views on the Western economies.

Save More

It's common knowledge that if a person has the wisdom and discipline to save for the future, then he or she can eventually enjoy a permanently higher standard of living. However, it's useful to look at a numerical example — such as the one I detail in chapter 10 of my introductory textbook — to see just how significant a higher savings rate can be, on a person's future income. As Albert Einstein reputedly remarked, the most powerful force in the universe is compound interest.

Incidentally, people shouldn't feel guilty about saving more, notwithstanding the handwringing coming from mainstream economists. As I explain in my book, everybody can increase his or her standard of living through saving. In other words, it's not the case that if Alice makes a better future for herself by saving a higher fraction of her income, then there must be some Bruce out there who is going deeper into debt and will suffer a lower standard of living in the future. Society really can save and invest "on net," in the sense that everybody can obtain claims to a growing stockpile of capital goods that make workers more productive.

In the current recession, it's actually more important than ever that people save more. Contrary to Keynesian warnings, if households and firms save more, they will actually speed the general economic recovery.

Develop Multiple Streams of Income

When people hear the advice to save more, they typically think that they should stop going out to lunch, and instead bring a bologna sandwich to work or school. Although one obvious way to save more each month is to reduce frivolous expenditures, that's not the main thing I have in mind.

If a person really wants to start socking away a lot more each month, the best avenue is to boost his income, not cut spending. Particularly for young people (my target audience), there may not be that much room to cut. However, there's no limit on how much (in principle) someone can earn.

Don't misunderstand me. By all means, if a 22-year-old with no steady income is making huge payments on a sports car and rent in a posh neighborhood, then obviously it would be very prudent to move to a cheaper place and to switch to a boring vehicle with 80,000 miles on it. Yet even after plucking such low-hanging fruit, everybody — especially young people — should start brainstorming about how to bring in more income.

"Incidentally, people shouldn't feel guilty about saving more, notwithstanding the handwringing coming from mainstream economists.… Society really can save and invest 'on net.'"

Notice here that I don't simply mean someone who currently works in an office should consider working nights as a waitress. In fact, that's not primarily what I have in mind. Instead, I think young people should consider a host of entrepreneurial ventures. Rather than looking for other bosses, young people should become their own bosses, at least in a few limited areas.

To some people this suggestion may sound intimidating. But notice that plenty of young people are entrepreneurs and they don't even realize it: Anybody who babysits or cuts lawns for neighbors is an entrepreneur. Such kids have to find customers (usually through word-of-mouth) and provide a service for which they get directly paid. That's what an entrepreneur does.

When I have mentioned this recommendation in public settings, sometimes students ask me what sorts of businesses they should start. The short answer is, "I don't know; that's what you need to figure out." The entrepreneur looks around and identifies a product or service that people currently lack but would be willing to pay for, in such amounts as it would be worth the entrepreneur's money and effort to provide it.

The reader should keep in mind that I'm not saying a person needs to brainstorm until finding "it," the fantastic idea that will eventually make someone rich. On the contrary, it's worthwhile doing all sorts of different ventures, so long as each one is self-contained and doesn't threaten to absorb too much time. It may take a lot of trial and error to gain the skills, confidence, and knowledge of customer demand before finding something really profitable.

As with all of my recommendations in this article, generating multiple sources of income is always a wise thing. However, in the present environment it is critical. Even someone who currently has a "good, steady job" can't be sure of his position even a year from now. A young person who inculcates that weekend business now, can expand the business in the unfortunate event of a layoff. But if that same young person, who has always (say) thought of starting a dog-walking service, tries to do so next year when the unemployment rate shoots up to 12 percent, she will be competing with that many more people. It's much better to get a fledgling business established now, during the weekends or other days off, so that the owner will already have a solid base of customers when the economy slumps again.

To reiterate, my advice is not to try to save more by looking at the monthly budget and saying, "Well, this is how much I make, and so if I cut back here, here, and here, then I can afford to put aside $250 more per month." No, I would much rather a person say, "If I cut back here, I can free up another $100 per month. And if I cleaned three houses every Saturday, then after expenses and treating myself to a nice dinner every weekend, I could save an additional $600 per month."

Sell Your TVs

"Everybody — especially young people — should start brainstorming about how to bring in more income."

The most succinct tip I can give, in order to find ways of generating new income, is to sell every TV in the house. I got rid of my TV during one of my frequent moves in grad school. At first I went through psychological withdrawal, but now it would sicken me if someone put a TV in my house. I can't imagine how much it would destroy my productivity. People can still watch their favorite shows on the computer.

Build Up at Least a Month's Worth of Expenses in Cash

Now if a person is saving more each month, the obvious question is: How should those savings be used? I think the first step — and no I'm not trying to sound like Dave Ramsey — is to accumulate at least a month's worth of cash. (Depending on the person's preferences and habits, it could be best to put this cash in a can in the closet, in a bank checking account, or in a bank savings account.)

The point of doing this is to get out of the habit of living paycheck to paycheck. Such a lifestyle is bad for (at least) three reasons: Most obvious, it leaves a person vulnerable to even a minor setback. If there is an unexpected expense, or if the person gets laid off, then obviously a small cushion of cash would be crucial.

Yet beyond this obvious justification, there are two other reasons that building up at least a one-month window of cash balances is a vital, immediate step. First, it frees up more time, especially for a person who has followed the earlier steps and is now earning income from several sources. Rather than having to run to the bank every time a new check comes in the mail, and rather than having to go online and check the bank balance every other day to make sure nothing is going to bounce, a person with at least a one-month cushion can better afford to let the paychecks and bills accumulate, then deal with them in one fell swoop. This allows for the person to spend more time focusing on the business(es), rather than stressing out about cash flow.

The other main reason the paycheck-to-paycheck mentality is destructive for the entrepreneurial person, is that the person is more prone to goof off whenever he's done enough to "get through the month." But once that critical threshold has been extended past the one-month barrier, there is little difference between having enough to pay for one month versus two or three months. Once a person takes it for granted that he will have money left in his checking account even after paying all his bills for the month, that surplus will mysteriously begin to drift upwards with each passing month.

Tithe or Give to Charity

It seems counterintuitive, but when a religious person tithes (or when a nonreligious person gives to charitable causes) there is somehow more money each month to work with. For tithing — where a person is supposed to give a specific percentage of income to the church — I think it's because the practice forces a person to stay on top of his finances.

You Can Donate Now

More generally, by focusing attention away from oneself, things become clearer and it's easier for a person to do the "responsible" things like avoiding impulse purchases and doing the extra work needed to bring in more income.

This last point is crucial for people who are suffering from depression and are in a financial hole. Part of what keeps them there is that, deep down, they don't think they deserve to live stress free like the other people they see around them, who somehow have their act together and don't let bills pile up on the kitchen table. By bringing in the church (or a charity that the person really respects), the depressed and financially beleaguered person can stop dwelling on self-loathing and instead focus on helping others.

Eliminate Variable-Rate Debt as Quickly as Possible

If a person already has a decent amount of cash on hand, I think the next goal should be to eliminate variable-rate debt as quickly as possible. The most obvious example is credit-card debt rolling over at an APR that moves with the prime rate. If the dollar crashes as many Austrian economists fear, we can expect massive jumps in interest rates. This will wipe out many people who thought they were doing just fine the month before.

Note that "eliminating" variable-rate debt doesn't have to mean paying off the balances. Using a new balance-transfer promotional offer, for example, might allow a person to lock in a fixed rate for a year or more.

I have written on these pages about the pros and cons of credit-card use. Unlike my other suggestions, this particular one — namely to get out of variable-rate debt quickly — is based on our current situation, where I believe there is a real danger of interest rates spiking with little warning.

Acquire Some Physical Gold and Silver Coins

Once a young person has accumulated at least a month's window in cash and has neutralized variable-rate debts, I think an excellent outlet for some of the saving each month is the acquisition of gold and silver coins. These don't need to be collector's items; in fact my favorite thing is "junk silver," because if the Big One comes it will be easy for other Americans to recognize US coins that were minted before the 1960s and have an easily verifiable silver content.

$25 $22

"Anybody who babysits or cuts lawns for neighbors is an entrepreneur."

From an Austro-libertarian perspective, the other great benefit of buying at least some physical gold and silver is educational: This is what genuine, market-produced commodity money feels like.

Conclusion

The above tips are mostly common sense. Except for the warning about variable-rate debt, they are good ideas in any setting. Yet they are particularly important, especially for young people, in our present environment.

In closing, I want to stress that I am by no means a role model in this arena. I can write with confidence on the above matters precisely because I have seen firsthand what happens when you don't follow those guidelines. If you want to keep your hair, you will give serious consideration to my recommendations.

Robert Murphy is an adjunct scholar of the Mises Institute, where he teaches at the Mises Academy. He runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to "Man, Economy, and State with Power and Market," the "Human Action" Study Guide, The Politically Incorrect Guide to the Great Depression and the New Deal, and his newest book, Lessons for the Young Economist. Send him mail. See Robert P. Murphy's article archives.

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TIP OF THE WEEK - One of the best websites on contrarian investing

One of the best websites on contrarian investing

Jason Brizic

September 2, 2011

Most people follow the herd.  Contrarians go against the grain.  They buy when others sell.  They sell when others buy.  They fish the bottoms below value investors when buying equities.

They say, “You make your money when you buy.”  This is another take on “buy low; sell high”.  Contrarians practice the art and science of buying low – really low.

I discovered an excellent website called Zeal LLC that specializes in contrarian investing.  Their website is www.zealllc.com .  It’s a good blend of technical analysis and fundamental analysis.  There are several years of essays available for free.  Read a few of their current articles and you will pick up some good insight into stock and commodity markets.

Here is a sample article on the volatility index (aka the fear index).  I watch the volatility index weekly.

* * * * * * * * * *

Stock Fear Ceiling

Adam Hamilton     August 26, 2011     2923 Words

 

Fear is the greatest buy signal ever seen in the stock markets.  This overpowering emotion flares fast, driving excessive selling that rapidly hammers stock prices down to irrational oversold levels.  These fear-driven lows are the ideal time for investors and speculators to buy low, necessary before selling high later.  Provocatively stock fear has an effective ceiling, absolute levels that demand aggressive buying.

 

I mentioned this stock fear ceiling in passing a couple weeks ago in my latest essay on trading stock fear.  I heard from a surprising number of traders interested in this concept, for good reason.  If stock fear has a ceiling, it would flag the highest-probability-for-success buying opportunities ever seen.  Whenever this ceiling was hit in the future, it would be the ultimate signal to boldly deploy capital regardless of events.

 

While fear is ethereal and can’t be measured directly, plenty of sentiment indicators infer it.  The most popular by far is the famous VIX (pronounced “vicks”).  Discussed often in the financial media, this measures the implied volatility of certain S&P 500 index options.  The S&P 500 (SPX) is America’s flagship stock index tracking this nation’s biggest and best companies, and the best proxy for the stock markets as a whole.

 

The VIX uses complex formulas to analyze and weight SPX options prices expiring over the next 30 calendar days.  Traders are constantly buying and selling options based on their own near-future outlook, which bids up or drives down specific options’ prices.  The aggregate of all this short-term SPX options trading is distilled down into implied volatility, or how volatile options traders as a group expect the stock markets to be.

 

The VIX expresses this construct as an annualized percentage.  A 20 VIX reading implies that options traders expect to see the SPX move up or down at an annualized rate of 20% over the next 30 calendar days.  Since fear is a far-more immediate and powerful motivator than greed, options volatility soars after major selloffs (the time to buy low) before waning to insignificance after major rallies (the time to sell high).

 

Despite the VIX’s popularity, it is a watered-down usurper.  Today’s VIX was created in September 2003 to replace the classic VIX, which is now known as the VXO.  That original VIX only looked at options for the elite S&P 100, the top 20% of S&P 500 companies.  And it only used at-the-money options.  While this methodology lives on in the VXO, the new VIX changed how it is calculated.  Today’s VIX considers options for the entire S&P 500, including out-of-the-money ones.  This makes it less responsive to fear.

 

This is a problem for a fear gauge.  During sharp selloffs that spark intense fear, the first stocks to be sold are the biggest and most-liquid ones.  They have the large volumes and liquidity necessary to absorb the widespread exodus of capital without suffering anywhere near as much price damage as smaller less-liquid companies.  And at-the-money options’ prices are always quicker to respond (with bigger moves) than out-of-the-money ones.  So while the new VIX works, the classic VXO remains superior.

 

Fear shows up quickest and largest in at-the-money options representing the largest and most-liquid companies in the US stock markets.  Thus I continue to use the original classic-formula VIX, now known as the VXO, in my stock-market-sentiment research.  If you prefer the new-formula VIX, it would still lead to the same conclusions.  A less-responsive thermometer still gives you the temperature.  But with its history only extending back to 2003, its track record pales in comparison to the VXO’s since 1986.

 

As the classic fear gauge, the VXO is the best sentiment indicator to flesh out the concept of a fear ceiling in the stock markets.  This first chart shows the SPX superimposed over the VXO since 1996.  While the VXO’s history extends back a decade earlier, there was only one major fear spike in that entire span.  So the past 15 years out of the last quarter-century are the relevant ones to illustrate the fear ceiling.

 

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And these 15 years have been extraordinary indeed!  They witnessed the once-in-34-years transition from secular bull to secular bear in early 2000 as the Long Valuation Wave crest passed.  They saw three cyclical bulls alternating with two cyclical bears within these longer secular trends.  They encompassed booms and busts, a popular tech-stock mania and a stock panic, sovereign-debt defaults and currency routs, wars and political turmoil, unprecedented terrorist attacks, and every kind of disruption under the sun.  It’s hard to imagine a more extreme 15-year period!

 

Yet despite all this, with one notable exception I’ll get to later the VXO never materially exceeded 50.  A 50ish VXO is the absolute fear ceiling of the stock markets in normal conditions, meaning times when an ultra-rare panic or crash is not upon us.  At every single one of these 50ish approaches in the past 15 years, traders were utterly terrified, convinced the stock markets were thundering off a cliff.  Yet fear still didn’t surge any higher, I suspect it couldn’t.  VXO 50 is the effective limit.

 

When you think back to some of these events that spawned extreme fear, like August 1998’s Russian debt default or the September 2001 terrorist attacks in the US, it’s hard to imagine anything scarier.  These events and several others galvanized the whole world, sparking extraordinary anxiety and fear.  Other than ridiculous scenarios like global thermonuclear war or an alien invasion, it’s hard to imagine traders worldwide being any more frightened.

 

Yet the VXO still peaked near 50 consistently.  A 50 VXO means the annualized change options traders expected in the stock markets over the coming calendar month was 50%!  At VXO 50 options traders believe there is a one-standard-deviation chance (68%) that the S&P 100 (and broader SPX) will either soar or plunge at a 50% annualized rate over the next 30 days.  This obviously isn’t sustainable.

 

Whenever traders are terrified enough to expect such gigantic moves, which only happens after extreme selloffs, the selling has already passed.  Fear works this way in general too, with its maximum levels happening just as the threat is gone.  In a haunted house for example, it is anticipation that builds fear.  Once the actor with the bloody mask and chainsaw jumps out and screams at you, peak fear has already passed.  When options traders expect the worst is exactly when the worst has just been seen.

 

Yes, stock panics and crashes like 2008’s and 1987’s see fear soar to a whole new level and shatter the VXO 50 ceiling shown above.  But these events are exceedingly rare, and only happen at very specific times in the bull-bear cycles.  They are essentially once-in-a-generation fear super-spikes.  In normal market conditions that aren’t panics and crashes, 99%+ of the time, VXO 50ish is fear’s absolute ceiling.

 

The stock markets can be viewed as an endless sentiment wave oscillating between extreme fear and extreme greed.  If you want to buy low and sell high, you have to “be brave when others are afraid, and afraid when others are brave” as legendary contrarian investor Warren Buffett put it.  This means buying when everyone else is scared (high VXO), and selling when everyone else is greedy (low VXO).

 

The next two charts zoom in to show all the VXO 50 episodes of the past 15 years in more detail.  Since fear mushrooming extreme enough to slam into this absolute ceiling is pretty rare, I also considered lesser fear spikes running from roughly VXO 40 to VXO 50.  This is the high-probability bottoming zone all investors and speculators should welcome with open arms.

 

Every VXO closing high is labeled, along with the number of days it is offset from the actual bottom in the SPX.  Normally this is zero, VXO highs occur exactly on major SPX lows.  But sometimes the stock markets will grind along and take a week or two to bottom, slumping to a slightly-lower secondary low after fear is already bleeding off.  In addition, the best SPX gains seen within the immediate subsequent one-month and two-month periods following each VXO high are noted.

 

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As you can see, buying fear spikes is incredibly profitable.  It doesn’t matter whether the stock markets happen to be in a secular or cyclical bull or bear, they always rally sharply after fear grows too extreme.  The excessive fear forces stock prices to be battered down to irrational oversold levels, so as that unsustainable fear inevitably abates stocks soar as capital floods back in.  The gains are huge!

 

This essay would grow far too long if I analyzed every major VXO high in detail.  But take a look at the kinds of gains across all of them.  On average over this incredibly-chaotic span between 1997 and 2003, the SPX soared 13.0% sometime within the first month after a VXO peak and 16.4% sometime within the first two.  After extreme fear comes extreme rallies, running as high as +19% within one month and +24% within two!

 

These are not only incredibly-large and fast gains, but they are in the broader markets.  Many investors and speculators prefer individual stocks in leveraged sectors like commodities or technology.  Since these high-flying popular stocks are battered much lower during fear spikes, they soar much faster coming out of them.  Their gains often double or triple those seen in the broader SPX.  Buying great commodities stocks during extreme fear spikes can easily yield 50%+ gains within a couple months!

 

Since these awesome buying opportunities are rare, as the VXO doesn’t often soar into the 40s or hit its 50 ceiling, contrarian investors and speculators shouldn’t hesitate to capitalize on them.  The higher the VXO gets, the more cash (raised from selling high near the preceding interim top) should be immediately plowed into high-potential stocks you want to own.  Since these fear spikes are fleeting, this stock research into what to buy must be done well before the short-lived when to buy arrives.

 

While 1997 to 2003 may seem like irrelevant ancient history to some, it is crucial in establishing the importance of the VXO 50 fear ceiling in normal market conditions.  This next chart extends this analysis to the modern period of big fear spikes running from 2008 to 2011.  While 2008’s once-in-a-century stock panic was an obvious exception, outside of it the VXO’s high-odds bottoming zone held strong.

 

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2008’s ultra-rare stock panic drove a fear super-spike the likes of which hadn’t been seen since the last extreme selling event in October 1987.  On October 19th, 1987 the stock markets crashed with the SPX plummeting an unbelievable 20.5% in a single trading day!  This blasted the VXO from its prior-day close of 36.4 straight up to its all-time high of 150.2!  Actual crashes easily shatter the normal stock fear ceiling.

 

After that the VXO never even came close to breaking out above 50 again until October 2008, fully 21 years later.  During another crazy-brutal selloff over a two-week period ending October 10th, the SPX plunged 25.9%!  This drove a VXO super-spike to 86.0, and a secondary selloff 6 weeks later once again pushed the VXO up to its panic peak of 87.2!  Panics also easily rocket above the VXO 50 ceiling.

 

But this certainly doesn’t mean a panic or crash should be expected every time the VXO nears 50, far from it.  These extreme selling events are exceedingly rare, so expecting them is usually irrational.  On one terrible day in US history, terrorists hijacked airplanes and flew them into skyscrapers.  So every time a jet is seen in the sky, should skyscrapers be evacuated?  Ultra-low-probability events shouldn’t be weighted highly.

 

In our entire lifetimes, we have only seen a single stock panic and a single stock crash.  Even in the past century, there have only been a couple of each!  The panics were in 1907 and 2008 while the crashes were in 1929 and 1987.  These events are exceedingly rare because it takes decades for complacency to grow extreme enough to fuel such massive fear blowouts.  They are once-in-a-generation occurrences.  Expecting another panic or crash soon after the last one is like expecting another massive wildfire in an area recently burned out by one.  It can’t happen because there isn’t sufficient time for enough new fuel to grow back in.

 

Panics are 20%+ plunges in the stock markets within a couple weeks, while crashes are 20%+ plummets within a couple days.  Panics only cascade out of lows deep and late in cyclical bears, representing the capitulation selling climax of those bears.  Crashes only erupt from multi-year highs at the ends of 17-year secular bulls.  If it hasn’t been decades since the last panic or crash, and the stock markets are not in the right place in their bull-bear cycles to spawn them, they aren’t going to happen.  They are irrelevant for fear-ceiling purposes unless the stock cycles are favorable for one, which isn’t often.

 

Since 2008’s panic there was one major fear spike last summer, but it was sloppy.  A variety of crosscurrents dragged the SPX to a secondary low after the initial VXO peak, which moderated the immediate gains considerably.  But even if you had bought stocks in that early fear spike as we did, the resulting gains over the next 6 months were huge as the SPX belatedly rallied as expected.  Many of our commodities-stock trades added during summer 2010’s fear spikes were realized last winter at 100%+ annualized gains!

 

And all this brings us to this month’s massive fear spike, where the VXO rocketed near 50 for the first time since the stock panic!  Not coincidentally, this happened to be during the second correction of this SPX cyclical bull.  Traders have been terrified in recent weeks, utterly convinced that European sovereign debt, or European banks, or Obama’s out-of-control spending, or the resulting USA debt downgrade are going to soon push the US stock markets over a cliff.  Fear has been incredibly intense.

 

But fear was equally intense during all the VXO 50 spikes in the past quarter century as well, yet the markets still rallied dramatically.  Each time the VXO slammed into its effective ceiling in normal market conditions, the SPX rallied sharply soon after.  Such extreme fear forces everyone susceptible to being scared into selling anytime soon into dumping their positions immediately.  This soon exhausts all available selling pressure leaving only buyers, who soon ignite the massive and sharp post-fear rallies.

 

Fundamentals are irrelevant when fear peaks, things always look the worst after the stock markets have fallen hard.  Sharp stock-market selloffs lead to a bearish selection bias among the financial media and traders, they choose to dwell on the most-pessimistic stories they can find while ignoring any positive ones.  After being hyper-oversold in a major fear spike, capital floods back into stocks no matter what is going on fundamentally in the global economy at large.  Bull or bear, recession or not, it doesn’t matter!

 

I started my own research into VXO spikes way back in the summer of 2002, and have been well aware of the VXO 50 ceiling ever since.  We bought aggressively each time it was seen, and recommended our subscribers do the same.  They’ve earned fortunes by steeling themselves to buy low when everyone else was scared and then later sell high when everyone else was greedy.  We bought aggressively during 2008’s stock panic too, even though I hadn’t anticipated an ultra-rare VXO super-spike.  Their great rarity makes them inherently unpredictable.  It didn’t matter though, the subsequent gains were still enormous the following year.  Excessive fear must be bought!

 

Extreme fear flags the best buying opportunities ever seen, the lowest stock prices possible.  And VXO 50 is as high as fear gets the vast, vast majority of the time.  So when this latest VXO 50 spike emerged in early August, needless to say we started buying aggressively.  In our popular Zeal Speculator weekly newsletter, we’ve added 13 new stock trades and 6 new options trades in August alone!  I fully expect these to soar to massive gains over the coming months as the stock markets inevitably recover.

 

While buying fear isn’t easy psychologically, it is necessary if you want to buy low.  Fighting the crowd yields amazing gains over time.  Since 2001, during a tough sideways-grinding secular stock bear, all 591 stock trades recommended in our newsletters have averaged annualized realized gains of +51%!  We didn’t achieve this by buying high when it felt good and selling low when everyone was scared, but by doing the exact opposite.  If you want to thrive in the stock markets, subscribe today to our acclaimed weekly or monthly newsletters!  Learn how to see the markets and trade them like a contrarian.

 

The bottom line is stock fear has a ceiling, and that is represented by a 50ish VXO.  While this ceiling won’t hold during panics and crashes, those ultra-rare once-in-a-generation events aren’t worth worrying about the vast majority of the time.  Normally whenever the VXO surges to 50, it is time to buy aggressively as fear has peaked so a huge stock-market rally is imminent.  This is true in secular and cyclical bulls and bears alike.

 

And just a few weeks ago, the VXO once again slammed into this effective ceiling.  Fear was incredibly intense, with perma-bears, chicken littles, and pessimists coming out of the woodwork to call for a continuing stock plunge.  But market history clearly shows that expecting the stock markets to head lower after a fear-ceiling approach is almost never the right bet to make.  Extreme fear should always be bought!

 

Adam Hamilton, CPA     August 26, 2011     Subscribe

Link to original article: http://www.zealllc.com/2011/fearceil.htm

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