Investing Journal: Investing

Enron: The Smartest Guys in the Room documentary on PBS

Thu, 03 May 2007 20:19:18 GMT

A very well-done documentary on the fall of Enron is on PBS this weekend here in Seattle on Sunday at 11pm.

Check it out to see how amazingly far the corruption went. I love MSN Remote Record with my Media Center.

http://tv.msn.com/tv/episode/independent-lens/enron-the-smartest-guys-in-the-room

How much do I need to save?

Mon, 08 Jan 2007 07:32:06 GMT

An article in the August 2006 edition of AAII Journal (paid subscription), called "Analyzing Your Financial Health Using Personal Financial Ratios," got me thinking about my lifetime plan. The article talks about three ratios that you should track to gauge your financial health:

Savings-to-income
Debt-to-income
Savings-rate-to-income

The idea is that you start saving when you're 30 years old, and you have a lot of debt, due to a house or whatever, and you have little-to-no savings. The goal of the model is to have no debt, and 12 times your income in savings when you retire. The model assumes that the market will have a real return (inflation adjusted) of 5% per year (~2% less than average), and that you can withdraw 5% a year, which should generally last as long as you live. (More on these assumptions below).

Given these constraints, you need to save 12% of your yearly income. If you follow this model, you'll have paid off your debt, and you can then retire at age 65 on 60% of your income, with 20% supplemented by Social Security, and since you don't need to save the 12%, you should be fine on 80% of your income.

The wiggle room you have, is that many of us are able to live on less than 80% of our income if required to, especially once you get housing out of the way. There's a chance that the stock market will suck, but you can't prepare for everything, and you'll just have to reduce expenses.

Thanks to my investing hobby, I find myself being frugal to be able to have more money to invest, and I'm doing quite well on the savings-to-income and savings-rate-to-income ratios. My mortgage is too high so I'm over on the debt (according to a table in the article, you should have 1.7 times your income in debt at age 30), but that's ok, because I'm still on track to pay it off by the time I'm 65.

As I was thinking about this, something really, really important hit me. I realized that I'm on track, given average market returns, to have a good retirement. Did you notice the big caveat in that sentence? "Given average market returns." What happens if the market doesn't achieve average returns? Sure the 5%/5% above was slightly cautious, but it is also possible that the 5% rate of return / 5% withdrawals is too optimistic, although over 35 years, that would be surprising. Most of my investing research and education that I've done is me trying to get the highest rate of return possible relative to the market. Well if I achieve average market returns (7%), I'd be looking at having at somewhat luxurious retirement. So whether I get 7% or 8% (inflation adjusted), doesn't really matter. I'd be rich enough. The most important thing is being protected if things go wrong, which can include poor market returns, or having the right insurance. I don't have earthquake insurance on my house, but having it would barely reduce my standard of living (~$200 per year), but not having it could surely make me have a retirement well below my current expectations. It's making me take a closer look at risk, which fortunately, is what the Unexpected Returns book I'm reading is covering, so I'm sure I'll be covering it in the future.

The Year Ahead - 2007

Thu, 04 Jan 2007 07:48:59 GMT

I'm not one to make short term predictions about what I think will happen, because frankly I think that's impossible. However, I spent some time reading up on various analysts reports online and in Fortune and Business Week, and noticed surprising amount of bullishness for the year ahead; so I thought I'd summarize the points I liked, and define my strategy for the year. 12 of 12 analysts polled by Bloomberg expect a rally next year, and the last time they've done that is in forecasting 2001, which seems odd to me, given the fact that the yield curve was inverted during most of 2000. Also, Business Week's long list of analysts' had average expectations of about 8% return. Slightly low, but most of them were positive. 8% is probably the safest number you can pick. Anytime the consensus is saying buy, and has been for awhile, you'll surely want to get out before they start saying sell, and it's not likely that if stocks do well this year, that many people will be able to be so bullish next year.

Fortune's annual "Investor's Guide" has two really good articles, one where 5 investment strategists are interviewed (video), and another about the high level of corporate profits. The 5 strategists all pretty much agreed that 2007 is not a year to take a big risks. They all preferred large cap, blue chip US and global companies.

One of the 5, Abby Chen says that despite the potential economic problems (which I'll get to later), yes "growth will be slower, profit growth will be slower, but the Fed can stay friendly longer, and we will have a longer-lasting economic profit cycle." However, according to Jeremy Grantham (Chairman of GMO), who was the only one who was very cautious, suggesting a mere 5% annual return was what we should expect over the next 10 years. (Note that I applaud Fortune for not giving silly 1 year price targets, but having the bulk of the discussion about what the long term looks like, and what short term inefficiencies that investors can take advantage of). Grantham's explanation of his low expectations: "Basically profit margins. I've been born and bred on the understanding that capitalism is based on competition bringing down excessive profit margins and allowing depressed margins to rise back.... If they don't go back to trend, it will be the first time in history."

The second Fortune article greatly expands the idea that "corporate profits are at their highest level since 1929," and that reversion to the mean is likely. The article is very similar to another article I read recently, called Beyond the Horizon, by Crestmont Research. The image below illustrates what's happening:

Fortune's numbers are slightly different, in that 2004 is at 10.1%, which is the highest ever, and 1929 peaks at 8.9%, but that's not really important. It's clear that profit margins are cyclical, and while they may continue to be above average for a short time, they will surely fall. I find it funny that a Banc of America advisor says this: "I think profits can stay at their loft levels as a percentage of GDP." Apparently because the "flat world" is making companies so efficient. Looking realistically at the economy, as new technologies arise, such as computers, the internet, and globalization, the companies that employ these technologies effectively are able to work more efficiently, and reduce costs, and increase profit margins. The higher the profit margins, the more people will decide to start a business, rather than invest in someone else's business. As profit margins increase, and stock prices along with them, it becomes much more profitable and less risky, to start your own business. The more businesses, the more margin compression, which will bring the average profit margin down, most likely shooting past average to below average. It really seems inevitable. I'm sure I'll have more to say on this later, since I'm starting to read "Unexpected Returns" by the author of Crestmont Research.

Back to the initial Fortune article, other analysts note that it's the 3rd year of the presidential cycle, which typically yields great returns thanks to potential presidential stimulus. A few extra insights indicate that the US consumer is in trouble, and to avoid companies that cater to the low-middle class, and that because of the likely decline of the dollar, real estate could be attractive in the long term.

Everyone pretty much agreed that risk was underpriced, especially Grantham. After others mentioned that blue chips are cheap, Grantham said that "it's not that these guys are cheap. It's that risky things have become extremely expensive.... Lower-quality stocks do exceptionally well when volatility is down, and high-quality stocks do exceptionally well when volatility goes up." And volatility is really low.

Now for my strategy. I currently have 25% of my 401K in cash, and have bought PSQ (short QQQQ) in my other accounts as a hedge (I have long-term stock holdings that I'd rather not sell). I also have increased my 401K allocation to Royce Low Priced Stock, because it's positioned for a below average year with lots of natural resource stocks. I'm considering going more into cash, I'm just looking for either a further rise, or a signal of a drop to make a move. I recently heard an advisor say that the fundamentals of the market aren't that good (citing many things mentioned above) but the upward trend is so strong right now, that it's not the time to bet against it. Tough to argue with that.

To finish off, I thought I'd mention Microsoft, which almost ended the year above $30, and almost beat the S&P 500 for the year. I stand by my argument that MSFT is spending too much money, and that the stock is overpriced. Although I guess it's not the high expenses that's really the problem, it's the fact that Xbox, MSN/WL, and Zune aren't producing enough profits. I'd wager that you'll do better in a money market fund than in MSFT in 2007.

Employee Stock Options - Hold them until expiration

Wed, 15 Nov 2006 05:24:37 GMT

Now that employees at Microsoft are starting to talk about selling their stock with the recent highs, I hear of some employees who keep their ESPP stock (Employee Stock Purchase Plan - where employees can buy stock for a 10% discount) but sell their options. I want to explain why this is a bad idea.

The following table illustrates a scenario of someone who owns stock and options, and how much they would make for selling (or exercising and selling) at a given price.

Sell at:	$25	$30	$35	$40	$45
100 Stock	$2,500	$3,000	$3,500	$4,000	$4,500
500 Options (25 Strike)	$0	$2,500	$5,000	$7,500	$10,000

As you can see, today (at ~$30), the worth of 500 employee stock options is very close to the worth of 100 shares of stock. However, over 5 years, at 10% growth per year, the stock should be worth around $45, at which point options are worth double the worth of the stock. Options are leveraged, and thus they make much more money when the stock goes up. Of course, looking the other direction, you can lose everything with options, and I think this is why Microsoft employees may be considering selling. As an additional data point, you can buy stock options on the open market with a strike price of $25 that expire in Jan 2009 for $7.10, which is nearly $3 more than you would get if you exercised and sold. Why would you exercise to make just $4.23? (Employee Stock Options are non-transferable.)

As I mentioned in my analysis of MSFT stock, the stock hasn't moved in 5 years, giving employees the impression that it might not move in the future, and that they should take their gains while they have the chance. My prior analysis should have left you with the impression that the stock is not going to move sideways for another 5 years (despite my thinking of $30 as a resistance point). The P/E of the S&P 500 as a whole is between 17 and 18, so with Microsoft at 24, it's reasonably priced given its potential to increase profits in many areas. My point is that the stock will go up over the next several years, so hang onto those employee options. Once they're a few months away from expiration, start looking for a good market peak to sell them.

On Managing Risk – Paul Merriman

Fri, 27 Oct 2006 17:01:42 GMT

Paul Merriman recently sent out an article to email subscribers about managing greed and fear. I'm just going to quote:

"In the very good times, it seems as if investing is about accepting wealth. You put down your money, almost like planting it in a garden, and watch it grow. But in fact, in good times and bad, investing is really about managing risk and managing your emotions. If you want to be a successful investor, you've got to do at least a decent job at both those tasks."

"Risk is not imposed on you from outside. It's something you choose and accept."

I subscribe to Paul's blog, and email newsletter. His investing style is buy-and-hold, widely diversified, which can be boring, but his returns really speak for themselves. You'll never want to use the S&P 500 as a benchmark again after you see the returns on his sample portfolios. He doesn't track the returns on his website, but I like to use DGEIX as a proxy (15% YTD). The ultimate buy-and-hold strategy best explains his advice, and you can get his practical advice on www.401khelp.com, which has model portfolios for the Microsoft 401K and other major companies.

Market Outlook

Mon, 16 Oct 2006 16:20:07 GMT

I've seen 2 articles this weekend parallel the market situation currently to the times before the 1987 drop. I don't necessarily agree with all of the parallels, but these are the articles:

http://www.equitrend.com/equinews.aspx?week=mZCq3BRvphA=

http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/ManicMarketIgnoresTheBadNews.aspx

Combined with so much instability in politics and housing, the inverted yield curve, and the fact that the markets have already returned 8-12% YTD, I'm getting a little worried about the future. The steady upward slope of the indexes for the last 3 months will have to break at some point. Also notice Russell 2000 extending above the trendline recently. And MSFT has gained 27% in 3 months…

Watch out. Now is the time to be careful.

Simplest 401K strategy best?

Fri, 06 Oct 2006 19:20:17 GMT

A few friends and I have a quarterly contest to see who can achieve the best 401K results. This year's winner so far YTD (as of 9/29) is DJ with 13.4%. He only owns 3 funds, never trades, and he chose the 3 most different stock funds he could for diversity. Here are the picks with YTD returns:

ING International Value I - 17.01%
Vanguard Value Index Instl - 13.40%
Royce Low Priced Stock Inst - 8.8%

These 3 just happen to be the 3 best performing funds in the 401K. Good job DJ.

He'd be slightly hurt if growth came back into style, because he has a strong emphasis on value, but since value has outperformed growth long term, it's not such a bad idea.

Current activity with 401K and MSFT

Fri, 06 Oct 2006 19:11:49 GMT

Just thought I'd update mentioning that I've recently made changes to my 401K, and my outlook on MSFT.

401K

I've recently gone to 20% cash in my 401K because of the inverted yield curve and general market instability. The rest of my money is fairly evently distributed, with 20% in international, 20% in small caps, and the rest spread around some others. Oh, by the way, I do like our new Vanguard Small Cap Growth Index option (VANG SM CP GRTH INST), I just wish it weren't growth, and were either value or blend). I plan on leaving 10% in Managers Microcap fund (which will obviously decline in percentage over time since it's closed), because I think having some Microcap will provide added diversity.

MSFT

I think MSFT is way overpriced, and that we should be below $26 to be fairly priced. I base it on the larger spending, and thus slower growth in the coming several years. I think that our spending won't turn into significant profits for years to come, and that Zune, Vista, and Windows Live will not suddenly bring more than anticipated revenue. I really don't understand how the market can drop the price of the stock 15% on earnings forecasts, and then forget it, and revert to the prior price. Did you notice that since the day before the 11% drop (4/27) we're outperforming the Nasdaq?

Current market analysis

Tue, 01 Aug 2006 05:10:36 GMT

Looking at the slight market recovery of the past 7 days, there has been a strong 4% rise in the QQQQ, which gives the appearance that the market is heading up. However, the tell-tale sign that that market is not likely heading up, just looking at this simple graph is the declining volume. For each of the last 5 days, each of which has had a new market high (intraday), the volume has dropped. The market follow-through day I mentioned I was looking for last week never came, and since the window has now past, I think it'd be pretty safe to plan on the market breaking back down before recovering.

I haven't figured out how to make photos look good in Spaces yet, so excuse the ugliness. I love blogging from Word 2007, but I don't have it at home yet, so excuse the clumsiness, and misspellings for a little while longer. Link to QQQQ 3-month chart.

ATI and market conditions

Tue, 25 Jul 2006 06:22:49 GMT

While this blog is partly for me to keep public notes of decisions, and ideas I have about investing so that I can look back and see what made me think a certain thing, or how I reacted to a certain situation, I find that I rarely actually write those types of personal posts. Or maybe it's just that I don't really know what to think in certain situations. :) Anyway, here are 2 overdue posts.

ATI (ATYT) and NVDA have been on my watch list since I started working at Microsoft since I learned that Windows Vista would have GPU accelerated graphics. While I've purchased each since I started, it had been a while since I opened a position, and with Vista about to ship I decided it was time to revisit them. I went to the MSN Moneycentral report generator, and printed out 2 reports for NVDA and ATYT to see which would be the better purchase. Choose all the options you want there, and then bookmark the resulting page. Then when you want to view a new stock, just change the URL to include the new symbol. (MSN doesn't save your checkboxes, so you have to get around it like that.) Anyway, so I printed the reports, and dove into NVDA and ATYT's fundamentals. I simply compared them against each other, not with any benchmark or goal. I found that NVDA was worth as a company twice as much as ATI, while sales between the two are almost identical, but NVDA has much better earnings. NVDA's growing a bit more steadily, and while ATI has had some struggles, it looked to me like it would benefit most from a strong year for the graphics industry. Simply because their sales were comparable, but valuations were half. I decided to buy both ATI and NVDA, but more ATI. Today AMD announced they were buying ATI at a 18% premium to ATI's current price. Lucky me (except that this means that I no longer can benefit from a potential huge ATI stock price increase). Now I have to decide if I want to hold onto AMD, or put the money in NVDA, or find somewhere else for that money.

Regarding market conditions, I've been somewhat cautious these last few months, and not trading too much. I started following a paid market timing newsletter, equitrend.com, that has had great past results, but really messed up this downturn. As things were pretty steady for a few days before July 5th, I decided that the next few days would be key, and that if we saw a follow-through day (big gains on big volume), that the market would go up, and I should get in. If it were to drop back down, I thought we'd see new lows. Well, all of a sudden, equitrend's signal flipped to long, so instead of watching for my indicators, I went long with equitrend. Bad idea obviously, as the market went down like 5% the next week. Equitrend flipped back to short by the end of the week, but it was too late. I can't make anything out of the current situation, but I'm waiting for a follow-through day: 4-7 days after a market starts rebounding from a drop, there has to be a day with a big rally, with big volume. July 19th was almost a follow-through day, but it was too early, being on the 3rd day of a rally. I don't like counting today, because the preceeding two days kind of killed the rally, and had higher volume than today. If tomorrow has a big rally, we might be out of the correction, but I wouldn't be too confident. I wouldn't be surprised to see a new low before we pull out of this.

Market Timing update: The period in the 4-year presidential cycle between November of this year and April has the best record of any 6 month period in the cycle. The average return is something like 15% gains for just those 6 months. This also means that many bottoms happen in October. Look back over some charts, and look at Oct 2002, Oct 1998, 1994, 1990, etc, and the 6 month periods that followed. I don't have the time to make a nice chart of it, but the periods are absolutely amazing. Thus in my mind, I welcome a correction through October, at which time I'll go leveraged long if things line up properly.

CGM Funds - Ken Heebner a Fortune Interview

Wed, 21 Jun 2006 07:15:43 GMT

Fortune interviewed Ken Heebner, who runs the CGM Focus (CGMFX) and CGM Realty (CGMRX) funds (and others). Ken has quite a track record, 17.2% a year since he took over the Capital Development fund in 1976. The Realty fund invested heavily in homebuilders for years until they started peaking last year, and now is focused on hotel stocks. The Focus fund has made a lot of money on energy and copper recenly.

Ken reminds me of Peter Lynch in that he seems to do a lot of really in depth research that many analysts don't tend to do, such as reading "China Metals Weekly" to get a leg up on commodity prices. I'm impressed with the way he focuses his money and attention on a very specific trend or inefficiency. Check it out. It's another great article from Fortune, and really makes me want to consider one of both of his funds in my portfolio.

Microsoft falling

Tue, 02 May 2006 07:59:19 GMT

Last Thursday, Microsoft released 3rd Quarter earnings, and most importantly issued guidance for FY 2007. The market was anticipating EPS forecasts to come in around $1.53 per share, but Microsoft announced that FY2007 EPS would be between $1.36 and $1.41. Since FY 2006 earnings should be about $1.32, that means that while analysts were expecting 15% growth, they're only going to get 7% growth. And this is in a year when Windows and Office release new versions, and following a year in which millions of Xbox console sales already reduced margins.

Apparently Microsoft will be spending $2.4 billion dollars more than analysts anticipated. Fortune magazine recently quoted Ray Ozzie saying that Microsoft is going to have to "invest staggering amounts of money" in building an infrastructure for huge web services. Apparently Microsoft is taking that seriously. We don't know exactly what Microsoft is going to be spending the money on, but to put it in perspective, Microsoft spent less than $2 billion on all of MSN in 2005. (Before I forget, I just wanted to mention that Fortune is by far my favorite business/investing magazine. The thoughtful article on Ray Ozzie is very typical, and very good.)

First lets talk about the strategy. Well, one thing's for sure. This news is very, very bad for Google, and Yahoo. They surely should have fallen on the news. Since they haven't, they may be shorting candidates. Microsoft will spend billions to develop the best, most integrated suite of services it can, and also convince the world that it has the best suite of services, and will "do no evil" with its users' data. Of course, in my opinion, thanks to the FTC audits and controls implemented, Microsoft must be one of the safest places to store your personal data online.

Microsoft has all the potential to offer every single software service that is profitable, and integrate the experience tightly across its other products. MSN has been dripping with potential for forever, but it always seems to stop there--with potential. Messenger, Spaces, and Moneycentral have so much potential, but what have they done with it? Not enough. So the market sees two things here: that Microsoft spends lot of money on web services, and falls short. And that once Microsoft compresses its margins to invest for the future, will it ever uncompress its margins? Will the billions of extra expenses pay off? It's hard to say when you're talking about such new business models like building a hard drive in the sky for all of your users. How can you make any money giving people hard drive space on the internet? I think that's the market's biggest fear. Will the competitive spending pay off?

Second lets talk about the stock price. All across Microsoft employees are shocked about the stock price, but behind the shock, it's apparent that most employees expect the stock to bounce back up. That is if the employee still cares about the stock price. Most have stopped caring. However, this announcement is a fundamental change for Microsoft's strategy. This is not an overreaction from the market. Of course the market wants Microsoft to win the web, but according to the market, Microsoft needs to win the web without having to spend billions of dollars. Like I said, MSN's already dripping with potential. Once the spending starts, when will it stop, and will it accelerate growth, or simply prevent negative growth?

Some numbers: Microsoft estimated FY07 operating income to be $19 billion. A year ago, when Microsoft announced FY06 numbers for the first time, it estimated operating income would be around $18.3 billion. While MS basically met expectations, thanks to one-time charges every quarter, this $18.3 billion turned into only $16.2 billion. But ignore that $16.2 number, it's the $18.3 that the market should use to calculate growth, or lack thereof. Personally, I find it amazing that the growth can be so low in the year that Windows and Office are released.

And while a 10% move for a stock of Microsoft's magnitude is huge, we can look back to October 2005 and see that the price was at $24 then as well. Like a roller coaster, it went from $27 to $24 and back to $27 where it's remained. Why such activity with no material news? I have no idea. But now it's back down, and shareholders expect it to bounce back up. It's a trap. New, negative information has been added to the system. Microsoft's growth rate is slowing, and Microsoft's business model is changing. For the 3rd largest company in the US, change can't be a good thing. Just six and a half months ago $24 and bought you a company with an estimated growth rate of 15%. Today that same $24 buys you a company growing at 7%.

Now, I do believe in Microsoft as a company. I believe that with this new drive, Microsoft can win on the internet, but I don't believe that the short term is going to be good for shareholders. I think a fair valuation of the company now lies between $22 and $25.

Apple's suppliers

Thu, 20 Apr 2006 20:43:28 GMT

Frequently, when a technology company makes an amazing new product, the growth is already baked into the price of the stock, and it doesn't go up that much. Especially when the company is already big. AAPL on the other hand has had an amazing success story with its iPod, and its stock has been one of the best performers. Frequently, it's the suppliers of the big technology company whose stocks skyrocket.

It was announced yesterday that PLAY will no longer be the provider for the chips in the iPod. Their stock dropped 40% on the news.

The article above wages 2 guesses at what the replacement companies will be. SGTL which apparently excels at hitting new 52-week lows, and ACTS, which is fairly new, and been doing well.

SGTL recently announced lowered expectations for the year, but at the same time said:

“The company partly attributed the shortfall to a large customer's slower than-expected adoption of a new product and postponed orders.”

AAPL anyone?

ACTS reports earnings 4/26, and SGTL on 4/25.

This article also mentions that it could be LSI, but that’s unlikely:

http://www.forbes.com/2006/04/20/lsi-logic-0420markets11.html?partner=msn

Anyone feeling speculative?

Retirement Accounts: Traditional vs Roth IRA or 401K

Thu, 13 Apr 2006 06:58:52 GMT

A lot of websites and financial institutions have written about the new Roth 401K which began this year, and officially started at Microsoft this month. I'd like comment about the tax implications of choosing where to invest for retirement.

First of all, here’s a table summarizing taxes for the different types of accounts:

	Traditional	Roth	Taxable (long term)
Contributions	0%	Tax Bracket	Tax Bracket
Sales	0%	0%	15%
Withdrawals	Average Tax Rate (future)	0%	0%

As you can see traditional 401K and IRA plans allow you to defer taxes until retirement-that is the money is invested without ever paying tax on it. Roth plans make you pay taxes on your income now, but then no taxes are due on the growth.

Advantages of the traditional plan:

Tax Bracket Rate vs. Average Tax Rate

Most websites including the one above would lead you to believe that if tax rates remain the same, Roth and traditional plans are nearly equal. In fact, as noted by the table above, the tax treatment is quite different. When you contribute to a traditional plan, you don’t pay income tax on the amount you contribute, which lowers your taxable income. This lowered taxable income level means you save form paying taxes at your highest tax rate, otherwise known as your tax bracket. Now fast forward to retirement. When you withdraw money from your account, you pay ordinary income taxes on the money you withdraw. However, assuming you want the same income you had while working, your tax rate will be far lower than your tax bracket rate.

Based on today’s tax tables, people in the 25% bracket have an average tax rate of between 13.7% and 19.4% depending on how far into the 25% bracket you are. Every additional dollar they withdraw does get taxed at 25%, but the first $60K (married filing jointly) of taxable income is taxed at only 13.7%. That single fact makes a huge difference when deciding between traditional and Roth accounts. Note that this amount is taxable income, not even gross income, which is likely to be $10K higher thanks to the standard deduction. (Tip: You subtract your standard (or itemized) deduction from your adjusted gross income to get your average tax rate). This means that when you retire, your first $10K in income, including traditional 401K withdrawals, is not taxed.

Advantages of the Roth:

Social Security’s impact

Since traditional plans increase gross income, withdrawals during retirement may cause Social Security to be taxed. Social Security is only taxed once your gross income reaches a certain level. Since Roth plans don’t affect gross income, they may be more beneficial. I don’t understand all the rules, but see this page on Social Security taxation for details.

Future Tax Changes

Most people agree that future tax rates are more likely to increase rather than decrease, making the Roth more attractive, and a hedge against future tax increases.

More investment options (IRA)

Since most people’s only traditional option is only a 401K plan at work, they are limited to the investment options of the plan. If you invest in a Roth IRA, you can make up for any deficiencies of your 401K plan. For example, the Microsoft 401K plan doesn’t have small-value, international small, emerging markets, or real estate funds. Diversifying outside the traditional plan into a Roth IRA where you can invest in these or any stocks or specialized funds of your choice would be a good idea.

Large one-time distributions

Even if your regular income need in retirement is lower than your current need, there will most likely be onetime events where you will want to withdraw a large sum of money. You’ll want to take this extra sum out of the Roth so that it doesn’t push you into a new tax bracket.

More $$ invested (new)

I forgot to mention this in the original update, but this is a major consideration. If you have a lot of money to invest, and are running into the maximum contribution limits, investing in the Roth plan allows you to invest more dollars. If you make $100K, you can invest $15K in your 401K. Since you don’t have to pay tax on withdrawals from the Roth plan, but do in the traditional plan, the $15K in the Roth plan is worth more after tax. How much more depends on your tax rate in retirement, which of course, you can’t accurately predict.

Other considerations:

State Tax

Since you pay state taxes on ordinary income, if you plan to live in a different state in retirement, the difference in tax rates will make a difference. Since Washington has no state tax, if you work here and retire elsewhere, Roth has an advantage, while if you work elsewhere, and retire here, the traditional plan has the advantage.

Income changes

Think about plans during retirement to decide if your income level will be higher or lower during retirement. The less you think you’ll need, the better a traditional plan would be for you.

Conclusion:

Investing in both is better

Since we don’t know the future, it’s almost always best to have both a traditional plan and a Roth plan. A 50/50 split might not be a bad idea. That way, you can judge how much to take from each based on your circumstances for that year. From the time you start working, saving in the traditional 401K to get your employer’s match, and then investing in a Roth IRA would probably set you on track for a good retirement.

Get the right investments!

Despite all this talk about accounts, choosing proper investments in your portfolio will make a bigger difference than choosing the right account. Choosing the right account will only save you ~5-10% in taxes over the life of the account, but the decision just needs to be made once. If you diversify properly and choose either highly rated (if you believe in that) or low fee index funds, you can easily add a percent or two to your returns. 1% a year for 30 years leaves you with 30% more money. I’ll write other blog posts soon about how to maximize your returns while minimizing your risk.

5/22/2006 Update: AAII recently published an article on Roth vs Traditional 401K plans which looks pretty good, but is somewhat hard to understand. Again, the decision comes down to forecasting your retirement tax rate.

Microsoft 401K 2005 in review.

Thu, 02 Mar 2006 05:02:30 GMT

I just got my 2005 statement for my Microsoft 401K and thought I'd comment on the year.

The economy (GDP) grew at a rate of 4.3%.
Benchmark returns:
- S&P 500: 4.91%
- Russell 2000: 4.55%
- MSCI EAFE: 13.72%
- LB Agg Bond: 2.43%
- Money Markets: 3.13%
- Russell Midcap: 12.65%

As you can see, the 2 leading categories in 2005 were Midcap and International stocks.

The Microsoft 401K plan's best and worst performers (excluding bond and lifecycle funds) are as follows:

1. Fidelity Overseas - 19.29%

2. Fidelity Contrafund - 16.23%

3. Fidelity Growth - 13.50%

12. Microsoft Stock - -0.95%

13. Managers Microcap - -2.35%

It's interesting that the top 3 performers are Fidelity funds. Also of note is that the Managers Microcap fund, which came in last has a huge 17% annualized return since inception, is already up 10% this year.

My performance in 2005 was 8.4%, which was slightly lower than I would have hoped for 2 main reasons. First, I overweighted the Microcap fund that came in last (although this has served me well so far this year). Second, I took the advice of a seasonal timing strategy to decrease my exposure to stocks in the summer. This led to a small loss in the summer. I was able to reenter stocks in October, but it was at a higher price than my exit in late May. I was able to make up a little ground by buying MSFT in October, and then selling in November.

The following is my current asset allocation, but I'm considering decreasing exposure to small caps since they've already had such a huge gain. I'll also plan to time the market again this summer according to the above mentioned strategy and maybe combining it with another. And I plan to time MSFT because I think $26 - $27.50 is a pretty fair range. When it moves out of that range, I'll trade it.

MGRS FMT IS MICROCAP	18.19%
ROYCE LOW PR STK INV	16.56%
ING INTL VALUE I	15.21%
FID OVERSEAS	13.59%
VAN VALUE INDEX INST	9.55%
FID CONTRAFUND	7.44%
ARTISAN MID CAP INV	4.84%
FID GROWTH COMPANY	4.59%
MICROSOFT STOCK	4.48%
PIM TOTAL RT INST	3.66%
OAKMARK EQ & INC I	0.98%
VANG INST INDEX PLUS	0.91%

One more point on the Microsoft 401K plan. About a year ago Microsoft added some Lifepath balanced funds to the investment options. While typically I might recommend something like this for the average person who doesn't want to worry about their investments, I have to say I don't really like their asset allocation. And, their returns in 2005 were way less than I expected: 6.62%. It invests mainly in large caps, with some midcaps and about 20% in international. It also has a small percentage in bonds. As you can see, I have about 30% of my money in US small/mid caps, and 29% in international, with 4% in bonds (mostly as a placeholder to buy MSFT on a drop) and the rest in large caps. I'm a big believer in wide diversification since I don't think anyone can know which segment will do best in the future.

NLY earnings release

Fri, 10 Feb 2006 19:20:52 GMT

NLY released earnings last night and it dropped 3.7% in after hours to $11.50… 50 cents above its 52 week low. NLY is very similar to IMH, one of my holdings.

Details:

Core earnings were $.06 / share. Pretty pathetic.

Book value fell to $10.73.

The last 4 rows in the following table from the earnings release are quite interesting. The interest rate environment is improving. If long rates stay high things will be looking up, and NLY and IMH should turn around.

                                           Dec. 31, Sept. 30, Dec. 31,

                                                 2005    2005   2004

Leverage at period-end                          9.0:1  10.9:1  9.8:1

Fixed-rate mortgage-backed securities as % of

 portfolio                                         39%     34%    29%

Adjustable-rate mortgage-backed securities as %

 of portfolio                                      55%     61%    62%

Floating-rate mortgage-backed securities as % of

 portfolio                                          6%      5%     9%

Notional amount of interest rate swap as % of               NA     NA

 portfolio                                          3%

Annualized yield on average earning assets

 during the quarter                              4.10%   3.75%  3.25%

Annualized cost of funds on avg. repurchase

 balance during the quarter                      4.01%   3.51%  1.74%

Weighted average yield on assets at period-end   4.68%   3.96%  3.43%

Weighted average cost of funds at period-end     4.16%   3.69%  2.46%

I’m still long IMH, which is trading at $7.50 and had a book value of $12.93 as of Sept 30^th. I’m looking forward to IMH’s press release in 2 weeks. Reaching book value would represent a 70% gain from here.

Yield Curve Inverted today

Wed, 28 Dec 2005 06:29:11 GMT

Everyone has their own theory on what the Fed and markets are doing, but the best explanation I've seen is that the Feds have kept raising rates to cool off inflation and the real estate market. But, when it cools down (or bursts) it might cause a recession which would cause the feds to have to lower rates. Thus investors are betting that a few years from now, short term yields will be lower than they are today. This creates an inverted yield curve.

I've previously commented briefly in my blog about how a yield curve inversion is the best single indicator of an upcoming recession. Well today it happened briefly. I don't have much time to comment, but I wanted to link to a few articles.

ft.com reports on the inversion:

http://news.ft.com/cms/s/5ef906f4-7709-11da-a7d1-0000779e2340.html

Yield Curve research from the New York Federal Reserve Bank (http://www.ny.frb.org/research/capital_markets/ycfaq.html):

The difference between long-term and short-term interest rates ("the slope of the yield curve" or "the term spread") has borne a consistent negative relationship with subsequent real economic activity in the United States, with a lead time of about four to six quarters. The measures of the yield curve most frequently employed are based on differences between interest rates on Treasury securities of contrasting maturities, for instance, ten years minus three months. The measures of real activity for which predictive power has been found include GNP and GDP growth, growth in consumption, investment and industrial production, and economic recessions as dated by the National Bureau of Economic Research (NBER). The specific accuracy of these predictions depends on the particular measures employed, as well as on the estimation and prediction periods. However, the results are generally statistically significant and compare favorably with other variables employed as leading indicators. For instance, models that predict real GDP growth or recessions tend to explain 30 percent or more of the variation in the measure of real activity. See Estrella and Hardouvelis (1991). The yield curve has predicted essentially every U.S. recession since 1950 with only one "false" signal, which preceded the credit crunch and slowdown in production in 1967. There is also evidence that the predictive relationships exist in other countries, notably Germany, Canada, and the United Kingdom. See Estrella and Mishkin (1997) and Bernard and Gerlach (1998).

It is not a good time to take big risks in the market. The last time the yield curve inverted was in early 2000 (March was the first time it did so, which coincided perfectly with the market top). The market took a huge dive today, possibly because of this event. The yield curve is definitely worth keeping an eye on.

Yahoo has a good page to track the current yield curve, and this site has an interesting dynamic yield curve java app.

Investing vs Speculation

Thu, 01 Dec 2005 06:39:35 GMT

I can think of 4 general levels of trying to get a return on your money. Common definitions of investing consider the first 3 investing. I prefer to make the distinction.

Saving - money market account, or I would even say that 401K accounts for the majority of Americans are more savings accounts than investing accounts.
Investing - Buying appreciating assets for value, growth, cashflow or technical reasons. The difference between #1 and #2 can be as simple as having a plan or strategy.
Speculating - Making money off of fluctuations of prices.
Gambling.

I think the difference between the first 2 is not only the vehicle, but mostly the education of the person. Length of time doesn't necessarily have anything to do with it, although there is a tendency for time horizons to shorten as you go down my list. There's a huge overlap and grey area between 2 and 3. Today I was discussing currency trading, and to me, that's completely in the speculating level. Making zero-sum trades on non-appreciating assets is speculating not investing.

Mutual Fund Distributions -> lower October prices

Wed, 21 Sep 2005 18:14:08 GMT

It has been well documented that the summer months are poor, and the bottom is often hit in October.

I noticed the following today:

“Each calendar year, mutual funds distribute the capital gains they realized between November of the previous year and October of the current year.”

http://www.cbo.gov/showdoc.cfm?index=1641&sequence=1#t8

This would explain the low October trend since Mutual Funds want as low of a capital gains distribution as possible. Thus they sell their losers.

This means 2 things to you:

Get out of any poor-performing stock well before October.
You might find great prices on good companies that have come down in price in October.

Of course Mutual Fund companies know these rules as well, but lower distributions might persuade them to break them.

John Mauldin - Interest rate audible.

Sun, 04 Sep 2005 22:33:41 GMT

John Mauldin writes a weekly article to which I am subscribed by email (free). I have a link below to the most recent article with was REALLY good. All of his articles are well written and usually cover common interest global economic happenings. This week he sheds light on why the long term interest rates are staying low despite Greenspan continuing to raise rates. I'm going to quote a bit, which actually seems to be a quote pieced together from an article from Paul McCulley at Pimco.

"In fact, I submit that Mr. Greenspan's 'technically' upped the ante against himself today [in his Jackson Hole Speech], when he officially declared that policy is becoming "increasingly driven by asset price changes." Let me walk you through the logic of why, using the economic thesis of 'time inconsistency,' which won the Nobel Prize in Economics for Professors Kydland and Prescott.

"Their elegant, but simple thesis was that expectations about future policy reversals can undermine the power of current policy. My favorite real world example is that of a parent who says to a teenager: get a job this summer and save some money, or you will be walking rather than me driving you to school in the fall.

"If the teenager knows that the parent will, in fact, do the driving come fall, regardless of whether junior gets the summer job - because that's what happened last summer and fall - then the parent's policy is time inconsistent: if the teenager knows the summer policy will be reversed come fall, he will rationally ignore the summer policy of getting a job and instead go to the beach. The parent's policy is simply not credible.

"Increasingly, it seems to me, the Fed's policy of threatening never-ending Fed funds hikes, as Mr. Greenspan implicitly did today, so as to induce lower bond prices (higher bond yields) that will 'get at' frothy property markets suffers from time inconsistency. Bluntly put, the Fed has a credibility problem, because the markets know - because Mr. Greenspan has taught us! - that the Fed's asset price bubble policy is asymmetric:

"1. Deny that you can see them when they are inflating, tightening against them only if you can justify tightening on the basis of conventional inflation-pressure models and data.

"2. Ease vigorously and purposefully when bubbles confirm their existence by blowing up.

"...It's a time inconsistency problem! Why should we in the bond market bearishly discount an ever-rising Fed funds rate, if an ever-rising Fed funds rate will surely burst property prices, begetting a reversal to vigorous easing?

Thoughts from the Frontline

Tax efficient investing

Thu, 18 Aug 2005 07:29:50 GMT

There's an article in the July issue of The AAII Jounal about strategies that should be used to decrease the tax impact on your portfolio.

The article makes several excellent points:

Own bonds in a retirement account such as a 401K since the interest payments are taxable each year.
Hold off selling winning stocks as long as possible. There are 3 gains in doing this:
1. You pay long term capital gains tax (15%) instead of short term (~28%).
2. You allow unrealized "gains to grow unharvested until the end of the investment horizon."
3. You might be able to eventually eliminate taxes because: 1. At your death you can transfer the securities to your hiers and reset the cost-basis; 2. You can dontate them to charity.
Sell your losses.

The article also shows that there are 3 expenses that hurt active investors much more than passive investors:

Expense Ratio (1% vs. 0.3%)
Transaction Costs (0.5% vs 0.1%)
Tax Burden (1.02% vs. 0.54%)

These small differences degrade a gross performance of 7% to 4.48% and 6.06%. 1.5% will have a serious impact when compounded over several years. And we wonder why mutual funds can't beat their benchmarks. An actively managed fund would have to do move than 2.5% better in gross returns to actually give its investors benchmark-beating returns.

I thought the "Sell your losses" was most intriguing, but it makes a lot of sense. The losing stock you're holding is not necessarily more likely to go up than any other stock you might replace it with. In fact, due to the momentum factor (see my post below), it's probably more likely to go down than any other random stock. If you own a $1000 stock that falls 25% to $750, you can sell it at this point, and take a tax break of $70 if you're in the 28% tax bracket. You can then buy a $820 stock to replace the $750 one you just sold. Assuming both stocks appreciate at the 7% over 5 years, the ending values would be $983 or $1075.

It is interesting to note that in the above case, holding the stock in a taxable account provides 9.8% more worth than if it were in a retirement account. Never selling winners, and selling losers, and then using one of the 2 methods in 2.3 above would leave more money than if the account were a retirement account.

In an academic study by Profs. Arnott, Berkin, and Ye they found that using simulated random markets, the average annual gain from harvesting losses was .8% which compounds to 20% after 25 years! (Note this study was performed before the long-term capital gains tax was reduced to 15%, so current numbers would be slightly lower) Loss harvesting opportunities are greater for stocks than stock funds, because while the market may be rising, hundreds of stocks that make up the market are falling.

This one article is worth the AAII subscription.

Interest Rates going down again, bear market ahead?

Thu, 18 Aug 2005 06:51:43 GMT

I saw that in one of my prior posts in May I mentioned that I thought bonds were hitting a low. I was slightly premature as rates kept dropping for the next week. I just wanted to update that I bought back into bonds on August 9th after the Feds announced a rate increase. While I can't explain it, I felt it was a turning point for bonds and that they'll start heading back up. I've been right so far.

I'm actually rather bearish on the overall stock market (especially the tech sector) for the short term seeing as how August, September and October are historically the worst 3 months of the year.

Also, with the GAAP rules changing to require companies to expense options (in a company's first fiscal year that starts after July 1, 2005). I don't know if people will catch on before then, or if we'll have a terrible April next year as tech companies first start expensing options and have earnings go to zero. Fortune Magazine had an article on this several months ago suggesting that Ebay would have had earnings go to almost 0 for the first 5 years of existance (and this is a profitable company) if it had been following GAAP rules and expensing options.

I predicted (easy to say in hindsight) yesterday's poor market (I almost short QQQQ in anticipation, but I'm not that active of a trader), and thought today's rally was rubbish. Traders are just looking all over for good news, and apparently HP cutting back expenses to beat it's estimate targets was enough to trigger QQQQ to gain back almost .4% in after hours trading yesterday, which pretty much continued through today. Does a CEO trimming costs mean the economy is doing well, and other tech companies will do well? Not in my view. In fact, HP's lack of spending is obviously some other company's lack of revenue. While I am bearish now, you can't ignore the momentum and trends in the markets, and I wouldn't be too surprised to see the rally continue for a bit. There's obviously short-term momentum and long-term momentum. If I recall correctly, the best simple Moving Average timing strategy is the 1-day strategy. If the market went up yesterday, it's most likely to go up today. Up days and down days come in bunches, but run out of room as they hit support and resistances. My theory is that at some point this week, the QQQQ will test its 10 day moving average, and fail, or we'll see a slightly positive day tomorrow with low volume. If I'm right, I might just pick up that QQQQ short after all.

Momentum and trading psychology

Thu, 18 Aug 2005 06:42:17 GMT

I'm really getting interested in the psychology of trading and would like to do some more research in that area with a backtesting tool. I've begun to notice that even if you're right (long term), momentum can move a stock price in the opposite direction short term. A few cases in point:

IMH - IMPAC Mortgage Holding REIT

This company makes its money by borrowing money at a very low rate, and then reinvesting the money in mortgage backed securities. Since the interest rate curve is so flat, they're having a hard time making money now because the margin between their loans and investments is only .67%. Barely enough to cover expenses. The logic behind the company is that the book value per share is $11.77 (the stock is trading for $12.80), and the company has something like $200 in loans per share, and thus $211 in investments. It's about 20 times leveraged which means it's gross profit would be 20 * .67% or 13%. Since it has to pay expenses, and due to loan prepayments, it doesn't make this much. They just lowered their dividend to "only" about $.50 per quarter (a 15.6% yield!), about which they said: "we believe that it is in the best interest of our stockholders to decrease our quarterly common stock dividend to a level that current and projected future estimated taxable income can support." For the past few days I've been wanting to buy but the stock keeps dropping like a rock.

If there's one thing I've learning recently, it's don't buy a stock that's dropping like a rock no matter how good of a value it seems. Always wait for a rebound before you buy. A good rule of thumb might be to at least let it pierce a 5 or 10 day moving average before buying. Admit it now that you can NEVER buy a stock at the very bottom, and if you already think the price is ridiculously low there's obviously nothing stopping it from going lower. I see absolutely nothing that will make this stock rise in the short term... lowering the dividend in an announcement at the end of Septemeber sure won't help, and the next quarter's earning's release is likely to be even worse than the last one. I don't understand why people are avoiding the stock at the time when external conditions the company has no control over are terribly bad, and unlikely to get drastically worse. The yield curve can't get much flatter, although it might for the next few months, but with a long term perspective this company will have much more profitable times in the future, and still expects to pay a significant dividend as it's working through these tough conditions. I'm buying as soon as the downward momentum stops.

TLT - Long term bond ETF

I short this fund in early June and covered last week for a quick 3.3% gain. I had noticed the remarkable cycles that this fund had been making and saw that it was pretty obvious that rates were heading higher (after all the 10 year yield was 3.9%) and that they were peaking at 4.4%. The Feds released the news that they were raising rates, and the market immediately sent longer term rates lower. I took this as a signal and closed my position ASAP. I've found it fairly obvious where the major peaks were in the bond market, and find it really interesting how cyclical it is. From Sept through Feb each month had a fairly distinguished peak and trough. Pretty easy to trade with a 10 day moving average, but it didn't continue. The 3 major tops felt pretty obvious, and I'm starting to realize that bond rates aren't necessarily going to go up as everyone expects, and they might just keep testing 4% and 4.5% which provides some pretty good boundaries to a trading range. Anyway, I guess my point with this is stock prices are not even close to random but follow trends and have a definite momentum effect.

QQQQ - Nasdaq 100

As I'll mention in my next post (which oddly enough will appear above this, and you'll have already read it...) I'm quite bearish in the short term 2-3 months and with technology in particular. I was looking to short the QQQQ recently and noticed a very interesting trend with the 10 day moving average. It's well documented in articles such as this one [fundadvice.com] that moving averages can be used to trigger buy and sell decisions. You buy when the stock crosses above the moving average, and sell when it crosses below. Just about any moving average works, but the shorter the timespan, the more trades, and thus more commissions. I've seen values such as 30, 60, and 130 listed as recommended periods that have worked well over the historical data. Anyway, I was noticing that in these volitile summer months, trading the QQQQ's 10-day moving average would have yielded excellent returns. Since May 1st you'd have made 15%.

Also relating to trends, one part of the CAN SLIM method of investing states that you should be on the right side of the market, or ONLY buy when the market's in an uptrend, and ONLY short when it's in a downtrend. To track the market's momentum, use a moving average that is slightly less than the distance between the most recent peak and trough. Thus for today, these distances are 18 days or 60 days, depending on your trough, so SMAs just shorter than these should work well for measuring momentum. The 10 day moving average is trending down big time, and should provide serious resistance to any major market moves. The best time to buy or short stocks is when the momentum is already heading the right diection.

I'm really not as short-term a trader as this post might make you believe. I have some cash on the sidelines and have been wondering what I should do with it. Since it is the summer months and I'd like to hedge market risk without selling stocks, I've been looking for a good time to open some shorts, and I think tomorrow might be a pretty good day for that.

The sign of rising rates

Mon, 23 May 2005 23:50:51 GMT

Research suggests that bond rates are very unpredictable. The majority of investors actually guess wrong at even the DIRECTION that rates will be moving. Two years ago, people would have thought you were crazy for suggesting that the 10-year yield today would be 4.05%. Recently rates have been rising and falling, rising and falling, with everyone expecting them to be rising quickly. I also, along with the crowd, expected them to rise quickly. Recently, however, I changed my mind and decided that they won't rise until everyone gives up on them rising. I decided that the majority of people would have to assume rates might just stay low, for them to actually go up. The bond market seems to be VERY contrarian. Well the first sign is upon us, as Bill Gross, the Pimco bond guru wrote an article recently suggesting that rates would stay low for awhile. "If we had to forecast (and we do), we believe a range of 3 - 4½% for 10-year nominal Treasuries will prevail during most of our secular timeframe."

My take is, that as soon as other investors catch on to this concept, and start to move back into longer term bonds, we'll begin to see rates rise again. That's probably what's been causing rates to decrease so much the past few weeks. I've just sold the bonds in my 401K, and will replace them once the yield hits 4.5%.

Homebuilders

Thu, 28 Apr 2005 06:16:23 GMT

As humans I think we're more often guilty of faulty association than we are of lack of association. I hear that a stock could be "the next Microsoft" way more often than I hear people say "This time it's different." Both can be extremely dangerous statements, lulling us into complacency and blinding us from the facts.

Currently most people I talk to seem to think real estate is overpriced and due for a pullback. The reason for this is because real estate has appreciated so fast, and is growing much faster than the GDP. Personally, I fall closer to the "real-estate is different", and "they're not making any more land" crowd than the "the bubble's going to pop" crowd.

The way I see it, if the population were not increasing, houses would appreciate by the same rate as inflation. However, since the population is increasing (via immigrants if not via children), there is going to be greater demand, and constant supply. This means the housing appreciation rate will be greater than inflation over the long run.

Of course, this statement becomes quite faulty when we look out 100 years, and if we assume a 2% above inflation appreciation rate, then a house would cost 7x more than in does today, in today's dollars. I guess what will have to happen first, is that prices would get so high that the average family could not afford one. Maybe we're getting close to that now in some areas, but prices haven't slowed in California yet, so when will it? Honestly that's something that I can't answer.

I do think that certain areas (Las Vegas) might have gone up too high too fast, and may fall back, but not very far, and not in too many areas. After all, there are lots of investors waiting for prices to drop to be able to buy. The one reason that might cause a nation-wide decline in prices is a nation-wide recession, which seems avoidable in the short term future. Although, the housing market has had some of its best years throught the recent recession...

Today Pulte Homes released earnings and it was an all-star report. Not only did they beat the estimate by 16%, they raised guidance for the year by 4%. How did the after-hours traders greet this news? Up 1.7%. Some more facts:

Profits were up 60% over last year.
Home closings were up 14% (8K homes).
Average selling price up 11% ($300K).
New orders rose 12% (12K homes).
The order backlog is now $6.5 billion (20K homes).

I think those numbers speak for themselves. The kicker, is that the Forward P/E ratio is 7.5. And remember, the backlog means that the forward earnings are almost guaranteed. As for future growth, the analysts are estimating 14% per year. To put these numbers in perspective, MSFT's Forward P/E is 19.4 (2.5x higher), and its growth rate is 11% (20% lower). If a tech stock had a track record similar to the numbers above, and a history of beating earnings by significant amounts, it would have a P/E ratio of over 40. Obviously, wall street does not believe the analysts when they say that the future growth rate is going to be 14% going forward, or the stock price would be be about triple of where it is now. The stock is actually priced like earnings are going to significantly decrease in the future.

Fortune magazine had an article last month about Toll Brothers (another homebuilder) which was a good read. The CEO stated that NIMBY (Not In My BackYard) politics are really benefitting the homebuilders. Any new homes that are approved for construction in highly-populated areas are selling for incredibly high prices. Since NIMBY seems to be here to stay, homeprices will continuually rise he says. Yet he also outlined how his company would be ready to reduce costs should a slowdown occur.

My biggest concern regarding the homebuilders, is why on earth are the stocks not going up in value? PHM should have risen at least 5% after hours with such a stellar earnings release. Do I really want to buy into an industry where people seem to be just waiting for it to fall, and don't even bid up stocks that have good earnings? I guess that's a pretty small risk to take with so many other factors in favor of these stocks. There are dangers in being a contrarian, but when you're right, there are great rewards.

Motley Fool's Stock Madness 2005

Thu, 07 Apr 2005 18:00:11 GMT

http://www.fool.com/News/mft/2005/mft05031707.htm

The Fool is having a poll-based contest where their writers pit 2 stocks against each other, and then have readers vote based on who wins. It's down to the final 4 now with APPL and SIRI going at it, and UPS and NFLX going at it.

SIRI is priced even higher than XMSR (which I've already written about as being overpriced). I have a feeling that winning the Stock Madness tournament pretty much dooms a stock. Think about it. If everyone already likes it, then who is there left to buy? I guarantee you, that if the contest had been held last year, NFLX would have won. That's how big NFLX was around the Fool last year. However, the stock is down 70% over 1 year! I don't quite expect SIRI to drop that fast, but I consider it at least that overpriced.