Archive for August, 2010

Acquisition risk in a short position

By: ispeculatornew | Date posted: 08.25.2010 (4:00 am)

Going short is always a risky proposition as is going long of course. Yes, in theory, a stock can go to one million and you could be wiped out but in reality, like any other price movement, it will usually happen very gradually and you will be able to adjust. There is one big difference though  and that is the extreme rise that can occur when a company bids for a stock that you have shorted.

Last week was a good reminder of what can happen when BHP Billiton made a hostile offer to buy giant Canadian company Potash for $38 billion, which was well abode Potash’s market value. The worst part for short investors in Potash is that the stock shot up much higher than the 130$ per share that was offered on speculation that it was the first offer by BHP but that there will be at least another one. The result? Potash ended Tuesday over 143$, much much higher than Monday’s $112.15 close, almost 30% higher.  Just take a look at the chart of Potash and you will get a better idea of what happened.

Another example

On Thursday, Intel (INTC) announced it was acquiring software security company McAfee (MFE) for $7.68 Billion, a premium of over 60% from the previous close. That means that short investors in McAfee lost a huge amount on that trade. Having a stop loss is useful and necessary but in cases like this, it offers little protection as the stock moves past the stop loss.

To be honest, the threat is important right now because many companies are sitting on huge cash piles which they often want to use in acquisitions.

How to avoid such situations…

There are no ways to make sure that shorting an acquired company will not happen of course but avoiding companies that are speculated to be for sale is one way to do it. In the case of Potash, I don’t think anyone saw this coming and it would have been difficult. But in the case of McAfee, it was easier to see that possibility given its industry and how powerful players could easily move into software security. Companies like Microsoft (MSFT) had been rumored to look into such acquisitions in the past.

Personally, I have not had the impression that many of the companies that I short are good potential targets. Last year, I was worried that Yahoo would be a good target and that was certainly a major worry when I would short the stock. But after its search deal with Microsoft, it seemed very unlikely and I have not had to worry about it since.

Other Risk to consider…short squeeze

When traders notice a very high concentration of short positions on a stock, they can start to drive up the stock which will cause the short traders to be “forced out” of their positions. Of course, those getting out will be doing so at a higher price, which can create even more short positions to reach their “stop loss” limits. You can imagine the effect it can have on a stock when this cycle begins. Then, once the cycle is advanced, the person who started the cycle can close out his position with a nice profit.

Such a strategy is not executed often because a lot of money is required to move a stock enough to create a short squeeze. To be honest, I do not (yet) consider this possibility when selecting short stock picks at the moment but maybe one day I will get burned and have to look into it.

Still a good idea to go short?

I’ve said it many times, I think the long & short trading model that I’m using is perfect for the type of speculative trading that I am doing. It does have some risk involved but as long as the potential gains are large enough, I’m fine with it. That being said, I think that all traders that use short positions had second thoughts this week seeing how Potash and McAfee took huge leaps….

Daily news – August 24 2010

By: ispeculatornew | Date posted: 08.25.2010 (3:17 am)

Tech news: (concern the stocks we follow)

According to FT, Facebook’s value now stands at $33.7 billion
Apple (AAPL) says 50% of Fortune 100 companies have started testing the use of Ipads

Best return:  IAC Interactive (IACI) +1,01%



Worst return:  Ctrip (CTRP) -6,16%

Catching a falling knife (continued) – RIMM & BP

By: ispeculatornew | Date posted: 08.24.2010 (4:00 am)

About 2 months ago, I wrote a post about two stocks that were dropping fast, Research in Motion and BP. Both had very different reasons for dropping and the question was mainly if it was a good idea to consider buying these two companies. At the time, Research in Motion (RIMM) was trading at $52.97 and British Petroleum (BP) was at $27.67 (on US markets). Almost 2 months later, we though it would be a good time to back and see how both of them have performed.

Without further wait… the results:

BP    +30,5%

RIMM    -8,9%

Obviously, they have reacted very differently. I don’t think many of you would have been stunned by the possibility that BP would gain 30% over 2 months.. it was a matter of resolving the situation in the Gulf of Mexico to start putting a stop to the oil leaks but also the cash drain. And that is now on course and BP’s stock has started its recovery as well. It did have to unload many assets which means that the stock will probably not regain it’s pre-leak level for a long time, but it is at least moving in the right direction.

On the other hand, Research in Motion is not looking good at all.Last week, Morgan Stanley updated its stock rating, recommending its clients “SELL” their holdings because of the following:

-Morgan Stanley estimates that RIMM’s smartphone market share globally will drop to 13.1% in 2012 (from 16%)
-Morgan Stanley reduced its estimated number of corporate subscribers in 2013 to 16.9M (from 21.5M)
-Reduced both short and medium term profit estimates

The fact is that Research in Motion is in trouble. I met a friend who works at a large multinational pharmaceutical company and the phones they provide employees with are the Apple Iphone. A few years ago, it was unthinkable for a multinational to not use the Blackberry but that “standard” is changing very quickly,  a very important danger for Research in Motion which depends heavily on these clients because of its struggles in the retail sector.

RIMM did announce a new upcoming phone, the Torch and it has not improved analysts so far or convinced anyone that it could stop the decline.

That being said..we are long RIMM

As we mentionned in the previous post, it is more or less impossible to time an entry into a stock that is tanking. You have to expect a possible 10-15 and maybe even 20% loss from your entry point as the momentum is always difficult to overcomee. That is very much the case for RIMM as analysts around the world continue to downgrade RIMM, telling their clients to sell, which has been triggering further downgrades, etc. It would be very easy for anyone to write a post about RIMM’s downfall right now and how the stock is going into the ground… but I don’t think it is.

The company, despite all of its shortcomings, continues to display growth and it’s P/E ratio should be considered useful. In that regard, seeing Research in Motion trade at a 9.1 ratio screams opportunity for me. The key is very limited downfall. Do you think that ratio will fall to 7 or 8? It might, but some stocks but little to no growth trade at higher P/E’s. Do you think that we will soon live in a world where all phones are either powered by Android or by Apple? I personally doubt it. They will grow much faster but that doesn’t meean that RIMM will cease to exist.

Was I a buyer at the start of 2010? No. But I am now…are you?

Daily news – August 23 2010

By: ispeculatornew | Date posted: 08.23.2010 (7:41 pm)

Tech news: (concern the stocks we follow)

HP (HPQ) made a $1.5B bid for 3Par

Best return:  Google (GOOG) +0,44%

Worst return: Travelzoo (TZOO) -5,17%

Financial Ramblings

By: ispeculatornew | Date posted: 08.21.2010 (7:51 am)

Always funny when I hear a new company dissing the Ipad. LG is the latest as it announced it would launch its own much improved version of the Ipad. Of course, no details were provided as to how it will be done and what will be better. And it’s probably counting on Apple not improving the Ipad at all in the meantime right? Sounds like a perfect plan…NOT.

Why the economy is most certainly related to investing @ BalanceJunkie
Money CAN buy you happiness @ GetRichSlowly
Facebook acquires Hot Potato then shuts it down @ Mashable
Location based alternatives @ TechCrunch
Intel’s McAfeee buy, an $11.5 billion waste? @ DailyFinance
School shows you how to be poor @ TheFinancialBlogger
Seeking solutions in an uncertain world @ ZeroHedge
Simplifying the financial reform blog @ TheBigPicture
How to pick your dividend stocks/funds @ TheDividendGuyBlog
8 dividend stocks delivering good news @ DividendsValue
The contango killing commodity ETF @ Wheredoesallmymoneygo

photo credit

Answering a reader’s questions!

By: ispeculatornew | Date posted: 08.20.2010 (4:15 am)

Good morning to all of you. Today, I decided to answer to a comment that I recently received because it was very well formulated and also many of those questions have been asked either in private or on this blog, it is related to the stock picks that we make. Here is Nathan’s comment:

Hello, I recently started reading your blog and have found the commentary interesting and engaging.

I was wondering if you could please go into further detail regarding how you go about formulating particular trades.

Specifically, what is your methodology/rationale for pairing up two particular stocks?

That is, I understand why you might be long a particular company. And why you might be short a different company. You then seem to pair the two positions, and I’m not clear on how you came about the pairing.

I am assuming your trades are based on the spread in performance of the two positions — is this correct? Do you take equal positions in both sides of the pairing?

How do you pick the second stock for a paired trade? Is it a competitor in the same space that you think won’t do as well, or is it simply a company in a different space that you believe will perform in a non-correlated/independent fashion from the first company? Or is the ‘short’ company selection a method of trying to hedge against possible negative performance of the ‘long’ company?

[I did try to find an explanation in previous posts but was unable to clarify to my satisfaction]

Thank you for your attention and blog postings.

**************************************************************************

That is certainly a loaded comment, I will do my best to answer as well as possible but feel more than free to ask more questions. Initially, I wanted to give more hindsight into how I pair up trades.

The easiest and preferred way is to trade two stocks within the same sector such as going Long Priceline against short Travelzoo. These type of trades become a “bet” on which of the two stocks will perform better which takes out a lot of the external factors. If one stock is mis priced relative to another, doing a pair trade is an attempt to profit when they become back in line. Because of the small number of internet stocks, I often have to look deeper.

The way I generally proceed is to look at my dashboard to find 1 or 2 stocks that either look very attractive or expensive. They would be the stocks that I would be looking to pair. Then, I will look for a stock that is similar in nature. For example, if I am looking to do a trade against Amazon, I would be looking for ecommerce companies that trade at a comparable P/E, has similar growth, etc. Once I find that, one might look very cheap or expensive compared to the other.

In most cases, I am able to find a stock that can be paired off reasonably well but not always. If you look at the trades that we did this year, you will find some trades that are well paired off (Priceline & Travelzoo, Apple & Blue Nile) but also others that are not as clear such as (Research in Motion (RIMM) and Monster WorldWide (MWW)). That would be a case where I was unable to get a good pair trade and decided to simply take what I considered to be an overvalued and an undervalued stock.

Why do I pair trades and how?

I do pair trades because it gives me no net exposure to the market (more or less), which means that a 20% increase or decrease in the market will have a very limited impact on the portfolio. There are positive and negative aspects about pair trading or “delta neutral” trading but personally it’s a type of trading I enjoy because I am not trying to predict the overall direction of the market but rather a small universe of 2 stocks. I would not do only pair trading but as far as speculative trading, it has been a good recipe for us.

When I initiate the trade, I would go long and short the same amount, and thus be market neutral. As soon as the stocks start moving, I start getting a small exposure and that will remain the case until the trade is actually closed. For example, if the stock that is long gains 10% while the other does not move, I will be net long. If the initial bet was 2000$ on each side I would have 2200$ long and 2000$ short. It does remain very limited though.

Traps

Pair trading does have its share of traps however and for me, the Chinese market was one example. Going long a Chinese stock against an American one that is similar in nature was a trade that I enjoyed a lot and worked very well for me. Why? Because the Chinese stock usually displayed higher growth, and a smaller P/E for a comparable size. Seemed like an easy trade. But this year, the Chinese markets have suffered greatly and apart from Baidu (BIDU), most Chinese dot com companies have suffered declines. Which explains why I try to make different types of bets. I would never do 5 trades long of Chinese companies against American ones to avoid such traps.

Bigger bets

If you buy and sell for 2000$ of stock, you will have spent 0$ as you can imagine. However, you do need money to initiate such a trade because your broker will need to protect itself in case I lose money. Generally, they will require about 70% of that value as collateral. In this case, if I have 1400$ in my account, they will let me buy and sell 2000$ worth of stocks which gives me some type of leverage. That is why a 7% movement in the stock actually represents 10% or so for me because of this “leverage”.

No secret recipe

All of this having been said, pair trading has been working for me but like every other method, hard work and discipline are the keys to success in my opinion.

Quick news – August 19 2010

By: ispeculatornew | Date posted: 08.19.2010 (3:36 pm)

Tech news: (concern the stocks we follow)

Dell (DELL) reported earnings of $0.32 (estimates $0.30) on revenues of $15.53B (estimates $15.2B)
Yahoo (YHOO) rated new “Market Perform” by Southridge research group
Google (GOOG) rated new  “Outperform” by Southridge research group
Moody’s upgraded Ebay (EBAY) to A2
NetEase (NTES) raised to “Buy” at Roth Capital
NetEase (NTES) raised to “Overweight” by HSBC

Best return:     NetEase (NTES) +12,16%

Worst return:     Travelzoo (TZOO) -3,99%

Adding a sovereign debt ETF to your passive income/dividend portfolio

By: ispeculatornew | Date posted: 08.19.2010 (4:28 am)

When writing about the single country ETF’s, I had mentioned that I anticipate a lot more ETF’s tracking foreign debt to be released in the upcoming years. This week, WisdomTree launched an ETF that could help gain new exposure to these markets. It is not corporate debt but rather national/sovereign debt but ELD certainly looks like it could fit in nicely in a dividend or a fixed income portfolio

Frankly, I don’t understand why there are not more ETF’s that cover sovereign debt. There is much more sovereign debt outstanding for emerging markets than for the US government and much more opportunities as well.

What is ELD?

ELD is a new ETF that was created by WisdomTree, it invests in sovereign debt that is:

-from emerging economies
-denominated in the local currency
-where foreigners can invest

It invests usually by buying government bonds or possible supra national bonds (IMF for example) or could also do swap trades based on these instruments.

In order to determine which countries should be invested in, WisdomTree uses a variety of criteria’s like the credit rating, inflation. debt ratios, CDS prices (which can be used to determine the default probability). The rebalancings are done quarterly and initially 17 countries are owned by the fund (14 of them are investment grade).  These countries are then ranked into 3 groups that determine how much weight they carry.

While most ETF’s track an index, ELD does not. It will be rebalancing in order to maximize return for limited

Historically, the performance of sovereign debt has been very solid. The return since 2003 has been 12% per year, a return that is very similar to that of US corporate bonds. However, the credit ratings of the sovereign debt is higher than the corporate bonds and they provide better diversification so I don’t see why they would not be included in a diversified portfolio.

Dividend Yield

The current yield in the basket is 6.80%. It is not clear if Wisdom Tree will have the ETF distributions be equal to that yield (as opposed to reinvesting into the fund or other options) but given how Wisdom Tree manages its other ETF’s, we can expect the dividend yield on ELD to be close to 6.80% which is considerable in the current environment and a good way to start building a dividend portfolio or add diversification to the one you currently have.

ELD vs EEM

When discussing asset allocation, I often hear talk about Emerging markets. But investing in emerging market ETF’s in an ETF like EEM or VWO is quite different from investing in sovereign debt through ELD. It’s not that one is superior to the other, they both have their pros and cons but I believe that both in the equity and fixed income portios of a portfolio, emerging markets have their place.

Pros

I have no doubt that a product like ELD will provide much needed diversification in a fixed income portfolio. I probably will not need to give you many numbers to convince you that the correlation between the return of a big financial institution and the government of Poland’s debt is very small. Also, the high yield of 6.80% might move over time but in general it will remain higher simply because many investors severely underweight foreign portions of their portfolios which provides great opportunities for those of us that don’t.

Cons

There is no doubt that a few more factors will influence returns on ELD. The interest rates, inflation rates and exchange rates will all have a significant impact on your return and will bring more volatility. That might cause dividend yields to rise and fall much more often than a domestic fixed income security. It could go in either direction though so you should not necessarily see it as a huge downside.Another con in my opinion is that since the ETF is not tracking an index, it will be more difficult to judge and evaluate the performance

Will I be buying?

I will personally probably be a buyer of this ETF in the near future. I will wait to see how exactly they are redistributing income from the fund but chances are good that you will soon see this ETF in my dividend portfolio. Just a side note, I don’t think that adding ETF’s to a dividend portfolio is that useful in general but in some cases such as this one, it would not be possible to add this type of exposure for an individual investor with this portfolio so I’m more than happy to try it out. How about you?

Quick news – August 18 2010

By: ispeculatornew | Date posted: 08.18.2010 (9:21 pm)


Tech news: (concern the stocks we follow)

Google (GOOG) tablet may go on sale November 26
Netflix (NFLX) cut to “Underperform” by Morgan Keegan
Apple (AAPL) will launch an HDTV that integrates its Apple TV set-top box
Research in Motion (RIMM) cut to “Neutral” by Wedbush
AOL (AOL) confirmed it had 100 Patch websites and expects to have 500 by year end
BGC raised Microsoft (MSFT) to buy and Yahoo (YHOO) was cut to hold

Best return:    Quinstreet (QNST) +2,25%

Worst return:     Netflix (NFLX) -5,47%

Starting over from point zero….

By: ispeculatornew | Date posted: 08.18.2010 (4:22 am)

Last week we took a look at our assets and how they’ve helped us get where we are financially and when you think about it, any move or job that you are currently doing was accomplished thanks to those assets. Now take a deep breath and close your eyes and imagine that you are down to no tangible assets, no money, no car, no house and just renting a place for a few months, with your knowledge and experience as your main assets.

One twist…

You cannot find a full time job, you need to start a business that will eventually enable you to build passive income. The good news is that you have a paid apartment for the first few months.

What next?

Knowing what you know, what would you do first and how would you organize your finances in order to reach a respectable level as quickly as possible? It’s a great challenge and many have done it in the past simply to prove themselves that they could do it!

What I would do…

There are no secrets, it is about being organized, and working hard. Here is what I would do, I am comfortable I could be back at a decent level in a year and back to solid income in 2 or 3 years.

Step #1 – Get a Plan

It’s all about being organized in my opinion and that is why many aspects are carefully planned, you simply achieve more. Here are the things I would determine:

business sector: the obvious one, internet business as this business is both easy to start and inexpensive. As well, it is very possible to achieve growth very quickly

how much do I need?: it is critical to determine a minimum amount necessary to survive as this will determine the possible reinvestments into the business

-making quick money: building a web business has its advantages but it also has downsides and it requires patience to start off because there is no get rich quick plan.

Step #2 – Work on the required minimum

If I determined that I needed 800$ monthly to live (apartment is paid in this scenario remember), I would probably try to write guest posts. TheFinancialBlogger wrote a good piece about this but basically this would require time but insure that I do not worry too much about eating every day:)

Step #3 – Work on the web business

I wrote about cheap valuations for internet businesses but since I have no money, I would be starting from the ground up. Getting quality content, traffic and making money. Once it does start generating money, I would do the following with the proceeds:

33% to increase quality of life
33% to save
33% to reinvest in the business

For a 300$ profit in the business, that would mean 100$ in each. So yes, despite making 300$, I would only increase my quality of life by 100$ but the objective is to reward myself but spend most of the money on the business.

The savings would help create an emergency fund, eventually a savings portfolio to create passive income through dividend investing.

And finally, reinvestments in the business would help in so many ways:

-domains
-hosting
-new design
-outsourcing
-coding
-etc, etc

As time goes by, both the business and savings would add up and lead me back to a similar position very quickly I’m sure. It would be hard work and I don’t think I’d put myself in that position for no reason but if I had to do it, I have no doubt I could.

How would you proceed?