Archive for March, 2011

What will you do when your portfolio will drop by 30-40%?

By: ispeculatornew | Date posted: 03.17.2011 (5:00 am)

Panic! It is usually what happens when markets crash, no matter if we are talking about real estate or the stock markets. Like all of you, I work hard to save money, trying to build myself a nice and solid passive income portfolio  in order to profit from life at its fullest. But until you only own government bonds (and even then), you are vulnerable to a major crash. They have happened several times over the years and one of the reasons why crashes do actually occur is because of the panic that is created by the rapid and what seems like a non-ending decrease in value.

Being in a roller coaster when it’s pitch black

Roller coaster rides are fun, they create adrenaline, stress and emotion like few things can do in life. The stress is limited however because you usually:

-Can see what is ahead of you
-Know that the outcome will be fine

A market crash is a much more scary proposition

First off, when markets start falling off a cliff, it becomes easy to panic, as newspapers and others start discussing “end of the world scenarios”. Not only do we not know what’s ahead but it can become very emotional when you start thinking about the years that you spend building up your portfolio in order to live an enjoyable retirement.

Now is the time to think about it

No matter how many people will tell you how to react in the next crisis, it is so emotional for many that they can act very irrationally. That is why I think today is the perfect time to think about how you will react when this will happen to you. I did say WHEN and not IF. No matter how much you’d like to escape this reality, the truth is that the market crashes every few years and you will be a victim at some point.

The worst thing you can do

Since the stock markets have existed, every market crash has been followed by a recovery. Some take weeks, others years but other than perhaps the incredible decline of the Japanese Nikkei, which is an entirely different scenario as the whole Japanese economy fell off a cliff, others have recovered fine. Unfortunately, when investors, especially ordinary ones such such as you and I, lose 20%-30% or even more of our portfolio value, it becomes easy to panic and do things that we will regret. I know some who have done it. After losing 20-30% of their portfolio’s value, they decided to sell everything else in order to avoid a disaster. Of course, when the markets recovered, they did not own the assets and while every other investor started breathing much better, these investors felt like they had just been ran over. They had “suffered” the entire market collapse without enjoying the rebound.

What you CAN do

-If you cannot afford or live with losing 30-40% of your portfolio, DO NOT invest all of it in the market

So what will  you do when the market goes through its next crash?

I know that I will keep my assets, and even continue putting money, in the same way. But I know that we are all different and I would love to hear your thoughts on this.

Why trading a VWAP is not as easy as it looks

By: ispeculatornew | Date posted: 03.16.2011 (5:00 am)

Yesterday we did a small introduction to VWAP trading, what it is, how and when it is used. The truth is that despite being a simple concept, it is one of the most used ways to trade for most institutional clients, it gives them a good way to benchmark the execution that was done in order to determine if the execution was well done and if the VWAP algorithm is doing its job.

Why would the algo not give good executions?

If you remember yesterday’s example, it implied purchasing about 2,500 shares of Apple every minute during 5 days. Easy enough right? Wrong. Someone one did a VWAP with those parameters would get killed. Why? Because of high frequency traders. If one of these algos checked the markets, they would see a buyer coming in with a buy 2500 every minute for days. Believe me, it would take advantage. How?

It’s all a matter of speed. Here is an example. If I know that a specific investor will be buying shares of Apple every minute, I will generally buy some Apple shares maybe 0.1 seconds prior to that and then resell them right after the investor has made his purchase. What this would do would be drive up the price for a few milliseconds and then bring it down.

The End Result?

The VWAP algorithm would end up paying a few penny fractions more on each execution while the HFT would collect those fractions. It might be small but over 3 million shares it adds up. This is also why many traders argue that High Frequency Traders do not only bring benefits such a liquidity and volume but that they also cost investors that execute similar strategies.

What to do?

There are hundreds of people that spend their days trying to figure out how to hide such strategies, how to execute better, while on the other side HFT’s try to find the strategies and profit from them. It’s an exciting game for all participants no doubt. Here are some of the strategies that are used to “hide” VWAP strategies:

-Changing the order size.. obviously, an order of 2500 shares every minute would be easy to detect
-Executing at more infrequent times (every minute is too easy to spot)
-Executing on different stock exchanges

There are so many different ways to improve execution  of a simple strategy such as the VWAP but the strategies must be improved continuously as HFT’s become better at detecting the strategies and “fronting them”.

Back to the basics: What is a VWAP?

By: ispeculatornew | Date posted: 03.15.2011 (5:00 am)

If you look in Wikipedia, you will see the standard definition of a VWAP: “VWAP is a trading acronym for Volume-Weighted Average Price, the ratio of the value traded to total volume traded over a particular time horizon (usually one day). It is a measure of the average price a stock traded at over the trading horizon.”

So what does this mean in clear terms?

Basically, longer term investors often want to get into rather large positions but buying those actual stocks is not as easy as it may sound. Why? Because of all of the day traders for one. For example, an investor that wants to buy 3 million shares of Apple over 5 days might want to do a VWAP. There are many ways to get it done but the one huge mistake would be to do a market order on 3 million shares. There are several reasons why you do not want to do that:

-At all times, there will be investors wanting to buy and sell shares of Apple and they will be posting “bid” and “ask” offers. So you might have the following:

Bid
10,000 shares @ 356.65$
20,000 shares @ 356.64$
17,000 shares @ 356.63$
20,000 shares @ 356.62$
many other orders @ lower prices

Ask
17,000 shares @ 356.66$
11,000 shares @ 356.67$
38,000 shares @ 356.68$
47,000 shares @ 356.69$
many other orders @ higher prices

If you place an order to buy 3 million shares of Apple at a market price, you will be hitting those “ask” prices and I can tell you that your execution price will be terrible because instead of buying Apple at the “current price” of $356.65, you will end up paying much more as not enough investors will  be ready to offer shares at that time. You might get your entire execution but the price will be very bad.

Another key aspect is that day traders and high frequency traders will see that you want to buy a large quantity of Apple (AAPL) shares and they will drive the prices up (more on that tomorrow). So no, you do not want to make a market order. The best option is to spread the buying over a day or several days. How? In the past, traders would manually put orders but splitting 3 million shares over 5 days would be a hectic and very imprecise science wouldn’t it?

In comes the VWAP

Electronic trading has its pros and cons but its benefits are important even for long term investors. How? In this case, algorithms are programmed to trade the stock over several days. For example, in this case, the algo would try to buy 500,000 shares every day. How? Well that is slightly under 77,000 shares per half hour or 2564 shares per minute. So to simply the process, the VWAP algo would buy 2500 shares or so every minute for the entire day. In the process it would also adjust for a few elements:

-The algo tries to get the best execution price available and will adjust its buying speed depending on how it is going
-The also tries to replicate the volume weighted price of Apple so if the stock starts to trade less, the algo will do the same and will do the opposite when volume picks up

Is it that simple?

Not quite. Tomorrow I will explain the challenges of executing through a VWAP and what makes some algos better than others.

If I were a billionaire…

By: ispeculatornew | Date posted: 03.14.2011 (5:00 am)

The old question used to be. What would you do if you won 1 million dollars today? Of course, with inflation and time,  $1 million is not what it used to represent. For most of you, $1 million stacked away in your retirement portfolio will not end up being enough to generate enough passive income to keep on the same pace in your lifestyle. Think about it… at 5% of interest or dividend yield, a $1 million portfolio will generate $50,000 but that amount will become less and less in real dollars because of the inflation. So no, having $1 million will not be enough to save the world, quit working at 25 years old or buy a house and car for all of your family.

Billion is the new million!!

Ok maybe, I’m slightly exaggerating in the sense that you can still do a lot with $1 million and needless to say that $10 million would be enough for most of us to enjoy life. But just for the sake of it, I thought it would be interesting to think about what is it I would do if I had $1 billion deposited into my bank account by tomorrow morning. I would love to hear from you as well. And no, I’m not looking to hear about the every single item that you would buy rather the general principles that you would use in managing that money. What would be your big plans? Here are ten things that would be on my list:

My list

Charity Fund: I have discussed the giving pledge and have become more interested in the work of many of those who signed the pledge in recent months. I think it’s incredible how much of a difference these individuals are making and would certainly love having the opportunity to sign up to give most of my money over time to charity through different forms.

Create my own VC fund: You all know it, I’m passionate about technology companies, Silicon Valley and I think there will be many more stories similar to Facebook. I would love to be involved in such companies and being an investor would be a great way to do so.

Stack away 99% of the money initially: I think we all have our different ways of seeing this but becoming rich overnight can be dangerous and many former lottery winners could testify. I would personally store away 99% of the money (in this case leaving me with a more than respectable $10 million) for one year. That would give me an entire year to think about good ways to manage the funds without being wasteful.

Make sure my inner circle can live a good life: My family and friends would obviously the first ones I would look out for. It’s surely a big challenge to not get into any fights when someone in the family has so much money (I wouldn’t know) but hopefully I could find some way to make it work.

Have my own plane & pilot: Traveling is perhaps my favorite thing to do and being able to go away where and when I want would be a luxury unlike any other for me

Hire a few people to take care of myself and family: Having a cook, a personal trainer and a few other people on staff would certainly be a great way to ensure being healthy.

How far away am I?

I would say quite far, I’m still working on my first million, but the first one is the most difficult right?:)

What is your list?

Nightmare scenario: Hacking stock exchanges

By: ispeculatornew | Date posted: 03.11.2011 (5:00 am)

You might have not heard about this because many are trying to keep this issue as quiet as possible but the US government launched some official investigations into recent security breaches into the Nasdaq’s networks. What is currently being said is that the hackers were not able to gain access to any of the trading machines and did not have any impact on the markets themselves but there is no doubt that such news brings to reality many scenarios that could be very very serious not only for traders but for the entire economic system. It is a very complex issue and we could discuss it for an entire day without even getting a complete picture but we decided to take a look at what this could mean and why it matters.

Why would someone try to gain access?

Terrorism: The reason most often discussed by the media and politicians is terrorism. As terrorists have proved in the past, one of their main goals is causing fear and uncertainty and that could happen very quickly. Provoking a crash or even the possibility of one would be enough for many investors to lose their confidence in the markets, the banking system and perhaps much worse. Since our system is based on trust more than anything else, it could have very severe consequences on the US economy.

Financial gain: No doubt, someone able to get access to the trading network would be able to do a variety of things that could result in major financial gains for the criminals, gains that would be offset by the general public, often without them even knowing about it.

How?

Fake orders: Once a hacker gains access, the easiest way to not get caught would be not post actual trades but rather only post flash orders. These orders can have a similar effect anyway as they can indicate that certain market participants have big orders to execute in one stock or even the entire stock market. Keep in mind that the bigger the attempt, the better the chances are of getting caught but also of that discovered vulnerability being found.

Trades: No doubt, if one hacker gains access to the network, he could make orders on behalf of a selected or many different market participants in an attempt to manipulate the market in one direction or another.

Crashes: We saw in May last year just how fast a flash could be created. Thanks to ETF’s, a single order (to sell a broad based ETF) can create hell if it is big enough and done quickly enough. Sell 100,000,000 shares of SPY and you will see the market tank

Is it already happening?

This is the difficult question isn’t it? The thing is that the smarter the hacker, the more difficult it will be to find. Someone attempting to create chaos would likely go for one big event. But a smarter more sophisticated hacker acting for financial reasons would likely do very small actions, enough to make millions, without generating too much attention to himself making it very difficult to catch them. The other thing to keep in mind is that like all other network security breaches, it is unlikely that we would hear about them as the exchanges do not want to create panic, or to encourage new hackers to try as well.

What to do?

I would personally think that one of important things is to avoid intra-day stop loss orders that could be triggered if something went wrong. Often, markets can be wild during the day only to recover after a few minutes or hours. Do not get caught during a mini-crash.

How many dividend stocks to own in your passive income portfolio?

By: ispeculatornew | Date posted: 03.10.2011 (5:00 am)

It’s a common question and there is no way to answer it perfectly. Why? Because you could probably bring 10 different “experts” and they would all come up with different answers. There is no perfect answer but it’s a question that I get so often that I thought it’d be interesting to at least give my point of view. Let’s start with the basics.

Why you would want a number of stocks to be as small as possible?

-Having less stocks also means less trading fees
-The more companies you have in your portfolio, the more difficult it becomes to track them

Why you would want it to be a big as possible?

-To smooth the passive income (adding companies makes dividend changes for one company less visible)
-To not depend on a specific sector or company too much (imagine having only a few financial companies during the most recent credit crunch)

So how do you decide?

So what does it become? It’s basically a balancing act where each person would have a different “middle point”. The number of stocks would generally depend on:

-Your ability to tolerate volatility
-The size of your passive income portfolio (for example, I have written about starting a dividend portfolio with $5000… do not spread such an amount over 10-15 stocks).
-The amount of time you want to spend researching these stocks
-The turnover you wish to have (are you a buy & hold or do you rotate often?)

How do I proceed?

It’s not necessarily set in stone, but here are my basic guidelines depending on the size of the portfolio:

[table “260” not found /]

As you can see, the number of stocks, at least for me, does not vary that much. Once I reach a passive income of $100,000 or so, I would generally keep the same number of stocks. Why? Because tracking and finding 25 winning dividend stocks is more than enough for me. It does give me comfort knowing that a 10% drop in any one of these stocks results in about a 0.4% loss for my portfolio which is very sustainable. I would from time to time change these 25 stocks obviously but trying to do too much reallocation can end up costing too much both in terms of trading costs but also the return. Why? Because chasing returns has always been shown as a losing strategy. You go with stocks that you believe in and that have strong fundamentals, not the stocks that have done the best in the past 12-24 months because those are very likely to not be the best performers in the next 12-24 months.

Is Facebook’s $75 Billion valuation getting out of hand?

By: ispeculatornew | Date posted: 03.09.2011 (5:00 am)

It’s amazing isn’t it? I received an email this weekend telling me that Facebook’s valuation was now up to $75 billion as it continues to race towards $100 billion and what will certainly turn out to be the most anticipated IPO in a very long time. Just 9 months ago, I had discussed the choice between owning 1/5 of Google or Facebook. Guess what… the question is now, do you prefer owning Facebook or 1/3 of Google? It certainly becomes a major challenge to price Facebook at this point for many different reasons. Some have been wondering about a new dot com crash but I personally have been very very bullish about Facebook and had said it was still a bargain when priced at $50 billion. Is it still now? Here are the main challenges that I see in pricing Facebook at this point:

Private Financials: Apart from a select few, no one has access to the Facebook financial statements. Sure, there are revenue and profit estimates all over the place but valuing from those becomes a major challenge

Unknown leadership: In Google’s early days, many investors had their doubts about Page & Brin managing the whole operating and bringing in Eric Schmidt turned out to be a confidence booster for investors. While many including myself do not think Mark Zuckerberg is a vilain, many still question his abilities to manage a $100 billion company.

Vulnerabilities: Facebook is part of this new breed of companies that must be very careful in every move in an effort to not have its users turn against it and security is also critical in keeping the users trust. How much downside risk does this present?

The new internet: The web is turning out more social and Google is one company who is worried about being left behind. Facebook is certainly the very core of this new internet but it’s not clear how it will be shaped 10 years from now and how that will impact Facebook.

Where are the revenues?

Of course, the major point is that Facebook is such a young company and a new business model that it is a major challenge to figure what the company will look like a few years from now. Even trickier is figuring out what kind of revenues and profits will be possible down the line in 5 to 10 years. There are a million different possibilities and I think it’s fair to say that revenues estimates could easily vary from a few hundred millions per year to several billions and possibly the biggest tech company in the world. But how can you compare Facebook to a company like Apple? It’s a challenge. I had discussed some of my ideas if I were Facebook’s CEO for a year. Here are the sources of revenues that we anticipate:

Display advertising: Facebook si already doing a decent job with advertising but that will certainly grow over time as local businesses understand how to make it work.

Search advertising/licencing: Over time, Facebook is gathering a lot of data that makes it more likely that its search will be able to compete. As well, it has made deals with Microsoft and others to provide data t a cost.

Giant store: I think Facebook will soon be able to help merchants by hosting their stores and making it much easier for consumers to “buy online” and of course that will be done

Taxing applications: As Apple does through the Itunes store, Facebook has started doing on its own. Applications and games that use Facebook to make it “social”  are now paying a tax, on all sales of apps, virtual goods or anything else. Companies like Zynga have been working almost exclusively through Facebook

So overall?

I can see how some might think that Facebook is worth too much at this point to be a deal and to be fair, since so many estimates are involved, I would have a hard time convincing anyone otherwise. But personally, I would still be buyer of Facebook well beyond the current prices…. How about you?

How long can Apple (AAPL) keep this going?

By: ispeculatornew | Date posted: 03.08.2011 (5:00 am)

When things seems too good to be true they usually are right? That is what I tell myself every single time I consider trading on Apple (AAPL) which has been on a streak like few others in the past few decades. The company that had to ask Steve Jobs to come back to turn things around has never looked back and remains to this day the type of investment that each one of us hopes to find once in our life.

How good do things “seem”?

Apple’s stock has been rising for years and it remains as unanimous as a stock can be on Wall Street. In fact, among the more than 50 research firms that cover Apple, not a single one considers the stock is too expensive and should be sold. And your average 1 year old could probably count the number of analysts that have a “hold” or “average” rating. All the others? They all consider Apple a strong buy and an opportunity to make a good return over the next 12-24 months. That is not necessarily something I love to see. Conventional wisdom has been pretty much one sided on this subject. If everyone likes an investment, it is usually time to get out. As if all of this wasn’t enough, Apple was just named the most admired company in the world.

What has been fueling the growth?

The most positive thing for Apple investors is that the growth in the stock has been more than justified by the surge in both sales and profits as Apple’s devices continue to be the “hot items” all around the world in electronics. Year after year, Apple has successfully launched new products and upgrades of its existing ones. Just look at the Ipad which has been a success beyond probably every single Apple employee & shareholder and it has only been on the market one year.

Is the stock still cheap?

Today, I decided to do an analysis of the stock, its pros and cons in order to see if I am still a convinced “buyer” of Apple stock. For comparison’s sake, I decided to put Research in Motion’s (RIMM) numbers for comparison’s sake. While Google’s Android powers Apple’s most serious competitor, the nature of Google’s business is so different that comparing numbers is kind of pointless. Obviously, RIMM is not anywhere near Apple’s momentum but since I still consider long & short trades as one of the best ways to profit from pricing discrepancies, I still think that looking at both companies is a good way to determine Apple’s value compared to its current stock price. To be sure, I have generally been on the long side in Apple trades and have had success closing another one of those trades last month and restarting one days later.

[table “259” not found /]


P/E ratio seems very reasonable

When I look at both companies, obviously Apple’s P/E is higher which makes sense given the overall growth which has been stronger over several years now and while Research in Motion (RIMM) has decent growth (which is so easy to forget), Apple’s 50%+ sales growth more than justifies its current 20 P/E ratio. If current projections hold, it’s P/E with next year’s numbers would be 13 which seems cheap in my opinion.

So it is all about growth…

It becomes easy to see that the only way the current valuation makes any type of sense is if Apple can keep up very strong growth for several years. If that is the case, I don’t have any doubt that Apple is in a strong position:

-Its Iphone is a dominant player and the recent addition of Verizon as a carrier was a necessary step to keep its dominant position in the US markets. I do expect the price of the Iphone to diminish over time thanks to other revenues. As well, the upcoming launch of the Iphone 5 is sure to bring many more customers.

-Apple announced it had now reached over $3 billion in revenues through the App store and that is sure to increase thanks to the most recent changes concerning subscriptions and in app payments.

-I had quoted an interesting post about the new media, and how content is being distributed, and to me, Apple is the perfect example of a company that is well positioned thanks to its Apple world.

-The Ipad became in a matter of months the dominant player in the tablet market which is exploding. It’s unclear how things will play out but competitors so far have been coming up with inferior products at often more expensive prices making it likely that the Ipad will remain the dominant player.

Downside risks

As in any business, there is risk and in this case, the major risks are around Apple’s product and its sales momentum, here are the main ones that I see as an Apple shareholder:

Steve Jobs: No doubt, as nice as it was to see Steve Jobs able to attend the recent Ipad launch, it underscored once more how dependent the company is on Jobs. He is the top guy in tech these days and perhaps the best leader of any company in the world but having that guy comes at an expense. If Jobs were to leave, it would greatly diminish Apple’s innovation in the long term and would no doubt get shareholders very worried. Jobs, who is on sick leave right now seems to be doing ok but there is certainly a lack of news and depending on one individual’s health is not the best feeling in the world.

Decent competition: While no competitor has been able to compete with the Ipod, the Iphone is under a more serious threat from Google’s Android and depending on how that plays out, it could affect the perception of Apple’s superiority. What happens if at some point the Iphone is not “The” phone to own? It could happen and would have long term impacts.

Lack of innovation: One of the big worries behind Steve Jobs’ health issues is the fact that he seems to be the guy that comes up with the big ideas or at least the guy able to filter the good ones and get them done. After the Ipod, came the Iphone followed by the Ipad. What is next? Apple’s stock supposes to a point that something will follow and while some speculate that an Apple TV will be the next big thing, it’s unclear and always possible that there will not be a big hit.

Major miss: Loyal Apple fans are ready to buy just about anything that is produced by Apple and that comes with amazing sales. But it also comes with a risk as one product miss could have a major impact on the perceived “perfection” of Apple.

Overall

I remain as convinced as ever that Apple is a terrific buy right now while I am already long, I would not hesitate to take a more important position. It is one of those few cases where every analyst seems to have it right.

Disclosure: Long Apple

News Corp (NWSA) acting greedy with Zynga?

By: ispeculatornew | Date posted: 03.07.2011 (5:00 am)

The idea was first put on by MySpace CEO Jason Hirschhorn.. if MySpace is for sale, one of the few companies that would care enough to make a bid would/should be Zynga. I thought Nicholas Carlson argued the point well and his valuation estimates of the deal made a lot of sense. $50 million is a lot of money for a company that is going downhill so quickly, but if it becomes a cheaper source of traffic for Zynga, then it could well be worth the purchase right?

Rumors came out on Friday that Zynga was about to walk away from negotiations for MySpace. Why? Because News Corp execs are acting greedy and want a lot of money. First off, it seems that they are asking for over $100 million, more than double the price that had been suggested as fair. But also, the company (not surprisingly) is asking to get paid in Zynga stock instead of cash. While most acquired companies generally prefer getting cash, Zynga, a private company, remains a hot buy and a difficult company to buy a stake in.

Of course, from Zynga’s perspective, paying in stock is not necessarily what it wants and would be part of the negotiations process. The company is scheduled to go public later this year and that stock could turn out to be much more when it reveals its financials.

So is paying over $100 million too much?

If you take a closer look at what things were, you will think that the price is a true bargain. Wasn’t MySpace purchased for $580 in 2005? Absolutely it was but as I’ve written in the past, the way News Corp decided to manage MySpace was terrible and while it might have helped short term profits, the long term impact on traffic, revenues and overall value was predictable.

Why is it a good match?

There are many reasons but one good one would be for Zynga to become less dependent on Facebook. While it’s true that the recently agreed 30% “tax” that Zynga pays to Facebook will likely keep things civil between the two, I would still think that developing “platform independent” games or working through a new social platform such as MySpace could be a big win for Zynga.

News Corp’s problem

Of course, the main issue here is that not many companies will be willing to bid on MySpace. A quickly declining web property can see its value very very fast and being greedy could end up costing the company. Just take a quick look at this chart from Sillicon Alley Insider. This makes a world of difference because few web players will be putting bids for MySpace giving it little leverage. If News Corp ends up waiting too much it will suffer the same fate as AOL when it sold back Bebo recently for $10 million, a property it had purchased for $850 million in March 2008

Will it get done?

I personally still think that Zynga will end up being the company willing to put up the most money for MySpace and if News Corp does end up selling it will be to Zynga. However, the longer that takes, the lower the value will be. As badly as I personally think MySpace should now be valued, I do see the value for Zynga if it can successfully move it from a “music social network” to a “music & games social network”.

Financial Ramblings

By: ispeculatornew | Date posted: 03.05.2011 (5:00 am)

It’s the weekend!!! I’m hoping that you have great weekends planned, if you get a chance, check out these posts from the past week!

What is your investor style? @ TheDividendGuyBlog
Interview with Bernie Madoff @ NYMag
Top Canadian dividend stocks @ The Financial Blogger
4 of the top tech companies are amon the most admired companies @ TechCrunch
The Financial sector: Capitalist bastion or corrupt oligarchy @ BalanceJunkie
Apple Ipad (1.0) data @ The Big Picture
Everything is now correlated to the Fed’s balance sheet @ ZeroHedge
What a financial advisor can and cannot do for you @ Amateur Asset Allocator
Amazon wages war against Netflix @ Invest2donate