Wednesday, November 26, 2008

The Turkey Effect

The Turkey, or Thanksgiving, Effect is a well-documented stock market phenomenon whereby the market is unusually bullish both the day before and the day after Thanksgiving. Nobody is certain why. Maybe people are overly-optimistic because they're in a holiday mood or perhaps the big dogs on Wall Street split early and leave trading in junior hands.

Historical evidence
I don't know the reason, but what I do know is that it certainly is no coincidence. According to a CXO Advisory Group web article, the day just before Thanksgiving (T-1) and the day after Thanksgiving (T+1) posted significantly higher returns. Return data collected from 1950-2006 showed T-1 days averaging about 0.37% and T+1 days averaging around 0.39%. These numbers look small but they're roughly ten times the average daily return during that period!

Since 1990, however, the returns have been smaller: about 0.19% for T-1 and 0.22% for T+1 with the standard deviation of T+1 being the smaller of the two and within reasonable limits. What makes the T+1 returns even more remarkable is that it is a half-day session. (US equity markets close at 1pm ET.)

We need to look no further than today's market action for confirmation of the Turkey Effect. The S&P 500 was up 3.5%, and I don't think it's unreasonable to expect a similar day on Friday. So, how can we best profit from it?

If you don't trade index futures, try options
You can play the index tracking stocks, such as QQQQ (Nasdaq 100), SPY (S&P 500), or DIA (Dow Industrials) but to get the most bang for your buck, I recommend the December at-the-money (ATM) calls. The options fields for all of these tracking stocks are generally much more liquid (and cheaper) than their index options. The chart below shows today's returns on candidate options.

The way to play these on Friday is to buy 10-15 minutes after the open (often the market slumps right after the open) and sell right before the close. You can place limit orders but make sure you're out of your positions before the close as you don't want to get stuck holding them over the weekend. (If nobody's biting at your limit order, change it to a market order.)

If the market does the unthinkable and reverse direction, don't get burned. Options need a bit more "wiggle" room than stocks, so I'd recommend placing a sell order if it drops below 20% of the purchase price.

Stock versus options returns
Today, the Q's gained 4.2%, the SPY gained 3.9%, and the DIA was up 2.8%. If instead you had bought the options, your return would have been magnified more than ten times!

So, instead of charging off to the mall Black Friday morn, stay home and buy some index options. You only have to wait three and half hours to pick up your paycheck. The stores will still be there and hopefully you'll have a lot more money in your pocket to buy that flat-screen TV and spread some holiday cheer.

Happy Thanksgiving!

Note: Do not trade options if you've never done so!

Tuesday, November 25, 2008

This 'n' that

Because this is a holiday week and Dr. Kris is in a holiday mood (translation: I'm just plain tired!), the remaining blogs will either be mercifully short or non-existent. We both get time off—yay! But just to keep everyone in the loop, here's a couple of quick things I want to pass along.

Currency currents
The currency markets are staging a reversal. The rally in the US dollar could be near its end as the chart of the UUP, the long dollar ETF, looks to be rolling over and is threatening to break through strong support at $26. If it does, you can either short it or buy its short ETF counterpart, the UDN.

Pressure on the dollar is good news for foreign currencies which could be starting a new bull run. All of foreign currency ETFs are up today, some of which are pushing against overhead resistance. The Euro and the British Pound Sterling are the most compelling, chart-wise. The Euro, especially, looks like it's going to break out any minute now. (The FXE is the Euro ETF; the FXB is the Pound Sterling ETF.)

Today, Swiss drug giant Roche announced that it will be acquiring Memory Pharmaceuticals (MEMY) in a $50 million cash deal in a move to bulk up its pipeline of schizophrenia and Alzheimer's drugs. This translates into 61 cents per share which is more than triple yesterday's closing price. The stock is currently trading at 57 cents and if I can snag it for a penny or two less, I'll add to the MANDA portfolio.

Dr. Kris on SeekingAlpha
Dr. Kris is now a contributor on SeekingAlpha, a compilation of daily financial blogs that address the markets and investing. It's a great place to get opinions inside and outside of the financial mainstream along with investing tips and trading ideas. A lot of my blog research winds up there which is how I stumbled upon it in the first place. You can leave your comments on any of the articles, but please don't leave me too many as I still haven't had a chance to comment on mine--argh! (Maybe when the turkey is cooking on Thursday...)

Speaking of Thanksgiving, if I don't get a chance to post by then, have an excellent holiday. Don't forget the Alka-Seltzer!

Monday, November 24, 2008

Pipin' hot: Water infrastructure plays

President-elect Obama wants to stimulate the economy by going the FDR/WPA route of creating two million jobs to fix America's aging roads and highways. He may want to add the country's crumbling water system to his infrastructure To-Do list.

An article addressing just this point was published in this weekend's Parade Magazine. Entitled “Our Crumbling Water Pipes”, the article cited recent major water main breaks in cities around the country spilling millions of gallons of drinking water in the process. The EPA estimates that fixing our aging pipelines will run in the neighborhood of $277 billion; not replacing it will it will cost even more due to the loss in potable water caused by underground leakage. In Western states especially, water is becoming an increasingly valuable commodity and any attempts to contain excess waste will be strongly encouraged.

So, how can we play this situation?

We can look at water pipe manufacturers, pipe maintenance and repair companies, and heavy-duty construction contractors. But the stocks I really like and are the purest plays are those involved in what is known as trenchless replacement technology. What this means is that instead of digging up the old, corroded pipe, you dig a hole at either end and literally “pull-through” a new pipe. How cool is that? There's also a similar technology called trenchless pipe rehabilitation that will automatically repair a leaky pipe in a similiar manner. Trenchless technology seems like the least expensive and quickest way to repair and replace our aging water pipe infrastructure, saving a lot of construction time and materials over conventional methods.

Pipe Manufacturers
Of course, that doesn't mean that trenchless technology will put the steel and concrete pipe makers out of business. Trenchless technology only addresses existing pipelines and we will always need new ones. Here's a couple of companies that have direct involvement in water pipe manufacturing.
Northwest Pipe (NWPX): Manufactures high-pressure steel pipeline systems for use in water infrastructure applications, primarily related to drinking water systems.
Ameron (AMN): Manufactures concrete and steel products for several infrastructure applications. Its Water Transmission Group manufactures and supplies concrete and steel pressure pipe, concrete non-pressure pipe, and protective linings for pipe and fabricated steel products. This is the only company mentioned here that pays a dividend (3.2% current yield).

Trenchless Pipe Technology companies
These are the direct plays on infrastructure repair and replacement. I prefer Insituform because it's the purest one of the two.
Insituform Technologies (INSU). The company is a worldwide provider of technologies and services for rehabilitating sewer, water and other underground piping systems without digging or disruption. The company operates in two segments. The rehabilitation segment provides trenchless methods of rehabilitating sewers, pipelines and other conduits using a variety of technologies including their cured-in-place pipe process. The Tite Liner segment provides a method of lining new and existing pipe with a corrosion and abrasion resistant polyethylene pipe. Most of the company’s installation operations are project-oriented contracts for municipal entities.

Layne Christensen (LAYN). This global company provides drilling and construction services and related products to the water infrastructure and mineral exploration markets as well as producing unconventional natural gas for the energy market. In the water market, the company's pipeline business is handled by recently acquired Reynolds, Inc., and its pipe renewal and rehabilitation services are conducted through its Inliner Technologies Division. Today, an analyst at DA Davidson upgraded the company from Underperform to Neutral.

Note: There are other companies that also provide trenchless services but they are all privately held.

Water-pipe contractors
Sterling Construction (STRL).
Sterling is a heavy civil construction company that specializes in the building, reconstruction and repair of transportation and water infrastructure. Transportation infrastructure projects include highways, roads, bridges and light rail. Water infrastructure projects include water, wastewater and storm drainage systems. The company's operations are focused mostly in the Southwest.

How to play them
Many of these companies have lost over half their market value in the past several months. Although they all experienced a nice boost today and some look like they might be putting in a double bottom, I would be a cautious buyer here. I think today's market rally is just a pre-Thanksgiving head-fake, so be careful! Add the ones you like to your long-term portfolio watchlist and if you really want to own some, start buying in dribs and drabs.

Friday, November 21, 2008

Is gold regaining its luster?

Yesterday on CNBC's Fast Money show, guest investor Peter Schiff* was on with his current market predictions. Two years ago, he was dead on when he said that we were in a huge credit bubble which would be followed by a financial crisis and a “major, major recession.”

Hello! Very few listened to him then, and although nobody's right all of the time, I thought that it might behoove me to listen to him now. So, what are his current recommendations? He says to get out of the dollar 'cause it's going to “fall like a stone”, buy the dips in commodities, and start investing in international equities. He also predicted gold is going to go through the roof in the next couple of years, possibly hitting the $2000 an ounce mark. Yikes!

Well, investors today seemed to catch the gold bug causing a spike in the otherwise severely depressed sector with some mining stocks advancing over 40% over yesterday's close! Technically, gold seems like it could be putting in a bottom, even if that bottom is only temporary. Mr. Schiff thinks that could drop to $600 before ultimately turning around and heck, who am I to argue? Judging from the chart of the GLD--a gold ETF that tracks the price of gold bullion and is the purest gold play out there--the $70, $65, and $60 all form major support levels (the GLD trades at roughly 1/10th the price of gold).

Even if the yellow metal does drop a little more, now isn't a bad time to start getting hoarding a few American Buffaloes. The question is, how should we play it?

Gold ETF plays
There are two publicly traded gold ETFs—the GLD and the IAU. They are identical in nearly every respect except for two: the GLD is much more heavily traded (average daily volume is 18 million shares compared with 800,000 on the IAU) and the GLD has options. If you're an options player, the play I like here (especially since we may not be completely confident where it's heading in the short-term) is to sell cash-secured December puts at the $65 or $70 levels. (See Recipe #6: Put Pot Pie for further info on implementing this strategy.) The premium you take in will reduce your overall cost basis and automatically give you a downside cushion.

When gold finally does put in a convincing bottom, then buying the January 2011 LEAPS would be appropriate. The beauty of this approach is that you can write monthly covered calls against it to reduce your cost basis.

There's also a double-long gold ETF, the DGP, that tracks twice the price of gold (divided by 50). It's trading at $15.40, is very liquid and non-optionable--another choice if you're very bullish on the sector. Just remember that not only are the rewards doubled, but so are the risks.

Gold stock plays
If playing options are just not you, then here are some recommendations on gold mining and exploration stocks. My selection criteria is based on technical factors (chartology), average trading volume (liquidity), and analyst recommendations of “Hold” or better. One plus that the mining stocks have over the GLD is that many of them pay dividends, albeit small ones. Most of these companies are well-established in the areas of exploration, mining, and production. The only speculative addition is Tanzanian Royalty (TRE) which is an exploration-only company. I included it because Tanzania is mineral-rich, the stock is relatively inexpensive, and I like the stock's recent upward chart action.

You can play any of the optionable stocks the same way as the GLD using cash-secured puts or call LEAPS. If you want to buy the stock (and get the dividend), I'd suggest the fractional approach—buy a quarter position now, another quarter in a few weeks, etc.

Remember that gold is predominantly used as a hedge against inflation which I don't think we'll have to worry about for a while. But, if credit remains tight, the world stops investing in US Treasuries, and the dollar tanks, people could be turning to gold as one of the few remaining safe havens. In that case, $2000 an ounce isn't that unthinkable...unless someone comes up with a cost-efficient way to manufacture it. Mr. Fusion, anyone?

*Click on this link to see the Fast Money interview with Peter Schiff.

Thursday, November 20, 2008

MANDA Holdings as of 11/20/08

Update includes the new listing SM&A (symbol: WINS).

Click on image for larger view.

Market Levels & Another MANDA Addition

Index support levels
Well, it looks like the VIX is continuing its uphill march closing over 80 today, up almost 9%. As the VIX shoots up, so plummets the market. Major market averages closed down 5-7%. The only intelligent thing I can say from looking at their charts is that from a bullish standpoint they all completely suck...and it appears that they are going continue to suck. ("Suck" is the financial technical term for really really really awful.)

So, what are the next support levels?

Unfortunately, pretty far away. In fact, I can't even give you a number on the Dow Industrials and the OEX (S&P 100) because they've both surpassed their ten year support levels and I don't have data going back any further. The good news is that I can give you support levels for the other indices:

S&P 500 ($752): Minor support is at 670. The next major support level is at—no, you don't want to know. (Okay, it's at 470.)

Nasdaq ($1316): The Nazzie is right on major support. Next stop is 1175, but I do think we could see it brush 1000. Remember Nasdaq 5000?

Dow Transports ($299): Minor support levels are 285, 250, and 215-220. Next major support is 200. Let's hope it doesn't come to that.

What does this all mean?
It means that you should be out of all your losing long positions and either be in cash or in short positions. (See previous blogs for shorting ideas.)

Another MANDA Addition
I don't know how I missed this one, but SM&A (WINS) is a management services company that provides business capture and proposal development services along with post-award risk management and profit maximizing to the homeland security, aerospace, information technology, and engineering industries.

On October 31st, the company announced a proposed merger agreement with Odyssey Investment Partners, a privately held middle market private equity firm. Terms of the all-cash deal is $119M which translates into $6.25 per SM&A share.

According to the company press release, management is delighted at the offer which is subject to the usual anti-trust regulatory issues and shareholder approval. It also may solicit other takeover offers during the first 45 days. The deal is being financed by Caltius Mezzanine and this is the only thing that really bothers me about this deal. Caltius finances deals in the $5-$75M range so I'm wondering where the extra dough is coming from...?

BUT...the stock has held up pretty well considering the market climate and I don't think that Odyssey would be dumb enough to make such an offer if it knew it couldn't raise the cash. The deal is expected to close late this year or early next year.

The stock is going into the MANDA portfolio today at a price of $5.61. This gives a yield of around 11.4% on the trade.

Disclosure: I'm going to purchase the stock in my own portfolio if it trades at or below $5.55.

Wednesday, November 19, 2008

Loading up on lemons

I said yesterday that if the market declined today that I would identify candidates for shorting strategies among the major indices. I have to laugh at myself because it's almost like shooting fish in a barrel since almost every stock out there is deteriorating. But I need some content, and this is the best I can do at the moment. (I need a vacation!)

Lemon selection
My basket of lemons are selected from the top 25 holdings of the Russell 2000 (mostly healthcare, utility, and technology stocks), the NASDAQ composite (mostly tech and biotech), and the S&P 500 (mostly large tech companies and conglomerates). My selection criteria was based on technical analysis only; fundamental analysis is left to you, dear reader. (Hey, I can't do everything!)

The worst of the Russell 2000
Two of the three lemons that I found not surprisingly came from the badly beaten down commercial real estate industry. Both Realty Income (O) and Senior Housing Prop. Trust (SNH) have recently broken major support. Realty Income is currently trading around $16 and has its next minor support level at $14.50. SNH is trading at $12 and is shortable down to the $10 level where it, too, has minor support. Both of these stocks pay a decent dividend which you don't get if you're short the stock, alas.

Wabtec (WAB) is a railroad that's currently priced just below $31. It recently broke major support and is chugging downward to test $26 support.

The worst of the NASDAQ
Apart from the financial CME Group (CME), the rest of the dogs are all well-known members of the tech sector. And speaking of the financial and technology sectors, the financial spyder (XLF) along with the semiconductor holder (SMH) are at historic lows which means we're definitely in good lemon-picking country. (Their monthly charts are below.) All of the following have broken major support except for Google and Qualcomm which are sitting right on it (and I expect that their support will not hold):

Applied Materials (AMAT): Current price = $8.42. Next support around $6.50.
CME Group (CME): Current price = $170.88. Next support around $144.
Cisco (CSCO): Current price = $15.08. Next support around $13.
Intel (INTC): Current price = $12.49. Next support around $9.
Amazon (AMZN): Current price = $35.84. Next support around $32.
Google (GOOG): Current price = $280. Next support around $220.
Qualcomm (QCOM): Current price = $30.01. Next support around $27.

The worst of the S&P 500
My top six picks from this index include Cisco, Intel, and Google mentioned above as well as General Electric (GE), Bank of America (BAC), and Citigroup (C ). These last three are trading at twelve to fifteen year lows and they've all broken major support levels. Where they eventually land is anyone's guess, but I'd aim for the $10 level on GE and B of A ($3-$4 moves), and $3 or even less on Citi (a $3+ move).

More lemons: The bailout banks
You would think that the stock of the banks that got bailed out by the government would be doing okay, wouldn't you? Uh-uh. Prices on all of them have fallen off a cliff; Goldman Sachs and Morgan Stanley are trading at their lowest point EVER with none of them show any signs of forming a bottom. Here's the list for your shorting pleasure: Goldman Sachs (GS), Morgan Stanley (MS), Merrill Lynch (MER), JP Morgan (JPM), Bank of New York Mellon (BK), State Street Corp. (STT), Wells Fargo (WFC), and two from above Bank of America (BAC) and Citigroup (C ).

This list should give you enough lemons to make a huge pitcher of lemonade which will hopefully put some profit in your pocket. If you do put on some shorts, remember to keep a daily watch on the VIX. When you see a spike, that's your cue to exit. The tricky thing about short positions is that the price can quickly move against you so you need to keep on your toes. Shorting is not for the faint of heart or weak of stomach!

Tuesday, November 18, 2008

Lemons to Lemonade: How to profit from the next downturn

Well folks, the volatility index, the VIX, finally broke through major resistance at 70 today. Most of the major market indices followed in the opposite direction by breaking through major support levels. The most notable hold-outs were the Dow Industrials, the NYSE Composite, and the Dow Transports. This last one could be a glimmer of sunshine in an otherwise stormy sky because the Transport Index typically (but not always) is a leading indicator of market direction.

I began pulling together today's blog before the big rally hit just before the close. Although the VIX closed below 70, I do believe that we're not out of the woods just yet. For those of you who are firmly attached to your rose-colored glasses, hope and pray these support levels will hold. For those of you who feel that the credit crisis has yet to play out completely, you may want to put on some short-term bearish positions. Here are some ideas...

The VIX and what it's signaling
The chart of the VIX shows major resistance at 70 which it just broke today. I've said it before and I'll say it again, but I think it could well go to 100. Well, at least 80 which is the next level of resistance.

My prediction is that the market will be heading down at least in the short term. So, assuming one has a few shekels left to trade with, how can we profit from this?

Profiting from a continuing bear market
There's many ways to profit from a continuation in the bear market. I've touched on some of these schemes in earlier blogs while one will be new. Before we go into them, we need to look find which markets have the greatest downside potential.

Index dogs
Technically, the Russell 2000 (RUT.X) and the Nasdaq composite (NASDAQ.X) are the worst of breed followed by the S&P Midcap 400 (MID.X), the Russell 1000 (RUI.X) and the S&P 500 (SPX.X) Let's take a look at potential ways to play them.

Buy index put options. It could take the VIX several weeks (or longer) to reach its maximum value, so you'll need to buy at least the January puts. But because of the accelerating time decay, I'd advise buying short-term options. In fact, my June 18th blog showed that the most profitable option plays were the January 2010 LEAPs. (A LEAP is an acronym for a long-term option.)

Buy put options on the corresponding index ETFs. The options will probably be cheaper but check on liquidity and bid/ask spreads. And don't trade options if you don't know anything about them. Here are the index ETFs:

IWM: Russell 2000. Liquid stock and options.
ONEQ: Nasdaq composite. This tracking stock isn't nearly as liquid as...
QQQQ: Nasdaq 100 tracking stock. Highly liquid stock and options.
IWB: Russell 1000. Liquid stock; thinly traded options.
SPY: S&P 500. Liquid stock and options.
UVM: Ultralong Russell 2000. (2x the Russell 2000). Liquid stock; fairly liquid options.
UVG: Ultralong Russell 1000. Stock thinly traded. No options.
BGU: A new family of funds that are 3 times the Russell 1000 index. (Ultralong and ultrashort funds are 2x.) Since this is a brand new fund, the options are highly illiquid and I would avoid them. (See the short version, the BGZ, below.)

Short the index ETF. Instead of buying puts, short the tracking stock. Don't forget to set your stop-losses!

Go long the short/ultrashort ETF and/or buy calls. Here are the short and ultrashort equivalents.
RWM: Short Russell 2000. No options.
TWM: Ultrashort Russell 2000. Liquid stock; fairly liquid options.
PSQ: Short QQQQ. No options.
QID: Ultrashort QQQQ. Fairly liquid options.
SFK: Russell 1000 Growth. Thinly traded stock; no options.
SJF: Russell 1000 Value. Thinly traded stock; no options.
SH: Short S&P 500. Thinly traded options.
SDS: Ultrashort S&P 500. Liquid stock and options.
BGZ: 3x short the Russell 1000. Liquid stock; very thinly traded options.

Note: All of the above strategies were summarized on a performance basis in the June 18th blog ETF or Options?

Another strategy
If you're more comfortable playing individual stocks, try going into the index and finding which stocks have been the worst performers. No, this doesn't mean you have to go through every stock in the Russell 2000, but looking at the top 20 or so will be enough. (Click on this link for Morningstar's list of the top 25 holdings in the Russell 2000.)

The Morningstar list gives the year-to-date returns for each holding, and I'd focus on the ones that are the biggest losers. Look at the fundamentals of the company and how they are performing relative to their sectors. Look, too, at the relative performance of the entire sector. Is it still in a downtrend? Has it broken major support?

Now apply the same criteria to the stock and if you have a real dog, then by all means short it or use a bearish options strategy.

When to exit
Exiting short positions is one of the holy grails of investing. Everybody has their own opinion and I'll toss in mine. Exit your short positions when the VIX has reached at least the 80 mark and shows a large topping tail. That's your cue to get out. If you're really adventurous, you could then start entering long positions.

If the VIX heads back over 70 tomorrow, I'll try to identify the worst of breed stocks on the above indices.

Friday, November 14, 2008

MLPs: Non-Oil & Gas Recommendations

Today we'll be finishing off the MLP miniseries by taking a quick look at some limited partnerships outside of the oil and gas industries as well as two MLP-focused funds.

Coal MLPs
You might just want to take a gander at these since coal could be an integral part of President-elect Obama's energy policy. They're all trading at or very near their all-time lows so now could be a good time to begin adding one or two to your growth and income portfolio.

Alliance Res Partners (ARLP) & Alliance Holdings (AHGP). Alliance Holdings is the general partner component of Alliance Res.* (Please see explanatory note below.) Although earnings were off by 25% in the last quarter, analysts expect huge growth in 2009. The company has steadily increased earnings since mid-2006 inception.

Natural Resource Partners (NRP). The company reported record Q-3 revenues and increased distributable cash flow by 59%. It's steadily increased distributions since 2002 inception.

Penn VA Resources Partners (PVR). Despite a decrease in third quarter earnings due to cash-payments to settle derivative contracts and higher interest expenses, the company CEO, James Dearlove, keeps an optimistic outlook: “At of the end of the third quarter, we had approximately $140 million of unused borrowing capacity under our $700 million revolving credit facility, which we believe provides adequate cushion to support our working capital needs and some modest growth opportunities. We are also confident that the fundamental characteristics of our business segments remain strong.”

Perhaps this is why this company has a higher distribution yield than the other two.

Fun & Done MLPs
There's two other MLPs that I'd like to cover. One wants to make sure that you have a good time and the other steps in when your time is up.

Cedar Fair (FUN). (You gotta love the ticker symbol.) This limited partnership owns and operates amusement parks, water parks, and five hotels mostly in the Midwest and the Mid-Atlantic. Probably its most famous holding is Knott's Berry Farm in Southern California. If you think that amusement parks have been suffering due to the recession, you'd be wrong. Revenues across the board have been up so far this year and Halloween sparked better than expected park attendance. Even if the economy worsens, the parks are closed until spring and by that time, the recession may have thawed. The major downside is debt, and the company has a lot of that. Paying down some of it might require the company to reach into its unitholders' pockets and reduce some of that juicy 14% yield.

This is a riskier play, but it could eventually pay off handsomely.

StoneMor Partners (STON). This grab 'em/slab 'em company owns and operates 223 cemeteries mostly in the eastern part of the country. There isn't much news to go on, but I did find that revenues are increasing along with the distribution payout which has increased steadily (although not as dramatically as some of the other MLPs) since it began in 2005. Revenue growth for the next five years is estimated in excess of 10%, not surprising considering the aging of the Baby Boomer generation. (Arg!)

Owning a piece of a plug isn't the sexiest portfolio holding but it could be a very lucrative one in the long run. The bonus is that a passing cemetery will put a smile on your face instead of a frown, and when was the last time that happened?

MLP Funds
I was able to find two funds that engage in MLP investing. One good reason to opt for one of these instead of making your own MLP basket is for tax reasons. With the fund, you'll get all of your necessary tax info in one form, and that could be a very, very good thing.

Bear Stearn Alerian (BSR). This is an exchange-traded note as opposed to a fund. What's the difference? ETNs are subject to the credit risk of the issuing bank. If that doesn't bother you, then check out this fund which tracks the Alerian MLP Index. (I betcha didn't know there was an index that tracked MLPs.) What bothers me about BSR is that it's only been around for a little over a year and it failed to make its September quarterly distribution. I'd really check into this one before buying.

Energy Income & Growth Fund (FEN). The fund has recently changed management but that hasn't help the share price which has dropped almost 30% in the past ten days. Its top holdings include Magellan Midstream, Energy Transfer Partners, Kinder Morgan, Enterprise Product Partners, Plains All American, Crosstex Energy, Enbridge Energy, Nustar Energy, and Holly Energy—many of which were on my list of recommended picks yesterday.

Note that the trading volume on both of these funds is low. If you like the ETN, you can buy it at this level or lower if you can get it. I'd be patient, though, in picking up FEN which is not showing any signs of price support. If you can snatch it around $12 or less, you'll be getting a yummy deal.

I hope you've seen some of the excellent advantages of adding MLPs to a long-term investment portfolio along with the disadvantages (mostly tax-wise) and potential risks running along the commodity supply-and-demand and short-term credit lines. I do think that despite these negatives, MLPs are a good value especially at these deflated prices, and I hope you think so, too.

Have a good weekend! Due your do diligence...or something like that.

*Note that many energy-related MLPs are structured where the partnership entity, that is, the company component that actually provides the services, is separated from the general or managing partner. Many MLPs offer both components as separate entities, each with their own ticker symbol. You can invest in either one but I prefer the partnership component because it pays a higher dividend. But if you're cowed by the concommitant tax complications, consider swapping the higher dividend for the tax simplification offered by the general partner. (Consult your tax advisor for further details.)

Thursday, November 13, 2008

MLPs: Current Recommendations

Today's market action indicates that we may be putting in a bottom, but whether this is THE BOTTOM or just a relative bottom remains to be seen. Personally, I don't think we've hit the bottom bottom as I feel we need to see the VIX rise a lot more (to 100?) before I'll be reassured that the worst is over. I still think hedge fund redemptions will continue until the end of the year. Why? Because investors will most likely want to take their tax losses in this year.* But in case I'm wrong and the indices are able to stay perched above current support levels, you need to have your list ready pronto so that you can lock in these low prices.

My blog for the past couple of weeks has been focused on income generating securities such as high dividend paying stocks and master limited partnerships (MLPs). Yesterday, we found that although MLPs trade exactly like stocks, they are structured differently as limited partnerships and not as corporations. This type of structuring avoids corporate taxation which is great on one hand because it allows a larger distribution (dividend) to be passed through to the unitholder (shareholder). On the other hand, the unitholder is ultimately responsible for the taxes which can become a complicated task at tax time.

Despite the tax complications, MLPs can be great additions to an investment portfolio (be careful of putting these in an IRA), especially if you have a long investment horizon. Today, we'll be sleuthing the space in search of beaten-down bargains.

There are a few important things to look for in an MLP. You want to find a company that is expanding operations, has enough cash on its balance sheet to pay dividends, and has a steady history of increasing dividends. I ran a screen through the MSN MoneyCentral stock screener using current dividend yield > 5, 5-year dividend growth > 5, average daily volume > 50,000 (to avoid liquidity issues), and with an analyst mean recommendation >= Hold (we don't want any perceived dogs). Here are the results (see the table at the bottom for a summary of current prices and distribution yields):

Oil & Gas Pipelines
Genesis Energy (GEL). The company beat recent third quarter estimates by 25%, earning 25 cents per share instead of the anticipated 20 cents. The company's CEO, Grant Sims, says that the company has more than enough cash to pay out distributions, with a cash/distribution payout ratio of 1.7 (that's pretty good). Further reassuring unit holders, he goes on to say that “the underlying cash flows from our businesses are not materially impacted by commodity prices and demand for our services appears to be steady. Genesis is fortunate to have approximately $170 million in available cash and debt commitments. This financial flexibility and high coverage of our distributions will be more than adequate to fund the internal accretive capital projects planned for the coming year and give us the ability to be opportunistic to hopefully continue to build long-term value for our unitholders.”

The stock hit a low of $8 on October 10th (the day of the grand market low) and is now trading at $9.42. If you like this one, now would be a good time to begin locking in that juicy 13% distribution yield.

Sunoco Logistics Partners (SXL). Despite losing revenue due to hurricane disruptions, the company is still increasing its distribution. It's also making new acquisitions and sports a fairly solid balance sheet. President and CEO Deborah Fretz is upbeat about the company's future: “Despite the turmoil in the credit markets, our business model remains solid and transparent and our strong financial position supports future growth. We announced a cash distribution of $0.965, a 3.2% increase versus last quarter and a 13.5% increase versus the third quarter 2007. It is the twenty-first distribution increase in the last twenty-two quarters. As announced last quarter, we expect to increase our 2009 distribution by at least 10% and we reaffirm this guidance given the investment opportunities we have underway."

Sunoco is currently trading around $43, and I'd grab some of this before it rises any further.

Magellan Midstream Partners (MMP). The company has healthy expansion prospects which are being funded by a $550M revolving line of credit with 18 banks, of which it has only used $15M. "We faced several challenges during the quarter, but our positive results show that our commodity-related activities continued to serve as a natural hedge against the negative impact of high refined products prices on demand for transportation services," said Don Wellendorf, chief executive officer. "The large majority of our operating margin continues to come from historically stable fee-based services, and we have an extremely strong balance sheet to fund growth opportunities."

This security is in a bit of a downturn. If you can pick some up around $25, you'd be stealing it.

Plains All American Pipeline (PAA). The company beat third quarter estimates with the CEO, Greg Armstrong, painting a rosy forecast: "We continue to see strong demand for our assets and services within each of our three segments, and we are pleased with PAA's positioning relative to the current state of the financial markets. We have a solid balance sheet, ample liquidity and are well positioned to execute our growth plans for the remainder of 2008 and the full year of 2009 without the need to access the capital markets."

The security is a good buy at current levels of $34; even better if you can get it around $30.

Kinder Morgan Energy Partners (KMP). This company keeps coming up on all of the high-dividend stock screens. Many Wall Street know-it-alls also like it—what can I say? It is the King Kong of the pipeline MLPs. I haven't seen any news to knock it, but I haven't seen any news that makes me want to love it, either. It's trading around $50; if it was five bucks cheaper I'd like it a lot more.

Nustar Energy (NS). Not only is Nustar an energy play, but with its asphalt refining capabilities, it's also an infrastructure play. It's two two two plays in one!

“While we expect earnings for the fourth quarter of 2008 to be down significantly from the third quarter primarily due to the seasonality of the asphalt operations, the full year of 2008 should be a record year with the highest annual earnings in the partnership’s history. Longer-term, we expect that asphalt supply markets will continue to tighten and margins will increase as the refinery coker units come online. And, although we have identified approximately $500 million of high-return internal growth projects that could be completed over the next two to three years, we have scaled back our budgeted strategic and reliability capital expenditures in 2009 to approximately $150 million in light of the current capital markets environment,” said Curt Anastasio, Nustar's CEO.

The security would have been a good buy at $41 when it traded near its low today. Try to catch it under $45.

Buckeye Partners (BPL). Company revenues are increasing as well as its distribution. The company hasn't missed a distribution payment in over 21 years. Forrest Wylie, CEO, maintains a positive operating outlook: "In connection with the current credit crisis, I would like to emphasize that Buckeye is in the favorable position of having a strong balance sheet that allows us to fund our current slate of internal growth projects with cash flow from operations and debt rather than equity. We have sufficient borrowing capacity available to us under our $600 million revolving credit facility. Our conservative approach to risk and credit metrics has put us in a good position in these times of tightening credit markets."

Anywhere at this level ($36) is a good buy.

Atlas Pipeline (APL) also showed up on the screener but it's a much riskier choice than the others. John Tysseland, an analyst at Citi, cut his ratings from Buy to Sell on the company last month citing increasing risk to Atlas unitholders. "Simply stated, as the price of crude continues to weaken the risks to Atlas Pipeline unitholders continue to mount," Tysseland said in a note to clients. “Atlas may have to cut its distribution if crude prices stay at current levels, and if they average below $60 a barrel for an extended period of time the company could violate its debt covenants,” he said.

The stock is trading at record lows and showed some price firming in today's strong market close. If you think that oil has found a bottom, you might want to dip your toe into the Atlas waters. It's distribution yield is 31%, but I wouldn't count on that lasting for too long.

Other popular picks
For the sake of completeness, I thought I'd include other MLPs (not necessarily oil & gas pipeline companies) that many Wall Streeter's have been touting: Terra Nitrogen (TNH), Energy Transfer Partners (ETP), Enbridge Energy (EEP), and ONEOK Partners (OKS).

I only covered the oil & gas pipeline companies today but there are many more in the MLP space. Tomorrow I'll conclude the series with a quick look at the best of the rest. Despite today's end-of-day monster rally, that doesn't mean we're out of the woods. In that regard, I'd strongly suggest tempering your buying by spreading it out, meaning buy a fractional position today, another in a few more days, etc. You may end up paying more but then again, you may end up paying less. And I don't want you any unhappy campers out there.

Another Good Resource
I just found this article today. It provides further insight into MLPs and is written by one of my favorite financial writers, Michael Brush. (I like those MSN Money guys!)

Make your money grow 7% to 12%, by Michael Brush. MSN MoneyCentral. 9/3/08

*Watch for stock proxies in the form of options to make up the shortfall. What this means is that if an investor wants to take a loss in a certain sector, say the financials, she might sell those stocks this year to claim the tax loss while simultaneously buying options in the same sector to cash in on her positions just in case the sector rallies. Next year (and after 30 days), she can then sell the options and repurchase her stocks without tax consequences.

Wednesday, November 12, 2008

Master Limited Partnerships

I've been promising an overview of Master Limited Partnerships (MLPs) and here it is, for what it's worth. Going into this I had little idea of how complicated MLPs are compared with ordinary dividend paying stocks. Sure, MLPs trade just like stocks, but their characteristics--especially when it comes to taxes--are vastly different. It would behoove you to at least be aware of them before you doing any investing in this area.

What is an MLP?
MLPs have exactly the same liquid trading characteristics as stocks, but they are very different from them. MLPs are structured as limited partnerships: the general partner is the company that runs the operations and the limited partners are the share holders, called unit holders, who share in the profits. (Note: An “L P” after a company name means limited partnership and is most likely an MLP, if in the energy space.) MLPs are what is known as “pass-through” entities, meaning that income generated from operations is not taxed on the corporate level. Rather, the entire dividend (called a distribution) is “passed-through” to the unit holders who are ultimately responsible for paying the taxes. But don't let that dissuade you because in most cases asset depreciation can offset the majority (usually 80-90%) of the tax liability. Because the distribution is not doubly taxed allows for a higher distribution amount which is good for the unit holders.

Types of MLPs
Most MLPs are engaged in oil and gas businesses (including propane) involving distribution (via pipeline), storage, and retailing. There are a few MLPs involved in coal (which could be a hot commodity if President-elect Obama has his way), one involved in amusement parks (FUN). and another involved with cemeteries (STON)! Don't laugh--the last one could have a bright future what with the aging of the baby boomers.

Tax consequences
MLPs maximize their tax advantages by owning long-term depreciating assets such as pipelines. Unit holders can offset their distributions by the rate of depreciation (also called the rate of deferral—typically on the order of 80-90%) and pay taxes on the remaining 10-20% at ordinary income tax rates. The balance of the tax isn't owed until the security is sold or until the total distribution income exceeds the cost basis. This is why this investment is great for those with long investment horizons.

It's also a good one for estate planning. If the owner of the security dies, the reduced cost basis is stepped up to the current share price thus eliminating any current tax liability.

MLPs that operate in more than one state (and most do) will have tax consequences in most of them. Each state has a certain specified threshold above which you'll be required to pay taxes. This can be a real drag come tax time. My recommendation with all of the above is that unless you're a tax-filing ace, have a professional tax preparer help you with MLPs.

MLPs in IRAs
Holding an MLP in an IRA is not unwise, but it is complicated. If you receive MLP distributions totaling more than $1000 in a year, you might be taxed on it (yes, even in an IRA!) depending on how much of that distribution can be considered to be unrelated business income (UBTI). You can find out the amount subject to UBTI by looking at your K-1 statements. On line 20: Other Information, UBTI is coded by the letter “V”. If you have more than one MLP, add up all of the UBTIs. (Note: The UBTI can be a negative number.) If the total is a positive number, you'll owe taxes on that amount.

Why buy MLPs now?
MLPs are an attractive vehicle especially for those of you with longer investment horizons because of their relatively high distribution rate. Plus, you're getting a steady double-digit (in most cases) rate of return which is nothing to sneer at. In a recent article, Jim Jubak feels that natural gas is the short-term winner from the utility cash crunch, saying that when the economy finally turns around demand for electricity will skyrocket forcing utilities to turn to natural gas as the only quick fix. He goes on to say that lowering interest rates will put upward pressure on high dividend paying stocks and MLPs which will be more attractive investments than low-paying treasury notes.

What to look for when shopping for an MLP
1. A high tax basis which is the level at which you can depreciate assets. You want this as high as possible, at least 80%. To keep this rate high, a company needs to either make new acquisitions or construct new pipelines or facilities. You can read about a company's expansion plans in its quarterly and annual reports in the management summary as well is in the Summary section found in the SEC 10-Q and 10-K reports (

2. A company with a strong distribution growth history. Most, if not all, MLPs pay their distributions quarterly. One place to check their distribution growth pattern is at Yahoo! Finance. Just enter the stock symbol, click on Historical Prices, and select Dividends Only. It's that easy.

3. Some MLPs offer tremendous incentives to its managers (e.g., the general partners) if they can meet certain distribution pay out levels. These incentives should be listed in the company's annual report.

4. A large, established player in the field. High construction costs coupled with demanding government regulations makes entry into this field difficult. MLPs with large asset bases and widespread operations hold a definite advantage over the smaller players.

5. You also want to check the balance sheet to make sure that the company is not loaded up with short term debt.

MLP risks
The article cited below from Personal Investment Notes gave the best discussion of MLP risks:
“The pipeline MLPs are considered more conservative and are characterized by stable cash flow and slow growth. Propane distributors are more aggressive investments than pipelines. The propane industry is a non-regulated, seasonal, slow-growth industry with moderate exposure to commodity prices. Coal MLPs also have moderate exposure to commodity price volatility. However, their principal end-user customers are public utilities, thus, overall risk is considered relatively low. The riskiest are the E&P MLPs [oil and gas exploration and production].

Generally, the MLP distribution is not guaranteed. Most MLPs (like corporations) have restrictive debt covenants, which can impair distribution payments if a default occurs.”

There's a lot here to know but I hope I haven't dissuaded from adding a couple of these to your portfolio. After all, if they're good enough for Jim Jubak, Jim Cramer, and Mark Cuban, they're certainly worth a look.

Tomorrow, we'll take a technical look at the MLP field and I'll toss in my recommendations.

Master Limited Partnerships. Personal Investment Notes. 5/16/08

Should you follow Buffett this time?, Jim Jubak on MSN MoneyCentral, 11/11/08.

Tuesday, November 11, 2008

In Remembrance

In honor of Veteran's Day, the Stock Market Cookbook is taking the day off.

To all of the brave men and women who have risked life and limb defending the principles of freedom and democracy, a heart-felt "Thank You!" We shall not forget your service.

Monday, November 10, 2008

MANDA Holdings as of 11/10/08

Click on image for larger view.

New MANDA Addition: Centennial Communications

I know I said that I was putting a freeze on any new acquisitions for my M&A Fund, but rules are made to be broken and besides, this looks like a fairly solid deal. The credit crisis seems to be easing (a little) and consolidation in the cellular communications space is inevitable. Well, today Centennial Communications (CYCL), a guppy in the ocean of cellular carriers, was swallowed up by industry leviathan AT&T (T). It's an all-cash deal worth $8.50 per share. Centennial's stock more than doubled on the news over yesterday's closing price of $3.84. Centennial's largest shareholder has already agreed to the merger. Completion of the deal is subject to shareholder and regulatory approvals. AT&T figures the acquisition to be completed by the second quarter of 2009.

An analyst quoted by Reuters put in his two cent: "I'm surprised to see a deal in this economic climate. But on the other hand, AT&T is using cash on hand and taking advantage of the significant decline in asset prices," said Michael Nelson, a wireless analyst at Stanford Group. "This is one of the few rural wireless assets left. Perhaps it was inevitable," he added.

I bought the stock near the end of the day at $7.80, representing a 9% return on the trade (assuming the deal goes through). That's roughly a 30% annualized return. I'll take that right now, thank you!

Reader FYI: I'm doing research on those high dividend paying master limited partnerships (MLPs) and should have a report on them in the next few days, so stay tuned!

Friday, November 7, 2008

High Growth Rate Dividend Achievers

Over this past week, we've been looking at picking up some reliable, high-dividend paying stocks. In Wednesday's blog, I suggested looking at the components of the High Growth Rate Dividend Achievers, an index based on criteria set by Mergent's Dividend Achievers. From this index of one hundred stocks, I selected three (plus one other not from this list) that had dividend yields (DY) greater than 4.5 and that I felt would have the most chance of success in this credit-starved market environment.

Here are my top picks:

Pfizer (PFE). Current price: $16.86, DY = 7.6%. Pfizer has been steadily declining since 2000 (down 65% ) and its current chart is not encouraging. Sure, the stock has been trading in an upward-sloping channel, but volume has been decreasing. This is a bearish sign, and judging from its previous decline, I expect the price to drop another $2 or so from this level. However, if President-elect Obama begins to spruce up the healthcare system, the drug stocks (and anything in the drug and healthcare sectors) could benefit. When (and if) the price does decline further and the stock looks like its on a rebound, you might want to sell an out of the money cash-secured put.

Polaris Industries (PII). Current price: $32.51, DY = 4.7%. Polaris makes snowmobiles and other all-terrain vehicles (ATVs). It beat last quarter's estimates and raised full-year guidance, although fourth quarter profits are projected to be flat. Stock-wise, the company lost half its value in the last couple of months. It just broke major support at $36 and although it bounced off support at $25, that doesn't mean it can't go lower, especially if consumers feel that a new snowmobile is a budgetary extravagance. If the stock heads up, try selling the $30 puts. If it falls below $30, sell the $25 puts.

Kinder-Morgan Energy Partnership (KMP). Current price: $53.40, DY = 7.6%. KMP specializes in pipeline transport and energy storage of various materials including crude oil, natural gas, and coal. It operates as a Master Limited Partnership (MLP). Many analysts feel that MLPs are safe havens in this market and their low debts and high cash-flows are perfectly structured to weather the credit storm. Now is a great time to pick up these puppies. KMP has strong resistance at $55 and unless oil falls a lot further, I wouldn't be too worried about picking up some shares right now.

Enterprise Products Partners (EPD). Current price: $24.50, DY = 8.5%. Although not on the Dividend Achiever list, EPD is another oil and gas MLP, similar to KMP above. Even its chart pattern is similar to KMP's. Resistance is at $25, and I'd be a buyer of this one at this level. The reason that EPD probably didn't make the index cut is that the company has only been around for 10 years. It has steadily increased dividends since 2000 with many annual increases greater than 10%.

More on MLPs
A week or two ago entrepreneur Mark Cuban said in a CNBC interview that he was buying up MLPs because of their relative stability and high dividends. He's a billionaire and I'm not, and what he had to say made a lot of sense. I think a little hitchhiking around the MLP universe is in order which will hopefully turn up a few more high growth dividend achievers.

But I'll leave that adventure for next week. Have a good weekend! Go Cal! Beat 'SC!!!

Thursday, November 6, 2008

Another Dividend Stock Screener

I forgot to mention another resource in yesterday's recipe to find high dividend achiever stocks. MSN MoneyCentral's stock screener is a very comprehensive and powerful tool that is free to use. (Click this link to go directly to it.)

In yesterday's recipe I mentioned that using Mergent's Dividend Achievers book and/or one of their premade indexes would help you identify good, undervalued stocks with currently high dividend yields. The theory is that you start buying these stocks (especially in your retirement account) while you can still lock in these high yields. Another way is to use the above screener as an identification tool.

The screener is a powerful tool with about as many inputs as an investor could want. Unfortunately though, it can't access data any further back than five years unlike the Mergent book which includes relevant data for up to 50 years. Notwithstanding, one can still use the screener to find some good stocks.

Initializing your search
What you need to do is just play around with the input parameters. There are a lot of them, but don't get discouraged. Once you get the hang of it, it's really pretty easy. Here's a few parameters you might want to use as your foundation screen:

Dividend Growth
This parameter is the one that should be on all of your screens. Companies with strong historical growth rates are usually committed to continuing it. You can vary the growth rate, but I like to start with a growth rate >= 10. If you don't get many at this level, try lowering it.

  • Growth Rates: 5-year dividend growth >= 10

Current Dividend Yield
Since we're looking for beaten down stocks to lock in a high dividend yield, we should set our parameter to choose those stocks with DY's greater than our minimum acceptable level. Mine is 5.

  • Dividends: Current Dividend Yield >=5
EPS Growth Rate
Since dividends come from earnings, we want some sort of industry consensus that the company will be able to at least pay its dividend in the coming years. A 10% minimum average annual earnings growth over the next five years will weed out the shaky companies (think GM and many financial stocks).

  • Analyst Projections: EPS Growth Next 5 Yrs >=5

These are the basic parameters. Here are some you can use as a springboard to refine your search even further.

Refining your search
We're looking for undervalued companies with steady cash flow. Parameters such as a low PEG (Price/Earnings ratio to Growth) will find undervalued stocks while those involving low debt/equity ratios will find companies who will stand a better chance of being able to service pay their dividend instead of servicing their debt.

  • Advisor FYI: Price Ratios: PEG Ratio Below 1 = True Now
  • Advisor FYI: Financial Condition: Debt to Equity Decreased = Since (Last year or last quarter)

Some evaluation of the condition of the company can be had by using the Analyst Projections: Mean Recommendation >= Hold. I know I've mentioned my skepticism when it comes to analysts, but if you think a company looks rosy but all of Wall Street is screaming "Sell!", there just may be something wrong with it.

Simulation results
Using all of the above parameters (with Debt/Equity Decreased Since Last Quarter) yielded four stocks: Sasol LTD (SSL), New York Community Bancorp (NYB), CNOOC LTD (CEO), and Preferred Bank (PFBC). They all have DYs ranging from 5-8%, and all are heading downwards following the overall market. I prefer the first two because of their lower price (compared with CEO) and their higher liquidity (PFBC average daily volume is 86k).

A nifty way to get into either SSL or NYB would be to write cash-secured puts. I'd recommend the Nov 22.5 puts or the Nov 20 puts (more conservative) for SSL, and the Nov 12.5 put for NYB. Remember that selling put premium is tantamount to lowering your cost basis. (Cost basis = strike price - premium)

I do hope you try this screener or something like it. (I know Zack's has one but I don't think the free version offers as many features as the MSN screening tool.) Now's a good time to make your holiday dividend paying shopping list. Hey, a good dividend paying stock would also make a lovely addition to a young relative's tax-deferred college fund. (Check with your accountant first.)

Tuesday, November 4, 2008

Election Break: A quick lesson in chartology

In the September 5th blog, we looked at how the 99 Cents Store's stock (NDN) was on a roll. It was on the eve of a major price restructuring announcement and it was anyone's guess how it would affect the stock. Apparently, shareholders seemed pleased with the news since the stock gapped up on heavy volume on the next trading day. Looking at this chart again this morning, I thought that it would make a ideal candidate for a lesson in basic chart reading.

What the daily chart tells us

[Click on the charts for a larger view.]

The daily chart above shows two horizontal lines, line A at $9 and line B at $11.20. You can see how line A provided support for the stock back last spring. It broke through that level on heavy volume on May 19th, and if you had been long the stock, that was your signal to either sell it of protect it with a put. Those with more risk tolerance might have shorted it then which would have paid off very well. The signal to cover your short position came on July 15th when a bottoming tail formed. If you weren't convinced that a bottom was put in on that day, the large up bar the next day should have convinced you to exit.

From the bottoming tail, the stock continued to rise just as fast as it had fallen. It broke through minor resistance at $8 in mid-August where it spent a week or so consolidating before breaking through major resistance at $9 in September. From there, it continued upward where it hit a ceiling at $11.20. Unable to break through it, the stock retreated testing the $9 support level twice. Finally, it broke through the $11.20 ceiling last Thursday and is in the process of consolidating at this level. (Now would be a good time to pick it up if you're interested.)

What the weekly chart tells us
So, the next question is: If we're now long the stock, how much profit can we reasonably expect? The answer can be found by looking at the weekly chart below. The stock formed a double bottom in January and July. A general rule used by technicians is that when a double top (or bottom) is formed, the amount of expected profit is the difference between the center of the formation and the top (or bottom) value. (This is exactly the same calculation as in the head and shoulders formation.) On the chart, these values are $10 at the middle of the double bottom and $6 at the bottoms giving us a $4 estimation for profit. The profit is measured from the center value so that we can expect the stock to rise to $14. There is resistance at this level and if the stock can't break through it, I would definitely exit the play.

I hope you were able to follow this example. I know it's a piece of cake for all of you seasoned technicians but many people don't understand the basics of chart reading and I'm here to help with that. I'd say that today looks like an excellent time to buy the stock, but I do have reservations about how the market might react should a democratic president and a democratic Congress be elected. You might wish to wait until tomorrow before making any market commitments. However, if you do buy at this level, I'd set a protective stop at $10.56 which was the low of the pre-breakout bar on October 29th.

Now back to my research on dividend stocks...

Monday, November 3, 2008

Dividend Stocks: Why you should own them!

For the past month or so, the financial media including dear ol' moi has been harping on the virtues of snagging some good dividend stocks while the pickings are ripe. The market is still on shaky ground and if the presidential election and the G20 meeting don't upset the applecart, chances are good we'll see a rebound (especially if the VIX can break its support level at 52). This means that now is the time to make a shopping list of stocks that pay a healthy dividend.

But what comprises a “good” dividend stock and why should you buy them now?

The case for owning dividend paying stocks
Did you know that stock dividends accounted for 42% of stock market gains over the past 90 years? According to a study by Ned Davis Research, dividend paying stocks increased 10.2% per year since 1972 while non-dividend stocks increased a relatively measly 4.4%. Inflation alone was about 4%. Also, dividend stocks in general are about half as volatile as their non-dividend counterparts. This means that although they won't rise as fast, they won't fall as fast, either, providing you with a bit of a cushion in bear markets (See reference below for full details on why you should own dividend paying stocks.)

Timing is critical to dividend yields
You want to pick up good dividend paying stocks when their prices are low.
Why? Because your dividend yield is increased. Remember that the dividend yield is the annual dividend divided by the stock price, so a lower stock price will increase the yield (assuming the dividend remains the same). For example, if a $100 stock pays a quarterly dividend of 50 cents, the dividend yield is 2% (((4x$0.50)/$100)x100%). But if that same stock loses half of its value, the dividend yield doubles to 4%. This effect becomes much more pronounced with lower priced stocks. One important thing to note is that even if your stock rises in price, your yield is locked in since it's tied to the purchase price.

Dividend reinvestment
Most (if not all) brokerage firms will let you specify if you'd like your dividends payed in cash or reinvested in the company stock. The answer to this depends on your age and circumstances. People at or near retirement may elect to take the cash while others might prefer the other option. If you're still young enough and don't need the income, I strongly advise reinvesting because it will not only increase your position size but the size of your dividend payout. The great thing about automatic dividend reinvestment is that there's no commission fee on the transaction. And speaking of commission costs, many companies will let you purchase stock directly through their DRIP programs (Dividend Re-Investment Plan) at no extra cost. The downside is that you won't have all of your holdings in one place which may not be worth the hassle especially if your commission fees are small.

Tax considerations
Dividends are taxed at the 15% rate which is lower than the capital gains rate (but that may not last depending on the outcome of tomorrow's election). Buying dividend paying stocks makes good sense in a retirement account. Some investments such as dividends from REITS (real estate investment trusts) may not fall under this special tax rate. Check with your accountant for further details.

I hope you see the benefits of owning dividend stocks. In the next few days, I'll be going through several recipes on how to find beaten down dividend payers and toss in my B O B (best of breed) recommendations from each group. This miniseries is sure to be worth your while.

Article: The secret to boosting portfolio performance by 42%, by Donald Moine, 2006. USA Asset Management.