Monday, October 25, 2010

Two Upcoming Series: Rule #1 Blitz and USCCB Investment Guidelines

Rule #1 Blitz
Before the advent of Netflix in Canada (which was a few weeks ago), I had to actually drive to the nearest Blockbuster to rent a movie.  So, one weeknight last year, my wife Renee and I decided that we needed some entertainment.  I'm usually the selfish one and pick an action or sci-fi flick, but this time, I was feeling especially benevolent and let Renee choose the movie.  She quickly picked up a movie with 2 actresses on the cover.  I recognized the older one being Meryl Streep, but the other, I did not know.  Examining it some more, I saw the title of the movie, "Julie & Julia".  I gave up a groan, thinking that it was probably going to be like that other movie, "Being Julia", that Renee dragged me to watch at the theatres a few years ago...a typical girl movie about romance, love, and dysfunctional women.  Why couldn't she pick something better, like, Resident Evil or something like that? ;)

When we got home, I reluctantly plopped myself onto the couch, not expecting much other than 2 hours of yawning.  About 10 minutes into the movie, I was a little intrigued because the story revolved around Julie, who was planning to blog about her experience cooking all of Julia Child's recipe in the next 365 days.  At that time, I had just started this blog and thought it was kind of cool that the movie was actually about blogging.  At the end of those 2 hours, I was thoroughly impressed, partly because it was actually based on a real story!  The movie gave me some motivation to continue blogging and I have to thank Renee for picking that awesome movie.

Anyway, why did I bring this up?  I thought I'd follow Julie's footsteps.  Blogging takes motivation and dedication.  I can't say I'm writing as much as I'd like to, and so, I'm going to challenge myself.  I'm going to go on a blitz.  For the next 10 weeks, I'm going to analyze a company with my Rule #1 spreadsheet and write about it.  I don't have a list of companies to analyze yet, and so, I'm open for suggestions.  Please leave a comment if you'd like me to analyze any particular company (traded in the US).  Now that I have announced this, I can't back down.  So, here we go...10 weeks, 10 analyses!

USCCB's Socially Responsible Investment Guidelines
In addition, I'm going to do a dissection of the United States Conference of Catholic Bishop's Socially Responsible Investment Guidelines.  I've talked about ethical investing on this blog before, but have never done a rigorous series on the topic.  So, here it is!

These couple of months are going to be exciting.  I'm pumped!  Please keep this blog in your prayers!

Rule #1 Analysis Spreadsheet: Updated with Payback Time

A while ago, I posted my Rule #1 Analysis spreadsheet for you.  I've had that sheet for a couple of years now.  Since then, Phil Town came out with a new book called Payback Time.  This second book of his changes the investing strategy a little bit, but remains true to the fundamentals set out in Rule #1.  Essentially, you still need to find great companies at great prices, and Phil adds one more tool to help you decide whether or not it's wise to "stockpile" or accumulate the stock of a particular company.

He comes up with a term called "payback time", which sounds like the name of an action flick, but it is really about how long it takes for a company to give you back your entire initial investment in earnings.  Phil uses the current EPS and extrapolates it into the future and sums up all of the earnings.  At some point in the future, the earnings per share will sum up to the share price.  That is the payback time.  For one to start accumulating a stock, the payback time should be 10 years or less.

So, I've updated the spreadsheet to include the calculation of payback time.  If you've seen the previous version, you'll notice that there are 2 more tabs.  The first is the "Stock Price" tab, where you simply enter in manually the current price of the stock.  The second is the "Payback Time" tab that shows what the payback time is.  Piece of cake!

If you have any questions, leave a comment or email me.  You can find my contact info in the About Me page.

Update February 17, 2011: I've updated the sheet.  Go to the Investing Resources to download the latest sheet.

Thursday, October 14, 2010

First Solar Plans on Doubling Capacity

Just read this press release from First Solar...They announced additional expansion plans, which will bring their capacity from 1.4 GW this year to 2.7 GW in 2012.  That's 93% increased capacity in 2 years, or 39% per year.  Even if their margins erode, it's kind of difficult to not increase EPS significantly.

One thing that is important when you see this type of expansion plan is how well the company will execute.  Some times the best laid plans do not go as expected.  However, for First Solar, their past history has been nothing short of spectacular.  The company has been in existence for 11 years, and has become one of the biggest panel makers in the world, while making tons of money in the process.

As I have said before and will say again: renewable energy is the next megatrend.  Don't miss out!

Wednesday, October 13, 2010

Don't Be Afraid of Options - Part 8: Options Spreadsheet

Figure 1: Pre-built Option Strategies

Ok, I lied when I said Part 7 was the last of this Option's what happens when you have bad planning!  Really, this is the last post of the series!  As I promised in my Fancy Options post, I would make my options spreadsheet available.  You can download it here.  Please remember to have macros enabled.

What Does It Do?
I call the spreadsheet an options builder, and that's exactly what it does.  You can build an options strategy with stock shares and up to 4 different options.  At the top of the spreadsheet, you will see a number of buttons that outlines the various pre-built strategies.  By clicking on any of the buttons here, the spreadsheet will configure itself for that particular strategy.  For example, if I click on "Long Strangle", it would set the number of stock shares to 0, set one of the option to be buying of a call, and another option to be buying of a put.  It doesn't actually enter the prices for you...come on, you still have to do some work!

Figure 2: Entering Data

Now that you have chosen your strategy, it's time to enter in the data.  In Figure 2, I have shown my recent position in GRMN, This is simply a Long Call strategy, where I bought 2 contracts of Jan 2011 calls @ $26 strike price.  At the left hand side are some input boxes for the general information about the underlying stock.  At the time of purchase, the stock price was around $27.  I bought 0 shares because I had only bought the calls.  The "display low price" and "display high price" is for graphical display purposes only.  This is the range in which the data will be shown in the graphs to the right.  Lastly, there is the commission cost per transaction.

To the right, there are 4 columns where you can enter in your various options.  Here, I only had 1 option, where I bought a call with an expiry date of January 2011 and strike price of $26.  The actual option price was $3.75 and I bought 2 contracts.  I've added some "clear cells" buttons to make it easier for you to start over from scratch.

Figure 3: Option Strategy Outcomes

Now that you've entered all of the data, it's time to see what happens in various situations.  For this, you can scroll further down in the spreadsheet for the raw data, or you can scroll to the left to look at the graphs, which is what I prefer.  I've shown 2 graphs.  The first one on the left shows the absolute dollar amounts that your option strategy would be worth at the expiry date.  The yellow line is a reference line of what the stock price was when you first entered into this position.  It gives you an idea of how far the stock needs to move for your position to be profitable.  As you can see here, my position breaks even if the stock rose to $30.

On the graph to the right, the information shown is similar, except the gains are shown in percentage rather than absolute dollar amounts.  I've added a light blue line that shows the percentage gain that the underlying stock has made.  This is intended to show the amount of leverage that you have with your position.

How Should This Spreadsheet Be Used?
In my opinion, this options spreadsheet should be used anytime you plan on entering into a position with options involved.  One of the biggest hidden costs for any options strategy is the commissions.  Since option contracts are typically cheap (e.g. my 2 GRMN calls cost me $779), commissions can add up fairly quickly if you're planning on trading the option.

In addition, the time value of an option is also something that is easily forgotten.  When I bought my GRMN calls, the stock was at around $27.  The strike price was $26, and yet the option cost me $3.75/share.  Therefore, the time value of the option was $2.75!  If I were to hold onto the option until expiry, the stock would need to move $2.75 (or greater than 10%) in order for my position to be profitable.  The graphs will highlight that for you.

Lastly, if you're into spreads and other fancy options, this sheet is useful because you can quickly tell when your strategy becomes profitable just by looking at the graph.  You can also play around with strike prices and expiry dates to optimize your position.  Play around with it.  It's actually quite fun to try different scenarios.

If you have any questions on how to use this spreadsheet or have a suggestion for improvement, please leave me a comment or email me.  You can find my contact info in the "About Me" link on the right.  Have fun!

Sunday, October 10, 2010

Don't Be Afraid of Options - Part 7: Ethical Investing in Options

This post is the last of the "Don't Be Afraid of Options" series.  I will close with a treatment of the ethical issues around investing in options.  In my last post on ethical investing, I talked about the ethics involved in owning shares of a company, that as a shareholder, one bears the social responsibility for the actions of the company.  Today, let's talk about owning options.  How does that fit in?

Ethical Risks in Owning Options
What should you be concerned about when buying or selling options?  Below are a few points to consider.

  1. Buying and selling options, in and of itself, is ethically neutral.  An option, as we have discussed in my past posts on options, simply gives the right to the buyer to either buy or sell a stock at a given price before a given time.  Its ethical implications are similar to that of gambling.  The Catechism of the Catholic Church (paragraph 2413) tells us that "games of chance or wagers are not in themselves contrary to justice."  However, gambling often leads to sin.  I would say under certain circumstances, using options recklessly can lead to sin.

    For example, if you put 100% of your portfolio in one out-of-money call option, in hopes that the stock would rise significantly, you risk losing the value of your entire portfolio.  Losing that much money often leads to anger and could also deprive one's ability to provide for one's family.  If you are going to get into options, make sure you know exactly what you're getting into and know what risks you are exposed to.
  2. Owning options is entirely different than owning shares of a company.  Companies never obtain money from options that are traded on the market.  Companies do offer a similar instrument for their shares, but these are called warrants.  The options that are traded on an options exchange are created by investors.  It's almost like sports gambling.  In places where sports gambling is not prohibited, one can bet on the outcome of a certain sports game, but these wagers do not affect or are affected by the teams playing the games (unless illegal activities are taking place).  They are linked only because the wagers are based on the outcome of that particular game.  The same goes for options.  They are linked with the underlying stock only because their value is dependent on the stock price of that company.
  3. If a company participates in unethical activities, is it morally acceptable to own a call option for that company's stock?  Let's examine that a little bit.  Who is selling the call option to you?  An investor who owns the company's stock may be selling you the call option, because he wants to have an income while he holds onto the shares, because he has a somewhat bearish outlook of the company in the short term.  If he didn't have the ability to sell the option, he may have sold the company's stock instead.  So, your buying of the call option gave an indirect boost to the shares of the company.

    However, you do not actually know why the other investor wanted to sell that call option.  The above was purely hypothetical.  In my opinion, the buying of the call option falls into a somewhat grey area in investing ethics.  You could be helping out the immoral company, but maybe not.
  4. How far would you need to be removed from the company before you are no longer ethically liable for its actions?  I don't think I can give you a good answer.  Say there is a company called Nuclear Warheads Inc. making nuclear warheads, and as we know, nuclear warheads are weapons of mass destruction.  They are, without a doubt, an immoral thing.  I have not heard of any other uses for nuclear warheads that are beneficial to human life.

    So, the company that supplies the machinery to Nuclear Warheads Inc., called Warhead Machinery Inc., is likely to be somewhat morally liable.  Although they are not making the warheads themselves, they are knowingly selling a product to a company that makes unethical products.  Then, there's the company, Machinery Tables Corp., that sells tables on which various types of machinery sit.  They are somewhat less morally responsible than Warhead Machinery Inc.  Moving on, a steel company called Steel Co. supplies Machinery Tables Corp. the steel that they need to manufacture the machinery tables.  I would say Steel Co. is pretty far removed that they are not ethically responsible.  But the point is, where does one draw the line?  It is a difficult, if not impossible, task.

    Since there are thousands of companies available for anyone in which to invest, why would one risk one's personal values by choosing to buy/sell options of a company that one knows is immoral?  I believe the risk is too great.  I would rather be safe than sorry.
The Key is Knowledge
The key to investing ethically and responsibly in options is knowledge, the knowledge of i) the moral principles of the underlying company, and ii) the risks involved in your trade.  If you have both, and both are not contrary to your values and principles, I would definitely encourage you to invest in options.  I believe options are a very good complement to purely investing in company stock.  When used properly, they can reduce risk and increase returns.

Now that you have finished reading my series on options, go out there and try them out.  I've had success with them and I believe you will too!

Friday, October 8, 2010

Exploring Ethical Investing - Owning Shares of a Company

I remember once I had a brief conversation with someone about how investing in a company's stock is equivalent to putting your money in the company.  In effect, you are part owner and are partly responsible for the actions of the company.  Therefore, it would be problematic if the company, whose shares you own, engaged in questionable dealings.  That particular person disagreed with me.  His reasoning was that the shares were already in the free market, and that you are buying the shares from someone other than the company.  So, the company doesn't actually get your money, but only the money of the person who initially paid for them.  There's some false logic in this argument.  I will show you why.

Mechanics of Stock Offerings
Before I get right down into the details, let's start with the basics.  How do stock shares work?  I'm sure you all have heard of the term, IPO, or initial public offering.  This is when a company "goes public".  What that means is that the company is selling portions of the company as shares that will be traded on a stock exchange.  A share represent an actual, albeit small, portion of the company.  The money received from these shares goes directly into the bank account of the company and the executives will then decide what to do with this money.

If the company is a successful one, it would be rare for it to create shares and sell them again in an offering.  However, if the company fails to make money and gets deeper and deeper into debt, one of the ways to get out of debt would be create shares again, out of thin air, and sell them to the public.  This is called a "secondary offering".  As you can guess, the initial shareholders aren't going to be happy about this, because they initially owned a  large piece of the pie, but after the companies created more shares, their piece of pie just got cut and sold to another person.  Secondary offerings are called "dilutive", because, as the term implies, the value of your original shares are diluted.

Aside from these 2 types of offerings, companies do regularly issue shares to their employees or to fund acquisitions of other companies.  So, everyday operations do depend on the value of a company's shares.

How Do Ethics Come In?
For the majority of us, we're not privy to buying shares from either IPOs or secondary offerings.  Institutional investors are the ones that get invited to that party.  We typically buy shares that are traded on the open market.  So, it is true your money does not go directly to the company itself, but to whomever currently is trying to sell those shares.  However, that does not mean your money is not invested in the company.  Here are a few reasons:

  1. Let's start off with an analogy.  You're living in the ghettos of South Central LA and have befriended some drug dealers for whatever reason.  Drug dealing is a big business and the local drug lord recently decided that he was going to grow his business even more.  He split his "company" into 5 parts and sold 4 parts to 4 individuals, so that he could use that money to build up his inventory.  The drug lord was still doing the hard work, buying cocaine from other drug lords in Columbia and then selling them to highschool kids.  So, the 4 other owners really don't do much work.  They just sit around and collect cash once a month.  One of them is the drug dealer you just befriended.  However, he just had a baby and decided he was going to call it quits in this risky business.  So, seeing that you've made some money in the stock market, he proposes that he sell you his part of the business.  You're a little iffy, because you don't really like the idea of owning a business that sells drugs to kids, but he assures you that the money you give him will never get into the hands of the drug lord, because the money that was used to buy that share of the business was already paid.  Seeing how logical this is, you agree and buy that part of the drug dealing business.

    So, you see how ridiculous this story is, right?  There is absolutely no difference between this story and you buying shares in any company on the stock market!  None!
  2. When you place an order to buy shares of a company, you have just created more demand for the stock.  This new demand increases the stock price by a small fraction.  What happens when the stock price of the company goes up?  As I mentioned before, a company can issue new shares to do a number of things: obtain new funding, reward its employees, buy other companies, etc.  As a result, your action of buying the stock shares just gave the company more buying power because its shares are now worth more than if you had not bought them.  Your money does affect the way the company operates!
  3. You benefit directly by owning the shares of the company.  If the company grew significantly between the time you first bought your shares and now, it is likely the share price would have increased.  By selling the shares, you stand to make a good monetary gain.  Likewise, you can also make money if the company issues dividends, because it had made money from its operations.  You benefit directly from the operations of the company.  Regardless of how removed your money is from the company, there is an undeniable tie between the operations and you.  If the company makes abortifacient drugs and you benefit from it, I would say you are pretty responsible for the death of the fetuses.
Tread Carefully
So, I hope I have convinced you that by owning shares of a company, you bear the responsibility of the actions of the company.  There are many great companies out there, including ones that strive to be morally responsible.  Do make good moral principles a requirement when selecting a company to own.  Just as you wouldn't want to own a drug dealing business, make sure you don't own a company that violates your moral principles!