The Stock Market's Resiliency

The housing/banking crisis of late 2007 to early 2009 was a devastating blow to the US economy. On October 1 of 2007 the Dow Jones Industrial Average ($INDU) was at 13,930. Then the free fall began, and by March 9, 2009, the Dow had plunged to 6,547, losing more than half of its value. But, little by little, the market recovered, taking us to today, where the Dow is 12,653, making back almost all of the ground it lost during the banking crisis. That is why experts put their faith in the power of stocks as investments. It takes time, but the market is resilient, and it does come back eventually. Many people saw their portfolios cut in half from 2007 to 2009. Those who are retired or close to retirement hopefully had a large percentage of their investments in something safer than stocks, like bonds. At the depths of the crisis of 2009, some probably got discouraged with the Dow and withdrew their investments. This is the worst thing that a person could have done. Just think about how many blue chip stocks were at bargain prices at that time. That would have been the time to buy like never before.

Since 1980, the growth of the Dow has been nothing short of amazing, when compared to the sluggish overall rise that happened during previous decades. From 1980 to today, the Dow has multiplied over 14 times! Consider these figures, showing the value of the Dow:

1-1-1930..... 267
2-1-1940..... 146
1-1-1950..... 201
1-1-1960..... 622
1-1-1970..... 744
1-1-1980..... 875
12-1-1989..... 2,753
11-1-1999..... 10,877
10-1-2007..... 13,930


How long before it hits 15,000? Stay tuned.

*Some information from money.msn.com.

The Future of Best Buy

I recently took an international business class. We had to choose one company and one country, and determine if that company should expand into the country we chose. I chose Best Buy (BBY) and the country of Norway. I determined that Best Buy not only should avoid expansion into Norway, but they should cut costs in America, and maybe close down certain locations here. Best Buy faces fierce competition especially from amazon.com. Also retailers like Wal Mart and Target sell much of the same merchandise that Best Buy sells. I predict that eventually Best Buy will go the way of Circuit City, and cease to exist. In September of last year, one of the company's officers sold almost 11,000 shares. In April of last year, another officer sold 43,000 shares. Insider transactions can be accessed easily through finance.yahoo.com. Last year, Best Buy's share price fell by 27 percent. Their sales of televisions and computers has declined. Best Buy used to depend on sales of DVDs and CDs but many people do not buy these anymore, instead they buy mp3s and watch movies on demand or stream via Netflix. The percentage of physical media allocated to each store has been shrinking. The transition from physical media to digital media has hurt many brick and mortar book stores and CD stores. Amazon.com has an advantage since they have no physical retail outlets. Best Buy's total assets versus total liabilities as of February 26, 2011 is almost $18 billion in assets versus about $11 billion in liabilities. Retained earnings are over $6 billion. So, the company has breathing room financially, but still I wonder about the long term health of this company, and its cash flow.

* Some information from finance.yahoo.com and The Wall Street Journal

Sector Rotation Utilizing Cyclical and Secular Investments

Jim Cramer's book "Real Money" discusses rotating one's portfolio through different investments based on multiple (price to earnings ratio) contraction and expansion. He also talks about secular stocks versus cyclical stocks. I would recommend that everyone reads the book for some great tips. He even includes a chart to show when to get in and out of certain investments to maximize the growth of your portfolio. He says that the economy follows specific patterns that can be tracked. Cyclical stocks go along with the economy. When the economy is good, people will buy discretionary items or luxuries. Cadillac will probably sell more cars when the economy is strong and people have money. Secular stocks on the other hand, do well no matter what the economy is doing. People will buy soap and detergent even if the economy is poor. You can rotate investments between cyclical and secular booms. We will pay a higher multiple to earnings for the growth of a secular company than for the growth of a cyclical company. One can’t be deferred, one can. Many people like to invest in secular stocks such as Procter and Gamble (PG), Johnson and Johnson (JNJ) and Kimberly Clark (KMB) since they pay a good dividend and they are companies that sell products that are widely used by the average consumer. Sector rotations: Depending on the state of the economy, you should buy or sell certain stocks at certain times. These will be either cyclical or secular investments. You want to buy based on multiple expansion and sell based on multiple contraction. This is tied into E x M = P. Earnings x multiple (P/E ratio) = price per share

In a recession the stocks with the biggest multiple expansions are the secular investments, such as P&G. When P&G peaks, get into a cyclical stock. When the fed cuts interest rates, get into something discretionary. Purchase cyclicals when the M is highest. Sell non-cyclicals when the M is highest.

PG was $44 when market bottomed out in March 2009. 9 months later it was $62. Low price times higher multiple will equal same earnings.

When times are bad, buy something like PG which is non-cyclical. The earnings will be good even in bad times. The E will be good and the M will contract. As things turn around, the M will expand, making it more expensive. A higher multiple will be paid for secular or non-cyclical stocks.

Before times get good, get into something cyclical like MYG (Maytag) or Dow (DOW) (smokestack stocks), since lowering interest rates will raise their earnings and the multiple will expand since people will pay more for it. On the low end of the cycle, the cyclicals will be cheaper since the earnings will be smaller.

The above information is a summary of principles from Jim Cramer's "Real Money". Investing can be risky, so do your homework or hire a professional before trading securities.

"Cheap" Stocks Versus "Expensive" Stocks

When I first started learning about stocks, I thought that a stock that sells for $50 per share was too expensive and I wanted to find a stock that sells for $25 per share. I learned that this view of stocks is overly simplistic and just plain wrong. Google (GOOG) is $623 per share. Jim Cramer has talked about how the movement of stock prices is tied generally to the basic economic theory of supply and demand. $623 is a lot of money for one share, but with a price to earnings ratio, or multiple, of 21, some would see it as a bargain. For comparison sake, Amazon (AMZN)sells for $179 per share, with a P/E ratio of 94. Google is in high demand since it is a company that has proven to be innovative and well managed. Apple is in the same category. In 2008, Google dropped as low as $260 dollars per share. Now it is over twice that amount. Smart investors would have bought Google in 2008 and sold it recently, turning a handsome profit. People will pay a premium for Google since the balance sheet shows that its total assets have almost doubled from the end of 2008 to the end of 2010, going from $31 billion to $57 billion. Total liabilities have gone from $3 billion to $11 billion over the same period. So, at the end of 2010, the total liabilities were only about 20% of the total assets, which is impressive in this day and age where many companies (and individuals) are carrying so much debt. The ratio of assets to liabilities for Amazon is over 50%. There are other valuation criteria for evaluating stocks other than P/E and the balance sheet analysis, but these are a couple of things to consider when picking investments. It makes sense to compare stocks in the same sector. So, if you want to buy a tech stock, you can compare Google to Apple, Microsoft, Amazon, E-Bay and others. Do your homework such as listening to conference calls, examining the balance sheet, following news about the company, analyzing the annual report, and other tasks. You can monitor trading of insiders who own large quantities of the stock, and look up historical prices/dividend yields by using sites like Yahoo Finance or MSN Money. Look at the 52 week high and 52 week low. Search for bargains, just like when you buy anything else. Buy low, sell high is the cardinal rule of investing. Past performance gives you an idea of the stock's track record and volatility, but future performance is more important. Look at the figures for revenue, earnings per share and growth rate. Google went public on August 19, 2004, selling for $100 per share. How many of us would like to take a time machine back to that day and load up on shares of Google? Ten shares bought for $1000 back then would be worth $6230 now.

Stock Selection Factors

So, you want to start buying stocks. What criteria should you follow to decide which investments are right for you? According to Kiplinger's magazine, here's what to consider.

1. Price versus earnings--- Look at the price to earnings ratio to decide.
2. Growth of the company--- Future growth is essential more than past growth.
3. Dividends--- Does it pay a dividend and has it been going up or down? Some of the highest dividend yields right now are paid out by Merck (MRK) at 4.4%, AT&T (T) at 5.9% and Verizon (VZ) at 5.2%.
4. Cash flow--- Does it have enough money coming in to pay dividends and debts?
5. Industry trends--- What does that industry or sector look like overall? Is it thriving or struggling?
6. Governance--- Is there a board governing what happens at the company?

Here's a link to the article:

http://kiplinger.com/columns/picks/archive/how-an-individual-investor-picks-stocks.html

Online Practice Stock Trading

Buying and selling securities involves risk, whether you are dealing with individual stocks, mutual funds, exchange traded funds (ETFs), certificates of deposit (CDs), an individual retirement account, (IRA), a 401k, bonds, precious metals like gold, or other investment vehicles. All of those acronyms can be confusing. You might wonder, how do I decide which stock to buy, or what are the advantages of an IRA versus a 401k? What is a Roth IRA? There are many sources to find answers to these questions, but it is possible to do some practice trading without spending any money. I found a virtual trading site where you can buy and sell, just like when you use online sites like www.etrade.com or www.scotttrade.com. The site is:


http://www.howthemarketworks.com/trading/index.php

You can choose how much money you start with, how often you trade, how much you buy, which stocks you choose, and more. This way, if you lose money, it is not real money, it's just virtual dollars. But, if you make a lot, you need to realize it's only virtual money, not real money in your account, so it's a double edged sword. I have had my account for about 18 months. In that time, my portfolio has risen 41.42%, whereas the rise of the S&P 500 stock index has been 21.48%. Too bad it is not real money. Some of my biggest winners have been Home Depot (HD), Procter and Gamble (PG), Google (GOOG) and Weyerhauser (WY). Biggest losers have been Bank of America (BAC) and Citigroup (C). Banks used to be conservative investments which were dependable and not volatile. But, since the housing collapse and the stock market crash of 2008-2009, these companies have struggled significantly.

One thing that helps with keeping a portfolio stable is diversification. Do not put all of your eggs in one basket. If you have a portfolio that contains shares of Google, Apple and Amazon, it is not diversified. Those are good stocks, but if the technology sector takes a hit, all 3 of these may take a hit. A diversified portfolio will have investments from different sectors. For example, you could have a retailer like Wal-Mart, a food company like Kellogg's, a tech company like Google, and a durable goods manufacturer like Whirlpool. If you don't want to buy individual stocks, a mutual fund can be purchased which does the diversifying for you. A mutual fund would be made up of several different stocks. Mutual funds or exchange traded funds are great ways to invest for people who want to take less risk, and they can be bought by those who do not want to monitor individual stocks. But, be aware that these investments sometimes come with hefty fees, so conduct research before buying. Often times an exchange traded fund has a significantly lower fee than a mutual fund, according to Kiplinger's magazine.

Investment Advice from the Pros

A few quotes from the book "The Best Investment Advice I Ever Received" compiled by Liz Claman.

"It is startling to know that a $23,000 investment at birth, invested at a 6 percent annual interest rate, would grow to $1,015,334.35 at age sixty-five. Time and compound interest are magic". From the foreword, by Paul O'Neill, former US Treasury Secretary

"Stay away from investments that you don't understand or that seem too good to be true. If an investment opportunity or a business has a strategy, a profit stream, or a financial structure that you can't figure out, or that doesn't seem sustainable, there is a very good chance you'll be disappointed over time". From Art Collins, Chairman and CEO, Medtronic, Inc.

"First, diversify your portfolio and minimize taxes and trading costs. Second, know your investment goals and choose your assets to achieve your goals. Third, invest regularly and avoid timing the market. Fourth, save as much as you can, and your investments will do better. Fifth, do not pick stocks unless you are following stocks regularly. Sixth, resist the temptation to sell stocks short". From John E. Core, Associate Professor of Accounting, Wharton School of Business

One can learn a lot from listening to the experts. Many years ago, I was a regular listener to the Bruce Williams radio show. I learned so many good lessons from that show that I still remember today. I don't even recall if he is still on the radio, but he has put out several books about business, money management and entrepreneurship. I also have learned a lot by reading magazines like Forbes and Kiplinger's. An international business class I had required all of us students to subscribe to the Wall Street Journal. In this day and age where it is hard to find a decent newspaper, the WSJ still is the ultimate source for Wall Street information. I guess I always had somewhat of an interest in business ever since my Dad talked about working as a stockbroker for Merrill Lynch in the 1960s. Back then, the company required all brokers to spend some time training on Wall Street. My interest in working in the television industry always surpassed my interest in business until the last couple of years.

Stocks to Hold on to Forever, and the Lessons of Toyota

A solid, dividend paying stock can be held for a long time, forever if you so desire. Super investor Warren Buffett has a portfolio that includes blue chip investments like Coca Cola, Exxon Mobil, Wal Mart, IBM and Intel. But, the stock market is unpredictable, and even a company that seems rock solid can have problems. Years ago, people saw GM and Chrysler as forever stocks, but they saw rough times and had to be bailed out. About five years ago I figured that Toyota (TM) would be a wise investment. The stock was over $100 per share, the balance sheet looked good, and it paid a decent dividend. Then came the recalls and the tarnished reputation of a company known for selling quality, worry-free vehicles. The company experienced supply chain challenges in the wake of Japan's typhoon. The stock is now at about $67 per share, about half the price at which I purchased it. But, Toyota has had ups and downs in the past, and I feel that things will turn around for the company. It is a good investment over the long term. Some would probably say that now is a time to buy, when it is low. It might be. Stock investing involves risk, and without a crystal ball, who knows what the future will hold. Buy low, sell high is the cardinal rule of investing, and if there is hope that a turnaround will happen, it's best to ride out the storm. Buy high, sell low would be a mistake. But, some may say if only a stop loss order was executed, the loss would not occur. I can see that argument, but on the other hand, a loss (or a gain) does not happen until a security is sold. The 52 week range for Toyota is between 60 and 93 dollars per share. So, at $68, it is closer to its bottom than its top. The dividend yield is still quite good, at 1.4%. But, this is down from its 5 year dividend average yield of 1.8%. Analysts on Yahoo finance rate it at a 2.7, which is neither a buy nor a sell recommendation. With the uncertainty in the European markets, things are unpredictable now for investors. When markets overseas hiccup, US markets do too. It's truly a global economy.

Individual Stocks: The Best Investment Over the Long Term

From the book “Stocks for the Long Run” by Jeremy J. Siegel---

Best performing S&P 500 firms, 1957-2006;

Altria (Philip Morris): return of 19%
Abbott Labs: return of 15%
Crane Co.: return of 15%
Merck: return of 15%
Bristol-Myers Squibb: return of 15%
PepsiCo: return of 15%
Tootsie Roll: return of 15%
Coca-Cola: return of 15%
Colgate-Palmolive: return of 14%
Others, all around 14% include; Heinz, Pfizer, Wrigley, P&G, Hershey, Kroger and CVS.

Short term, these may not move a lot, but holding them over the long haul can yield big results. These may not be the most "sexy" stocks, but long term they give great results. For these you need to take more of a buy and hold attitude, as embraced by Warren Buffett, as opposed to a buy and homework attitude, like Jim Cramer.

$1,000 in Philip Morris in 1957 would be worth $8.25 million in 2006. This is 50 times the accumulation in the S&P 500 index. The S&P is “safe” but you can make much more if you take risks. Individual stocks will pay more than index funds. I'd have some moral objections to investing in a company that makes cigarettes, but that is just my point of view.

Often times index funds, matching the return of the S&P 500 or the Wilshire 5000 will do better than mutual funds.

Historically, stocks have returned 6.8% after inflation over the last 200 years. The average P/E (price to earnings ratio, or multiple), is about 15. These returns will double the purchasing power of your portfolio every decade. With inflation at 2-3%, stock returns range between 9 and 10% per year. This doubles the value of your portfolio every 7 to 8 years.

It is a bull market if the economy is doing well, it's a bear market if the economy is struggling. Jim Cramer says: “Bulls make money, bears make money, but pigs get slaughtered.” In other words, you can make money if the market is going up or down, but do not get greedy.

Have cash as part of your portfolio, especially in a bear market. Buy stocks that pay dividends if you can (P&G pays a good dividend). It’s the dividends that make stocks outperform bonds. Stocks have yielded the best return over the long run. Bonds are less, gold is less than bonds. Precious metals prices will generally go in the inverse of the stock market. (Stock market low/metals high and vice versa).

Diversification means that no sector (a sector may be automotive stocks, or healthcare stocks, or bank stocks) is more than 20% of your portfolio. Don’t put all of your eggs in one basket. If one sector struggles, your whole portfolio will not go down the drain.

Jim Cramer's Buy and Homework Strategy

CNBC stock market guru Jim Cramer is not a proponent of buy and hold. His strategy involves buy and homework. This method involves buying a stock and then doing your homework to track your investment, to determine when to sell it, buy more, or hold on to it. Homework involves many tactics which include following news stories about the stock, looking at analyst's recommendations, looking at the balance sheet and cash flow statement, listening to conference calls, keeping an eye on competitors, monitoring any changes in management, and seeing if management is buying or selling the stock, and other tasks. Homework takes some time, and Cramer recommends that those who cannot do the homework, should invest in something diversified, like a mutual fund. He recommends taking one hour per week for each stock owned. Mutual funds can be great, but they cannot offer the returns of individual stocks. So, one must determine their tolerance for risk (losing money). Younger investors can afford to take more chances than older investors, since money lost can be gained back over time. If you are in your 20s, take risks. If you are in your 60s, take risks at your own peril. Jim Cramer says to use limit orders, not market orders. That way you lock in a specific buying point for your investment. With a market order, the stock can be bought by the broker at any time during the market day. You might want to buy a stock at 18 and sell it when it goes to 24. A stop loss order can lock in a price where the stock will be sold if it goes too low. You might buy something at 10 and have a stop loss at 8. The only issue with this is, you may miss out on the gain if a stock goes down, then back up. What is you have a stop loss at 8 and then it goes to 12? You have missed out on the gain.

An important formula that Jim Cramer discusses in his books is E x M = P, where E is earning per share, M is the multiple, or price to earnings ratio, and P is the price per share. He talks about evaluating investments based on multiple contraction or expansion. If you know the multiple will go up or down, you can predict the fluctuation in price. His book, Jim Cramer's Real Money talks about rotating investments through different sectors based on anticipating the contraction or expansion of the multiple.

If you want to see the investments in Jim Cramer's charitable trust portfolio, check it out here:

http://www.jim-cramer-charitable-trust-stocks.com/

There are some large cap, blue chip stocks here such as American Express and Coca Cola, which are also owned by investing maven Warren Buffett. The buy and hold tactic is practiced by Buffett, and he has done OK for himself. He recommends buying stocks which pay a good dividend, such as Procter and Gamble, Kraft and Johnson and Johnson. View his portfolio here:

http://warren-buffett-portfolio.com/


The dividend component of stocks can add up to a significant amount of money over time. Especially in tough economic times like we have right now, many play it safe investment wise, turning to dividend paying stocks. Cramer is knowledgeable, but just like with any investment advice, take it with a grain of salt. He is not perfect. Any investor who is perfect is probably that way due to using inside information. I like him since he takes a subject that could be boring (stock picking) and he makes it interesting.

CNBC's Mad Money Maven

Weeknights at 6 and 11pm, CNBC has the show Mad Money with Jim Cramer. It teaches you about investing in the stock market. He gives recommendations to buy or sell specific stocks. You might think that this sounds like a boring show, but not with the animated, crazy, but intelligent host Jim Cramer. He is a graduate of Harvard law school and he worked as a journalist before working as a trader for Goldman Sachs on Wall Street. He made millions for his clients when he ran his own hedge fund, Cramer, Berkowitz & Co. I have learned a lot from his TV show, his radio show and his books. Learning about the stock market is not rocket science, it just takes some time and patience to learn the basics. Cramer also owns a website, www.thestreet.com. His books include:

You Got Screwed! Why Wall Street Tanked and How You Can Prosper
Confessions of a Street Addict
Jim Cramer's Getting Back to Even
Jim Cramer's Stay Mad for Life: Get Rich, Stay Rich (Make Your Kids Even Richer)
Jim Cramer's Mad Money: Watch TV, Get Rich
Jim Cramer's Real Money: Sane Investing in an Insane World

* Some information from en.wikipedia.org