Newsletter February 4, 2007

InvestorsFriend.com Newsletter February 4, 2007

3 Words of Advice to Increase your Investment and Business Success

I will reveal this extremely valuable advice at the end of this newsletter

Performance

Our Stock Picks have fairly leapt out of the gate with good gains already this new year.

Our 24 stocks that are rated in the Buy or Strong Buy categories are up an average of 5.8% (in 1 month!). (The TSX index by comparison is up 1.2%) 19 out of our 24 are up in price and none of the other 5 are down by more than 4%. Frankly, these kind of returns cannot be sustained but we do expect to continue to out-perform the market to some extent over the years, through superior stock analysis.

Buying Higher Priced Shares

Many beginning investors are attracted to the idea of buying penny shares and seeing them soar a thousand percent or more. But I believe that the evidence is that most successful investors concentrate on larger established business that often tend to trade above $10, and often much higher. Out of our 24 Picks, exactly 1 is below $10 and yet we have achieved enviable returns.

Some investors protest that they cannot afford to buy a $50 stock. But there is no rule saying that you need to buy a minimum 100 shares for say $5000. In reality you can buy 20 shares of a $50 stock for $2000. (100 shares is a Board lot and there are certain advantages to buying and selling in Board lots but you certainly do not have to and nor will you necessarily be penalized in price for buying odd lots).

We also don’t think there is anything at all wrong with buying lower priced shares, even penny shares. But we favor buying already-profitable companies rather than speculative bets.

Beware Scams

I was recently listening to a radio ad for a real estate investment opportunity. The ad made statements about how stocks have not been a good investment and investors need a better deal. Whenever an investment opportunity pitch starts bashing stocks, our Country’s income tax policies or any other investment opportunities, watch out. If the real estate investment opportunity is a good one, they should be sell it without bashing other investments.

A common tactic when raising money for dubious or scam investments is to get the audience all riled up about something. A classic example is where they get the audience into a frenzy about our allegedly unfair income tax system and convince people that they are well justified in moving their money to off-shore tax havens. Even if it was a legitimate investment it would be illegal for Canadian residents to not declare income made anywhere in the world. But worse then that, this sort of pitch is often for a scam where you will never see your money again. The more heartless ones will even try to get you to collapse your RRSP (typically by swapping in other shares of supposedly equal value but which turn out to be worthless) and send your former RRSP money away never to be seen again. A cruel twist with this one is that when the government finds out the RRSP funds were removed illegally (since the swapped in shares were in fact worthless and not of the required equal value), they can require you to pay tax on the entire amount removed.

There are of course many very legitimate real estate investments. But if they start bashing other forms of investment, take it as a real danger signal. Also if they are offering to pay you a guaranteed high rate (I have recently seen 12% to 16%) on money that you invest with them (loan to them) ask yourself why they can’t just borrow from a Bank at a cheaper rate.

Tax avoidance (not evasion) is fine. But if an investment presenter starts getting rabid about the evils of tax, watch out, he or she may be trying to get you to make an emotional decision. They may be trying to divert attention away from the merits of their investment proposal by focusing attention on your unfair tax burden.

Remember, Warren Buffett’s first rule of investing reportedly is “don’t lose money”, by which I believe he means don’t invest in a dog investment where you will not get your money back even if held for several years. Scams are a good way to lose money. By the way, I believe Warren’s second rule, is “don’t forget rule number one”.

Trading Fees and costs

Investors using a full service Broker typically pay a minimum of $100 per trade (and I believe that $200 or more would not be uncommon), but that includes compensation for a certain degree of personalized investment advice.

Many investors using a discount broker are paying about a minimum $30 per trade for up to 1000 shares traded. For larger dollar amount trades this seems reasonable. For example if a client were trading 1000 shares of a $50 stock, that is a $30 commission on a $50,000 investment or only 0.06%. For lower dollar trades though it can get expensive. $30 on trading 200 shares at $10 is $30/$2000 or 1.5%. On penny shares the fee is often a minimum of $30 or 1.5%, whichever is greater. $50,000 traded across several penny shares might cost $750, which seems expensive, for several typically all-electronic transaction.

Recently there has been some substantial relief, active traders and those with more substantial accounts can quality for flat fees of $10 or lower. That’s a huge savings when it comes to penny shares. Check your discount brokers web site to see if you can qualify for the new lower fees.

With TD Waterhouse, you can qualify if you do more than 30 trades per quarter (not something I would recommend for most people) or if you have investments that are over $500,000 (and you are allowed to combine the accounts within a household to reach the $500,000) minimum.

I don’t have any issue with $100 plus commissions from full-service brokers, since the advice needs to be paid for. But I think the discount broker commissions on penny shares of say 1.5% arguably are excessive. One customer might pay $150 to trade $10,000 worth of penny shares while other customers pay $10 for the same trade. To my knowledge both transactions would cost the discount broker exactly the same. In a free-enterprise system, it up to customers who are paying high fees to consider moving to a cheaper broker.

Keep in mind that the bid/ask spread could be costing you far more than the trading fees.

When it comes to management fees and sales commissions, many people state that they would prefer to see this fee broken out separately. But their behavior indicates otherwise. Mutual fund investors routinely pay fees that include about 1% for management and another 1% for on-going sales commissions. The rest of the management expense ratio (which can add an addition 0.5% to 1.5%) covers other costs of the mutual fund operation. The sales charges and management fees portion often approximates about 2%, or $2000 per year on a $100,000 portfolio. Mutual fund investors usually and unknowingly pay these fees without complaint. However, investment advisors that try to separate out management fees and charge them separately often run into stiff resistance. Investors appear to be happier paying higher hidden fees rather than lower but visible fees.

Many investors choose their own stocks and therefore avoid high mutual fund management fees. Often they can spend $500 per year or more on investment newsletters and that can often be far less than they would have paid in mutual fund management fees.

I am not saying here that mutual fund management fees are too high. In fact I believe investment management has value and has to be paid for in one way or another unless an individual can do it themselves.

Can You Take the Heat of investing in Stocks?

I’m convinced that stocks are a great way to build wealth in the long term. But you have to able to take the heat.

Through the 90’s many investors saw year after year of double digits gains on their stocks. By around 2000 many had more or less forgotten that stock market indexes could go down.

But in the early 2000’s investors got a rude reminder that even well-diversified portfolios could go down quite dramatically.

Consider the S&P 500 index, which is a well diversified portfolio, and as stocks go, would be considered much less risky that a small cap stocks of a group of tech stocks. The S&P 500 has gained an average 10.4% per year since 1926, turning $1 into $3077. Even after inflation this was a gain in real constant purchasing power dollars of 7.2% per year, turning each $1 into $275 since 1926. Bonds meanwhile turned the same $1.00 into just $8.89.

But anyone invested in the S&P index over many years has also seen some gut-wrenching, faith-destroying and down right sickening losses over the years. Most recently, based on year-end data, that index (even adding back dividends) crashed a cumulative 38% during 2000, 2001 and 2002. And, based on daily closing values the loss from peak to trough was even greater!

Here is some of the history of returns in losses on the S&P index:

Using year-end data there was a cumulative 64% loss during 1929, 1930, 1931 and 1932.¬† Using daily data the loss was even more and even some blue-chip stocks lost around 90% from their peaks. (Imagine being 100% in stocks during that period and trying to explain that loss to the wife!). Luckily a great depression does not come around that often. But there were other noticeable losses. The market rose an even 200% during 1934, ’35 and ’36 to slightly more than recoup the losses since the end of 1928. But then the market handed investors a 37% loss in 1937. There was a decent gain in 1938 but roughly 11% losses in each of 1940 and 1941¬† as the roller coaster continued. Can you imagine someone bravely staying fully or substantially invested in equities through all that? But those brave investors who stayed with stocks caught one heck of ride from 1942 through 1962, as the market returned over 2100% averaging a return of 16.9% per year. During that wondrous 20 year stretch 17 years were winners and the three losing years saw losses of only 8%, 1% and 11%. The wondrous period ended in 1962 but the next really bad spell was not until 1973 through 1974 when the market handed investors a 37% loss, and inflation was 22% over the period which adds to the loss. However, the next really big loss period did not start until 2000.

It is well known that stocks have historically been great investments over the long term. But the above describes two periods in the last 80 years when stocks handed investors losses of around 35% plus the depression loss of around 64% – and these losses don’t add in the additional loss of purchasing power due to inflation. And the losses were even bigger and more frequent if one considers daily rather than annual data.

The age old question, is whether the long-term reward is worth the sometimes huge volatility and risks.

If you have an amount invested in equities that is large in relation to your total liquid assets, your total net worth or your total sources of income, then ask yourself if you are willing to take the heat of occasional very large losses. (You might plan to get out if the market drops but that is easier said then done, and if you do jump out on dips you will no doubt miss many of the best rallies.)

In my view understanding if you are willing to take the heat or financially able to take the heat is very much a personal decision. But I think investors need to understand as much as possible about past volatilities and returns. Your reaction to a 35% loss in the markets is likely to be far different if you are fully aware that drops like that have occurred in the past and have been more than fully recovered from in future years.

Some of you might decide that occasional big losses are simply part of the price to be paid for what appears to be the eventual out-performance of stocks in the long term. Others will decide they cannot take that heat.

We are now well into the fifth straight year of very bullish markets since the last “bottom” in 2002. At this point many investors may be starting to think that making money in stocks is quite easy. At times like this we need to force our selves to look at past data and remember that markets periodically have their down years.

Most investors decide to place some of their money in stocks and some in bonds, cash and other investments in order to spread risks and reduce annual volatility.

I am currently working on additional articles that will graphically examine past stock and bond market volatilities and returns based on historic data. This may help investors decide what portion of their funds should be in stocks at different phases of their lives. Stay tuned.

Internet Tip

When browsing this Web Site or any other Web Site, you can use “Control-F” to search for specific word content on that page. This can be very handy and is a big time saver. This works in the most common web browser, internet explorer, and I assume other browsers have a similar feature.

General Editorial Section

Lately, here in Edmonton, there have been a number of cases in the news where police officers have been brought up on criminal charges¬† for use of excessive forces. Recent cases include tasering a saucy youth (acquitted last week), tasering an apparently sleeping suspect (acquitted recently), roughly knocking to the ground and injuring an admittedly-cursing-at-the-Officer, and allegedly-spitting woman who was allegedly participating in Edmonton’s Stanley Cup run street riot at the time (still before the courts), killing an allegedly threatening prisoner in a holding cell (Pincher Creek, found guilty, upheld on appeal).

I don’t know all the facts, but I think criminal charges should never have been applied except maybe in the murder case. (And there I find it hard to believe he was found guilty, I would have given the benefit of the doubt to the Officer, how could a jury possibly know that the Officer did not feel his own life was threatened by the prisoner who I believe the Officer said was reaching for the Officer’s gun a the time?).

Do I think a different law should apply to professional Police Officers? Yes, in fact I do. In fact different laws clearly do apply to them. Officers are authorized to carry guns and to use force, including lethal force, when reasonably necessary. Society pays these brave Officers to wade into dangerous situations in order that we can all enjoy a reasonably peaceful and secure life.

Of course, that does not mean we should let Officers randomly use excessive force. But if they step over the line, it seems to me that should normally be an internal discipline issue. Repeat offenders should eventually be removed from the force. No police force should tolerate continued use of excessive force. But I believe that when we pay a man or woman to protect us and we authorize them to use force when needed, it is just plain wrong to bring them up on criminal charges when they step across a line. If an Officer wrongly perceives his life to be in danger, and uses force, then yes discipline and training is called for, and perhaps even dismissal. But I cannot agree that criminal charges should be involved. And certainly not in the routine way that criminal charges seem be arising recently.

Also remember, this is a very free country, most of us are used to great freedom of movement and speech. But if you are ever in the position of being ordered to do something by a Police Officer, do yourself a a favor and respect his or her orders in that moment. If you have a complaint, bring it up later, but do not get belligerent or uncooperative with an Officer. If you do, I will not sympathize with what may happen to you.

3 Words of Advice to Increase your Investment and Business Success

If you want to have success as an investor or in your business I believe that three of the most important words of advice that you could possibly receive are this:

READ YOUR BUFFETT!

This means seek out and read the writings of Warren E. Buffett. He is thought to be the second richest person in the world after his good friend Bill Gates. (And lately he is gaining on Gates). He has pledged to give away most of his wealth over the next 20 years, but meanwhile he still legally owns that wealth. He is generally acknowledged to be the most successful investor in history as well as the most respected and also one of the most respected Chief Executive Officers in the world..

Some may think it trite and superficial to suggest that merely reading Buffett’s words is any great piece of advice. But I am very serious. If you think about it, it should be obvious that we all have a great deal we could learn from the world’s most successful investor.

He has never written an investment book, although I understand he may be in the process of that now. He has written detailed letters to the shareholders of his holding company each year since 1977.

These invaluable letters can be accessed free at http://www.berkshirehathaway.com/letters/letters.html

I have a page of recommended books that includes several about Buffett and his methods and one that compiles the most relevant parts of his annual letters up to about 1999 (The Essays of Warren Buffett).

Full disclosure – If you order a book by linking through this site, investorsfriend inc. will make a small commission of about 5%.

I sincerely believe that reading Buffett’s words and books that describe him and his thinking has the potential to add greatly to your success as an investor or in your success in business.

After reading your Buffett, my next best advice would be READ BUFFETT AGAIN. This man is is to be studied repeatedly not skimmed and forgotten.

END

Shawn Allen, President
InvestorsFriend Inc.

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