Now Student Questions Answered!

Would you recommend a stock screen that best fits the application of the stock financial feature’s criteria for the class material?? I know some criteria requires to just go look at the characteristics, but the Momentum stocks seem to have a better defined criteria, that might fit a screener…

We are working on creating an online screener for the Investment U website.

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After 2 months, I finally got my reading package (How to Build A Million Dollar Portfolio… From Scratch: A Comprehensive Money Mastery Course ) by mail, and I started quickly to read them.

I read the second chapter and surprisingly found that you mentioned professor Theo Vermaelen, who was my Finance professor at INSEAD while studying an MBA. I clearly remember his teaching about buy-backs, but at the time, late Winter of 1999-early Spring of 2000, everybody at class was crazy about the Internet Bubble and hot IPO´s rather than buy-backs. But now I realize the value of this strategy in times of crisis and undervalued stocks. Below is the link and a snapshot of an INSEAD page where professor Theo Vermaelen published his most recent article about the buy back and he states that somehow the current financial crisis has diminished the number of companies going through a buy back program; nevertheless, he expects a higher return on investment over the market indices.

http://knowledge.insead.edu/BuybackInvesting090430.cfm

Professor Vermaelen has shown a portfolio of stocks where he put his money in order to prove that this strategy works.

I would like to ask you Dr. Brown if you know how to find companies that will go through a buy-back program near soon, so that we can also create portfolios like that of professor Vermaelen.

Professors Pyers and Vermaelen used http://www.lexisnexus.com/ to analyze the share buy backs. In terms of spotting new programs you could:

1. Google search starting with terms such as “share buy back [current year, current month]” Then look in Lexus Nexus or Google for information that indicates that the buyback is (1) the best use of funds (2) because shares are perceived by management as undervalued. BTW most community colleges and college libraries have subscriptions to Lexus Nexus. This alone could be worth the enrollment in an adult education “basket weaving” class!
2. Lou Basanese, Robert Williams, and Alex Green all look at share buy backs in their newsletters. That’s why the Oxford Club Chairman Circle membership is such a good deal. For a few grand you get the newsletters for life! Plus, the Oxford Club pampers the Chairman Circle Members…everybody else is a second class citizen!

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Dr. Brown:

Welcome Home.

1. I wanted to know how to calculate the time value of money when I have fixed return that I am trying to calculate for a set number of years. I know there is a way short cut the exponent of the formula for N (number of units of time), but I can’t remember how. The example I am thinking of is if you were looking to buy a business and you wanted to determine the true NPV.

I know you said this wasn’t necessary, but I am curious.

2. How do you recommend getting started with $500.00?

First Question: There are three ways commercial appraisers determine business value.

1. First is the “Sales Comparison Approach” which considers recent sales of highly comparable businesses in the area. This is sometimes called the market approach.
2. Second is the “Income Capitalization Approach” based on the principle that the value of the property is related to its net cash flow. Businesses rarely have constant net cash flow so the great difficulty here is in analyzing existing cash flow and correctly projecting future cash-flow. The three approaches to nailing down the net cash flow are: (a) Cross Income Multipliers [GIM] where the GIM = Sales Price ÷ Gross Income in terms of similar commercial properties, (b) Direct Capitalization when a discrepancy between operating expenses of the appraised property and comparables is suspected, (c) Discounted Net Present Value [NPV] where you pay no more for the property than the present value of all future cash flows [also known as Net Operating Income or NOI].
3. Third is the “Cost Approach” where you don’t pay more for the business than it would cost you to buy the land and build the structure.

I went through this to underscore how tricky business valuation really is. My best recommendation is to get a commercial appraiser to help you. Here’s a website that may help: http://www.appraisers.org/ASAHome.aspx

Second Question: Read the IU course booklet “The Seven Golden Steps” again. Sit down with your significant other – after he or she has read it too and come up with a plan going forward. EVERY self-starter starts with a very small amount. But, most people are not self-starters and never start. Which is why so few middle class people retire rich despite a lifetime of opportunities!

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How can I calculate the fair value to purchase a lease hold property for 15% annual return; for example: remaining land lease is 10 years and the annual net operating rental income is about $700K?

Here again a good commercial appraiser will help you do the very complicated Net Present Value calculations. Another important point is to ask around your area for the best commercial appraiser at (a) real estate brokerages and (b) title insurance companies in your area. NOTE: Commercial appraisers are ten cuts above the normal residential appraiser in brains, financial education, and experience… make sure you find a commercial appraiser NOT a residential appraiser.

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I hope this is not a dumb question: We hear that we should NOT invest more than 3 or 4% of our equity portfolio in a single company. Is our equity portfolio include Bonds and Money Market funds?

Or does it include only shares of companies and/or stock funds in our portfolio?

Thank you for your knowledge and insight!

First of all THERE ARE NO DUMB QUESTIONS EXCEPT THOSE NOT ASKED in the IU course community.

The reason I love the Gone Fishing Portfolio is that it spreads your cash out among classes; stocks, bonds, commodities, and real estate. That’s why I teach that its prudent to put no less than 70% invested annual savings into a core passive portfolio like the Gone Fishing Portfolio. Once done it’s easy to keep the percentage invested in single stock under control since it’s limited to 30%!

Thank you for your diligent study!

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My question is about using margin to buy stocks or to buy puts and calls. I see you advise to use NO margin. But how are we to invest in an opportunity that comes up, and we have no cash in the particular account? Is it better to raise cash and sell the losers first or sell some winners to be able to invest in a new opportunity?

I would think to use margin sparingly for buying puts and calls and using margin for shorter term trading rather than long term. I am also interested in selling covered puts which requires margin.

Don’t sell your winners…always hold your winners using the TradeStops.com program.

There will simply be times when you are fully allocated and will have to pass on an opportunity. Don’t chase opportunities with leverage because you will end up with very large unexpected losses at some point.

If you are going to use leverage you must have an extensive education in risk management, trading strategy, and money management. Those who are highly skilled with leverage respect it as greatly as they respect a stick of dynamite!

If you’re starting out with very little capital and minimal investing education and experience it’s particularly important that you avoid margin. Margin accelerates profits AND losses just like NO2 in a race car.

If you don’t know how to drive a super-charged race car you’ll wipe out.

Same goes with using leverage without really knowing what you are doing. If you are using the covered put strategy under Karim Rahemtulla’s guidance you should be OK as long as you really do correctly what comes out in his newsletter. But if you’re just starting out you should paper trade Karim’s Newsletter Instant Money Trader recommendations for 6 months or so to get practice. Here’s a good article on the subject:

http://www.investmentu.com/IUEL/2009/June/put-selling-strategy.html

Again, the a core passive strategy like the Gone Fishing Portfolio gives you a place to park your savings until you have the experience to move on to more advanced operations like single stocks, covered puts, covered calls, and LEAPS.

Be very patient at the start of your career. Overconfidence kills!

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You said to “challenge you on anything” so here is one.

Your March 27, 2009 report on the Investment U Conference you made reference to a group called the PIGS. You state that “this group could threaten to pull down one of the European Unions stronger members…” On April 1, I emailed you asking you to educate me about the PIGS. But you sent no response. I do count myself in the group that you said, “haven’t heard of another group, the PIGS.” I still don’t know what you are talking about.

So I challenge you to educate me on what or who the PIGS are. Are the PIGS going to fly or will they die? Or are they the cause of the current H1N1 swine flu and should we stay away from them. What group are they in the stock market?

Being a former university educator myself I hope you will do me the courtesy of answering this challenge.

I had a good laugh with your question! Also, I somehow lost your question when I did the call from Barcelona. I was coordinating everything through my BlackBerry Bold and it was a heroic feat just to pull off the call!

Here’s your answer:

The PIGS are Portugal, Italy, Greece, and Spain. The northern countries are harshly critical concerning ongoing EU PIGS membership due to low levels of the PIGS’ economic indicators such as GNP and GDP combined with a dramatic drop in PIGS’ Foreign Direct Investment (FDI) in recent years.

There’s a lot of finger pointing going on. And, it doesn’t help that economists pointed out that Italy should never have joined the EU in the first place!

But, let me introduce you to another way of looking at these countries in terms of social efficiency. There is no “social efficiency” indicator per se indicator in terms of how a society organizes its factors of production.

But we can look at perceived levels of corruption.

This is through Transparency International’s Corruption Perception Index at http://www.transparency.org/news_room/in_focus/2008/cpi2008/cpi_2008_table where 1 is the lowest level of corruption (Denmark), 180 is the highest level of corruption (Somalia).

Let’s take 4 countries known for high economic productivity in northern EU to compare levels of corruption with the PIGS:

Country	Corruption Ranking
Denmark	1
Netherlands	7
Austria	12
Germany	14
Average	8.5

Now let’s look at the PIGS:

Country	Corruption Ranking
Portugal	32
Italy	55
Greece	57
Spain	28
Average	43

So, clearly the PIGS suffer from social disorganization of which corruption is a symptom.

But this doesn’t mean that you should disregard stock investing opportunities in the PIGS. BRIC (Brazil, Russia, India, and China) are the focus hot attention right now for stock investors; in particular Brazil, India, and China where returns on some ADR stocks in the region have been stellar.

Let see how they stack up in terms of corruption and social disarray:

Country	Corruption Ranking
Brazil	80
Russia	147
India	85
China	72
Average	96

So, clearly you want to be aware of the fact that certain countries are prone to social disarray that affects economic productivity. But that doesn’t mean you can’t find good ADR stocks in these areas to invest in.

By the way, let’s analyze Puerto Rico in light of the United States. My wife being a native Puerto Rican nationalist loves to say that “The U.S. government has just as much corruption as the Puerto Rican Free Associated State!“

Country	Corruption Ranking
United States	18
Puerto Rico	36

I just don’t have the nerve to tell her how very wrong she is!

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Keep those good questions flowing,

-Doc Brown Over and Out!