Archive for February, 2012

Investing in Magazine Stock Picks is a Bad Idea

February 8, 2012

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While getting rid of old magazines recently, I ran into a Fortune magazine story from the turn of the century. Titled, 10 Stocks To Last The Decade, the column claimed that investors should bet on four “sweeping” trends that are sure to make money over the next decade: communications networking, entertainment, financial services and biotech. Simply identifying trends isn’t enough (niche ETFs were not available back then), so the magazine was kind enough to talk to hot shot fund managers to identify the following stocks that it said are well-positioned to capitalize on these trends (prices have been adjusted for subsequent stock splits):

Nokia (NOK: 54)
Nortel Networks (NT: $770)
Enron (ENE: $73)
Oracle (ORCL: $37)
Broadcom (BRCM: $118.50)
Viacom (VIA: $69)
Univision (UVN: $56.50)
Charles Schwab (SCH: 36)
Morgan Stanley (MWD: $89)
Genentech (DNA: $37.50)

A reader who followed this advice would have experienced a grievous loss of capital. Some of the stories are well-known: Nortel and Enron went poof! The technology names in the list have all declined substantially. Nokia is today trading at $5, Oracle is trading at $29; Broadcom at $38 and Charles Schwab at $12. Morgan Stanley survived the financial crisis but today trades at just $20. A little bit of financial archeology revealed what happened to the other names:

– The original Viacom split into Viacom Inc. (VIA) and CBS Corp. (CBS). Each share of the old VIA was split into 0.5 shares of VIA and 0.5 shares of CBS. The market value of the original shares today is $43.

– Univision, a Spanish-language broadcaster, went private in an all-stock deal in 2006 for $36.

– Genentech, the only winning stock in the list, was acquired by Roche for $95.

A $10,000 investment in each of these stocks in 2000 when the column was published, for a total of $100,000, would today only be worth $55,600 — a loss of 44% over a 11-year period. In the interest of fairness, it should be pointed out that the S&P 500 is down 10% in price level over the same time period. Granted, I did not bother to include the dividends that some of these stocks paid over the decade because it most likely won’t change the final conclusion: stock picks in magazines may be fun to read but the investment advice may not be worth the paper it is printed on.

Do Penny Mining Stocks count as Investments?

February 6, 2012

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In a recent column in The Globe and Mail, Rob Carrick wrote about a financial adviser who says he is investing based on a new fangled strategy called “the risk barbell”. A barbell is an asset allocation strategy that provides exposure to asset classes at the two extreme ends of the risk spectrum. The adviser says he puts three quarters of his portfolio in low risk assets such as Government bonds and the rest in high-risk penny mining stocks. It is very hard to evaluate a strategy such as this without knowing more about the risk-return characteristics of penny mining stocks.

It is true that an investor can obtain spectacular returns by picking the right penny stock. If you had picked up Aber or Aurelian Resources back when they were penny stocks, your investment would have become a ten bagger many times over. But that’s a bit like saying if you pick the right combination in the LottoMax draw, you can turn a $5 “investment” into $50 million. The key question is how likely is it that an investor will pick a winner out of the thousands of penny mining stocks that trade on the Venture exchange?

Research into penny mining stocks is hard to come by but I did find one study that looked at returns on stocks trading in the over-the-counter (OTC) markets in the US. The study covered a 9-year period and examined the returns from more than 7,000 stocks that traded in the OTC. The findings in the paper, titled Do investors overpay for stocks with lottery-like payoffs? An examination of the returns on OTC stocks, will be sobering for investors interested in penny stocks. It found that more than half the stocks in the sample lose more than 95% of their value (and in the interest of fairness, it must be mentioned that slightly less than 1 percent of the stocks in the sample returned 1,000 percent or more) and average annual returns were -30 (minus thirty) percent. A $1,000 investment in OTC stocks would, on average, turn into $30 over a 10 year period.

If penny mining stocks were to have similar return characteristics as US OTC stocks, an investor can, on average, expect a total loss of the capital allocated to the risk portion over time. One would hope that this particular risk barbell strategy does not require an investor to regularly rebalance her portfolio!

This and That: Pension Return Assumptions & TurboTax Giveaway

February 2, 2012

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Aggressive Pension Return Assumptions: The Wall Street Journal’s Jason Zweig points out that many private pension plans have unrealistic expectations of double digit returns from stocks. On the other hand, Berkshire Hathaway, whose pension plan is overseen by Warren Buffett, expects stock returns to range between 8% and 9%.

Pricey Dividend Payers: This column in the New York Times points out that investors attracted to dividends should note that the sectors that a rich in dividend-payers such as utilities, REITS, health care and consumer staples are now trading at rich valuations.

Canada’s Housing Bubble: The Economist magazine weighs in on housing prices in Canada pointing out that the ratio of housing prices to income is now 30% above the historical average.

Modest Housing Returns: Larry Swedroe points out that a long view of history shows that returns from residential real estate are rather modest. In any case, he suggests that we think of housing as a consumption item rather as a pure investment.

TurboTax Online Giveaway

With T-slips and tax receipts starting to roll in, it is time for a tax preparation software giveaway. Thanks to Intuit, I’m giving away three (3) coupons that are good for any version of TurboTax Online (valued at $17.99 for Standard and $32.99 for Premium). As always, entering the giveaway is real simple. Just leave a comment in this post and don’t forget to include a valid e-mail address. If you are reading this through your favourite RSS Reader or via-email, you have to click on the headline, get through to the website and scroll down to the bottom of the page and type in your comment.

Some quick rules:
(1) No purchase necessary. A skill-testing question may be required.
(2) Deadline for entries is 8 p.m. EST on Thursday, February 9, 2012.
(3) One entry per person please.
(4) I treat your privacy very seriously. Your email will be used for the sole purpose of contacting you if you happen to win.
(5) I’ll pick three (3) entries at random and announce the winner after the deadline. Thank you for entering and good luck!