What You Should Know About the Price to Sales Ratio

Posted on May 13, 2019May 12, 2019 by Manuel Jesus

Fundamental analysts focus on data available in financial statements. Among the most popular uses of this data is the calculation of the price to earnings (P/E) ratio.

Another metric is the price to sales (P/S) ratio. The formula is similar to the P/E ratio, but it uses sales instead of earnings. To calculate a stock’s P/S ratio, you simply divide its price by its sales per share.

price/sales ratio

This might be a familiar concept, but we sometimes forget that investment analysis is a fairly new field of study and the P/S ratio appears to have been publicly known for a little more than 30 years although it was probably used by some analysts before then.

Investment manager Ken Fisher popularized the P/S ratio in his 1984 book, Super Stocks. Fisher is a value investor who noticed a problem – many small companies have no earnings.

super stocks

Value investors at the time were unable to evaluate companies without earnings using their standard tools yet these companies have the potential to be among the biggest long-term winners in the stock market.

By the time the company reports earnings for several years, the stock may have gained several hundred percent or more. Fisher’s goal was to find super stocks which he defined as stocks capable of increase in value by 200% to 1,000% over three to five years. This meant he couldn’t afford to overlook companies without earnings.

Because super stocks may not have earnings yet, he focused on sales and recommended considering stocks with low P/S ratios, preferably 0.75 or less. Fisher also used other tools, including the price-to-research ratio to identify companies investing heavily in the future. The P/S ratio was a starting point for him rather than a standalone tool.

While Fisher may have introduced the P/S ratio, the indicator’s popularity increased after James O’Shaughnessy published What Works on Wall Street in 1997. This book was one of the first books to provide quantitative test results of a large number of indicators to individual investors.

Using data from 1951 to 1994, O’Shaughnessy tested dozens of indicators. His testing process allowed for an “apples to apples” comparison of different indicators. He would evaluate all stocks based on an indicator at the beginning of the year and form a portfolio of the stocks that had the best value, the lowest P/E ratio or the lowest P/S ratio among others.

He would repeat this process every year and found how the indicators performed over time. He then summarized all of the results in easy to understand tables that gave individual investors a chance to compare the various investment tools side by side.

Through his tests, he determined that the P/S ratio was among the best tools for value investors. His work showed the single best strategy using multiple indicators for stock pickers combined the P/S ratio with relative strength.

Later tests, however, have raised varying levels of doubt about this conclusion. In 2009, Richard Tortoriello’s Quantitative Strategies for Achieving Alpha, found indicators based on cash flow were the best performers. His tests used data from 1987 through 2006, a twenty-year period.

Alpha

Tortoriello followed a process that was similar to O’Shaughnessy’s but used more indicators and focused on tools professional investment managers used.

The test dates used by each author show one of the problems with the P/S ratio tests. O’Shaughnessy’s tests ended with data in 1994. The tech bubble unfolded after that. At that time, a number of internet companies began reporting strong sales growth.

Some of these companies had high sales and low P/S ratio because the sales were inflated by accounting techniques. Under generally accepted accounting principles at the time, a company could sign an agreement with another company to place ads on each other’s web sites.

The ads would be recorded as revenue by each company but no cash changed hands. These in-kind transactions made many companies look like they had sales at the time but the sales were an illusion, based on contracts that were allowed under accounting rules.

This example demonstrates that sales don’t provide enough information about the company’s financials to make an investment decision. Profits and cash flow are also important.

Looking beyond the problems with recording sales, at first glance the test period O’Shaughnessy used seems better than Tortoriello’s because it is longer. But accounting rules change and using longer test periods can mix apples and oranges.

This is a challenge to researchers. It’s important to use a lot of data but not too much. Twenty years is a good time frame because accounting rules change slowly with new rules being phased in over three to five years after being developed over a timeframe spanning several years.

However, when using more complex indicators that incorporate several variables, it can be better to use longer test periods. Test setup is a complex subject that researchers face at the start of their projects.

These problems explain why the P/S ratio may not be the single best indicator to use. In fact, no single indicator will ever be the best all of the time. But the P/S ratio is still valuable when used properly. Like several other fundamental metrics, the P/S ratio is best used in context.

P/S ratios vary greatly from industry to industry. The means the metric can be used to sort within an industry or sector. If you were looking for a utility stock, for example, you could sort the sector by P/S ratio and consider buying the stocks with the lowest P/S ratio.

Another way to use the ratio is to compare the current ratio to the 5-year or 7-year average for the company, the sector or industry. This helps to show whether the company is potentially undervalued right now. Additional research should then be conducted but stocks trading with P/S ratios below their long-term average are potentially undervalued.

In conclusion, it seems fair to say the P/S ratio can provide important information, but it should always be used with other indicators.

Stock market strategies

Stocks Under $10 Ben Graham’s Formula Says Are Buys

Posted on May 10, 2019May 4, 2019 by Manuel Jesus

Warren Buffett completed his graduate degree at the Colombia Business School which he specifically chose so he could study under Ben Graham.

Graham wrote the original textbook on investment selection with David Dodd. That book, Security Analysis, is still considered to be required reading by many market analysts. Graham also wrote The Intelligent Investor, a more accessible book designed for individual investors.

Graham believed that a company’s financial statement held the key to success. He advocated looking at the income statement and balance sheet to find stocks that offered value.

The Graham Number

In particular, Graham looked for stocks with a low price to earnings (P/E) ratio and a low price to book (P/B) value. He also explained a technique to combine these two metrics into a single number, the Graham Number.

The Graham Number is a geometric average of the P/E ratio and P/B ratio. The geometric average of two numbers is the square root of the product of the two numbers. Graham advised investors to look for value and defined value as a P/E ratio of less than 15 and a P/B ratio of less than 1.5.

The Graham Number combines those two values into a single data point. It is thus the square root of 22.5 times the P/E ratio times the P/B ratio. When divided by the current market price, ratios below 1.0 indicate value.

Now, we know from news stories Buffett recently told CNBC that “one of the fellows in the office that manage money … bought some Amazon (Nasdaq: AMZN) so it will show up in the 13F” later this month.

Buffett was referring to either Todd Combs or Ted Weschler, who each manage portfolios of more than $13 billion in equities for Berkshire.

Buffett has long been a fan of Amazon and its CEO, Jeff Bezos, praising the company’s dominance and the founder’s business prowess. But while Buffett has sung the company’s praises, he’s never bought Amazon shares.

So a headline that Berkshire was buying shares likely would spark interest in the markets.

“Yeah, I’ve been a fan, and I’ve been an idiot for not buying” Amazon shares, Buffett said. “But I want you to know it’s no personality changes taking place.”

The stock had a P/E ratio of almost 100 and a P/B ratio of almost 20 yet the Graham Number is just 0.11 so it could be an interesting value stock.

Of course, one example does not prove the value of the Graham Number, but it provides some degree of confidence in the technique.

The Graham Number could be used to screen for stocks that offer value, and it could be hidden value as in the case of Amazon.

Now, it is important to remember that there is no guarantee any stock will increase in value. Also, it is important to remember when we search for stocks using quantitative measures, our goal is to identify stocks that meet those criteria.

Just because a stock has a low Graham Number, it does not mean the price will rise and any individual trade based on that idea could be a winner or loser.

We recently screened for cheap stocks with Graham Numbers below 1.

We limited our search to low priced stocks.

Individual investors understand that low priced stocks could be appealing for two reasons. One reason is that the low price means they have little down side risk in dollar terms. The second reason is that low priced stocks are generally the ones that deliver the largest short term gains.

One study looked at how low priced, or cheap, stocks performed relative to more expensive stocks. The study found that cheap stocks delivered more than six times the average return of the more expensive stocks in a typical quarter.

That’s why we limited our search for potential bargains by focusing on stocks priced at less than $10 per share. While we would like to see stocks at even lower prices, there just weren’t many that passed our stringent screening criteria, so we had to use a cut off value of $10 to ensure some degree of diversification in this screen.

The stocks that passed this screen are shown below.

cheap stock picks

This list could be used as a starting point for research.

Some of these companies, like Mr. Cooper Group (Nasdaq: COOP), may not be well known.

Mr. Cooper Group provides servicing, origination and transaction-based services related principally to single-family residences throughout the United States. It offers mortgage servicing and a loan originations platform.

The company operates through its subsidiary, Nationstar Mortgage Holdings Inc. it operates through its brands, such as Mr. Cooper, Xome and Champion Mortgage.

The company’s Mr. Cooper brand is a home loan servicers that is focused on providing a variety of servicing and lending products, services and technologies. Xome provides technology and data enhanced solutions to homebuyers, home sellers, real estate agents and mortgage companies. Champion Mortgage is a reverse mortgage servicer.

The stock price does appear to be near support.

COOP weekly chart

Analysts expect earnings per share of $2 in 2019 with increases to more than $2.70 in 2021. With six analysts covering the stock, the lowest estimates are for earnings of $1.45 this year and $1.95 in 2021. Even at the lowest estimates, the stock appears to offer value.

The stock offers liquidity with average trading volume of about 900,000 shares a day and potential value. This could be the kind of stock that warrants additional research and demonstrates the possible value of using the Graham Number to unlock investment ideas.

Six Stocks Under $5 Designed for the Worst Six Months

Posted on May 9, 2019May 30, 2025 by Manuel Jesus

We are now officially in the seasonally bearish worst six months, the time of year characterized by the popular saying to “sell in May and go away.” This is the time of year with high risks and potentially lower than average returns.

Losses for the worst six months resulted from negative returns in just a few years. Stocks were actually up 60% of the time in the worst six months, close to the winning percentage of 69.3% for the best six months. Just a few years actually explain all of the performance in both time periods.

For the worst six months, the worst year, 2008, explains why this six-month period shows a loss. Excluding that year, we have an average annual gain of 3.6% in the worst six months.

This leaves us with a problem – even in the worst six months, stocks go up most of the time. Missing the gains means we fail to meet our primary investment goal which is to maximize wealth. If we sit on the sidelines earning nothing on cash for half the year, we are almost certainly not maximizing wealth.

Sam Stovall, a highly respected researcher at Standard & Poor’s, addressed this problem and found that defensive sectors, stocks investors turn to when they are concerned about risk, outperform broad stock market averages during the worst six months.

For specific investments, he advised looking at the consumer staple and healthcare sectors. His research indicated stocks in these sectors could provide market-beating gains even during the worst six months.

This week, we look at health care stocks that provide income and are priced below $10 a share.

Finding Potential Income For the Worst Six Months

We will start our search by focusing only on stocks that offer a dividend and, in effect, pay investors to wait for returns.

Then, we limited our search to low priced stocks.

One way to find stocks meeting these requirements is with the free stock screening tool available at FinViz.com. At this site, you could screen for a variety of fundamental factors, high levels of institutional ownership and bullish institutional transactions. An example is shown below.

stock screener

Source: FinViz.com

This screen is a reasonable starting point for additional research. There is no guarantee any of these stocks will deliver gains and risk should always be considered. It’s also important to remember that screens like this will not identify unique risk factors.

Stocks passing the screen are shown below.

stock picks

Source: FinViz.com

You can see these are not household names. But they are interesting companies with potential.

Digirad Corporation (Nasdaq: DRAD), for example, is a provider of diagnostic solutions. The company makes and services diagnostic imaging solutions for medical facilities and physicians’ offices.

Digirad provides equipment for nuclear cardiology, ultrasound, echocardiography, vascular imaging, and neuropathy diagnostics, along with equipment rental and personnel staffing.

Many of the company’s products are relatively portable, making them attractive to providers who avoid the expense of building a room to accommodate large equipment. The designs are also open, making them attractive to patients who often prefer open systems to closed-in designs that can create a feeling of claustrophobia.

healthcare products chart

Recently, Digirad acquired a mobile healthcare services division and the exclusive right to sell and service Philips Medical Equipment in the upper Midwest. The company is now integrating those operations and could grow its business with current operations or through the acquisition of small competitors as it has in the past.

DRAD began paying a dividend in 2013 and management has indicated they intend to continue doing so. However, some data sources indicate the company no longer pays a dividend.

This highlights the importance of research. We reproduced the results of our screen from FinViz in the chart above. You can see that data source indicates this is an income stock. Different data providers will sometimes present conflicting information.

If income is important to you, it could be best to verify the dividend with the company. That can usually be done by reviewing the company’s investor relations web site or by calling the company’s investor relations representatives.

The chart of DRAD is shown below and indicates the stock is in a long term down trend.

DRAD weekly chart

It does appear to be trading near support and the down side risk in the stock is limited to the price paid which is relatively low. If you do find this stock attractive it could be worth considering the stock as a trade, taking profits as they become available. After all, a stock can always be repurchased after it is sold.

The stocks we identified with the FinViz screen could all deliver significant gains, or they could all prove to be worthless. That is the risk of any investment but the potential gains in small cap stocks can be large while the potential risks are limited to the price paid at the time of purchase.

While screening tools can be useful, as we saw, they should always be used as a starting point for research since the data they use could be incorrect. It could be best to verify the data points that are most important in your decision process with at least one other data source.

Stock market strategies

This Company Demonstrates Why You Should Diversify Your Portfolio

Posted on May 8, 2019May 4, 2019 by Manuel Jesus

Many investors follow Warren Buffett because he may be the most successful value investor of all time. That means they read what Buffett says and try to incorporate his ideas into their own portfolio management.

This can be helpful but could also present some problems. Buffett, for example, has said, “stated that “diversification is protection against ignorance. It makes little sense if you know what you are doing.”

This contradicts much of what can be conventional wisdom about diversification.

Diversification, according to Investopedia “is a risk management strategy that mixes a wide variety of investments within a portfolio.

The rationale behind this technique is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security.

Diversification strives to smooth out unsystematic risk events in a portfolio, so the positive performance of some investments neutralizes the negative performance of others.

The benefits of diversification hold only if the securities in the portfolio are not perfectly correlated—that is, they respond differently, often in opposing ways, to market influences.

Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks yields the most cost-effective level of risk reduction. The investing in more securities generates further diversification benefits, albeit at a drastically smaller rate.”

This contradicts with Buffet’s view, which is in effect saying that studying one or two industries in great depth, learning their ins and outs, and using that knowledge to profit on those industries is more lucrative than spreading a portfolio across a broad array of sectors so that gains from certain sectors offset losses from others.

Risks Might Not Be Easy, or Even Possible, to Fully Understand

Let’s say you become an expert on an industry and believe you understand the risks of the industry. Let’s assume that it’s the utility industry. Zack’s summarizes key risks of the sector:

“Regulatory Risks: Most U.S.-based large-cap utilities are regulated at the state and local levels. With many of these companies operating in multiple states, that means an increased burden on management to ensure the company does not fun afoul of regulatory guidelines.

That is more of concern for the company than for investors. However, if a major utility gets into hot regulatory water in one state,

Wall Street is not likely to care about the fact that the same company operates in 10 other states. When companies draw the ire of regulatory bodies, it is rarely good for the stock, regardless of sector.

Commodities Prices: For decades, more than half of the electric power in the United States was generated with coal. Electric utilities started to drift away from coal in the 21st century as a shale boom made the nation one of the world’s largest natural gas producers.

Then when gas prices collapsed during the 2008 financial crisis, utilities embraced heavier natural gas use because it was cheaper and cleaner. The bad news is that as natural gas prices and demand spike, utilities could be forced to use more coal.

The worse news is that emerging markets could stoke coal demand, driving prices higher. Utility companies could be faced with higher prices at the same time for the two commodities they most depend on.

Growth Stocks in Favor: Utilities they tend to prove durable during market downturns. However, that cuts both ways.

In a legitimate bull market in which investors favor high-beta growth stocks in sectors such as technology, investors holding utilities stocks are likely to see their returns underperform the broader market.

Interest Rate Risk: A high interest rate environment is often viewed as extremely bad news for utilities stocks, for two reasons. Electric utilities are capital-intensive businesses that often carry large debt loads.

When interest rates rise, so does their cost of financing debt. And because those higher debt costs strain some balance sheets, some utilities pare or suspend dividends when interest rates are high.”

These are all risks that can be understood and quantified to some extent in financial models. Analysts could, for example, understand the risk to earnings of interest rates go up or commodity costs spike higher.

Yet, the risk that undermined Pacific Gas & Electric (NYSE: PCG) are not on the list.

PCG weekly chart

Wildfires Claim the Company

PG&E filed for bankruptcy after “Fire investigators determined PG&E to be the cause of at least 17 of 21 major Northern California fires in 2017.

It is also suspected in some of the 2018 wildfires that have been described as the worst in state history, including one that killed at least 86 people and destroyed the town of Paradise.

PG&E said it faced an estimated $30 billion liability for damages from the two years of wildfires, a sum that would exceed its insurance and assets. The bankruptcy announcement, in a filing with federal regulators, led the company’s shares to plunge more than 50 percent.”

This was a risk that investors would have found difficult to quantify. On the other hand, Boeing’s (NYSE: BA) decline after aircraft crashes were understandable.

BA daily chart

The fact the risk of crashes is part of the aircraft manufacturing business helps to explain the stock’s resilience.

What all of this means is the reminder, once again, that we as individual investors are not Warren Buffett. His mind allows him to understand risks that other investors cannot see, or perhaps he simply focuses on safety and only invests in companies where he believes he fully understands the risks.

Buffett does in fact invest in utilities and may have been able to quantify the risks of the potential disasters that companies face. But we do not have the resources Buffett has and will not be able to develop as complete an understanding of a company that he can.

That could mean that diversification might not be in Warren Buffett’s best interest as an investor but it could very well be in the best interests of smaller investors who cannot simply call any CEO and request an explanation of risks the company could face in the future.

Stock market strategies

Now Could Be the Time to Buy Brexit

Posted on May 7, 2019May 3, 2019 by Manuel Jesus

Brexit has been in the news for years and is still an issue that investors might not fully understand. CNN helpfully explains:

“What is Brexit? Britain + exit = Brexit. It’s the idea (once unthinkable) that the Brits will leave the European Union. But in a stunning result the United Kingdom voted to do just that in a bitterly fought referendum in June 2016.

Since then it’s been talks, disputes, finger-pointing and threats — just like your typical divorce. But the UK and the EU finally might have reached an agreement in which they can finalize their split.

How does it impact the rest of the world?

If you’re a European nation: You have the most to lose — on so many fronts. Just under half of the UK’s exports go to the EU. Just over half of its imports come from the other 27 nations in the bloc.

All of that is now up for a (painful) renegotiation. Then, think about diplomacy. Whenever Europe’s done something useful on that front, the UK — a serious military power — has often been in the driver’s seat.

So, the EU is losing a heavyweight.

If you’re the US: The world’s already dangerous and volatile enough. Some in the United States may worry that the unraveling of the union — a vital ally — will unleash more instability. The UK’s also America’s seventh-biggest trading partner.

It’s been … years since the Brits voted ‘yes’ on Brexit. What’s the holdup?

Turns out untangling a 45-year marriage is not as easy as the Brexiters claimed it would be. The fear of creating some serious unintended consequences (economic or otherwise) is high, and many hurdles have yet to be overcome.

The delays, the dangers and the constant bickering are now — just four months before Britain is due to leave — prompting some who voted for Brexit to change their minds, opinion polls suggest.”

What’s happening now?

After missing the deadline for a March 29, 2019 Brexit, everyone is back at the negotiating table. It’s on hold, basically, for some time.

What’s Next?

The Bank of England recently raised its growth forecast for the British economy through the next three years, and said it might need to raise its benchmark interest rate more than once over that period to control inflation.

UK Base Rate chart

Source: PropertyInvestmentProject.co.uk

Uncertainty around Brexit and slowing global growth are still weighing on economic activity in Britain, but the bank raised its growth forecast for this year to 1.6 percent, up from 1.3 percent in February. It cited expectations that Brexit fears would subside, global growth would stabilize and consumer demand would grow.

The bank kept its benchmark interest rate at 0.75 percent. But if the economy reaches a 2.2 percent growth rate by the end of 2022, as projected, inflation could pick up speed and the bank may need to raise rates faster than previously anticipated, said Mark Carney, the governor of the Bank of England.

Consumer price inflation in March was still slightly below the target of 2 percent for the bank’s monetary policy committee. Mr. Carney cautioned that future rate increases would be “at a gradual pace.”

Economic activity in the first quarter was bolstered in part by an increase in manufacturing as companies built up inventory ahead of the original date for departure from the European Union. But the effect of this buildup in activity is expected to dissipate in the second quarter.

Because so little is known about the terms of Brexit and Britain’s relationship with the European Union afterward, business investment has fallen over the past year, the bank said. And the lack of clarity could continue to hamper economic activity.

Many businesses do not expect a resolution on Brexit by the end of the year, Mr. Carney said at a news conference. “In that environment, it’s difficult to make those long-term investment decisions,” he said. “It’s very unusual to be in expansion and have investment falling.”

But the Bank of England expects the uncertainty to fade eventually and for the economic picture to brighten.

Minutes from the bank’s monetary policy committee noted that it would be difficult to establish how the economy was performing in the coming months because Brexit might make data volatile. “There remained mixed signals from indicators of domestically generated inflation and the cost of waiting for further information was relatively low,” the report said.

Trading the News

The stock market has reflected the uncertain situation. For investors in the U. S. an exchange traded fund, or ETF, could offer access to this story. The chart of iShares MSCI United Kingdom ETF (NYSE: EWU) is shown below.

EWU weekly chart An advantage of trading the ETF is that it provides diversification for investors who may not be familiar with the best companies to trade in the United Kingdom. The ETF is also priced in dollars which eliminates direct costs of currency exchanges since they are included in the fund’s expenses.

EWU initially moved up on the news of Brexit after bottoming shortly before the vote. However, at the beginning of 2018 it became apparent to some investors that the process was not going as smoothly as many had hoped. The deadline was approaching, and no plan was in place.

Traders could buy EWU if they believe the news associated with the rapidly approaching deadline will be bullish. Less optimistic traders could consider using put options on EWU to take a position to benefit from a down move in EWU.

As the deadline nears, volatility could increase and that means options premiums could potentially increase. Aggressive traders could consider selling options to benefit from that possibility and when selling options, spread strategies could always be used to limit risks.

Brexit creates a great deal of uncertainty and that is also creating potential trading opportunities. Now could be an ideal time to enter trades based on the expectations of the trader and options strategies could be especially appealing given their ability to limit risks.

Stock Picks

Another Sign of a Top

Posted on May 6, 2019May 3, 2019 by Manuel Jesus

Market analysts often say that they don’t ring a bell at the top indicating that there is never a loud and clear warning that the stock market has reached a top and is likely to fall. Instead, they need to look for more subtle signals.

Among the signals analyst search for is a proverbial “rush to the exits” by smart money which often includes the venture capital finds that fund Silicon Valley startup companies.

That makes recent news that one of the largest VC funds is looking for a way to cash out as The Wall Street Journal reported,

“SoftBank Group Corp. is considering audacious fundraising plans, including a public offering of its $100 billion investment fund and the launch of a second fund of at least that size, as it looks to seize on an exploding startup scene, people familiar with the matter said.

More immediately, SoftBank is negotiating with the sultanate of Oman for an investment of several billion dollars in its existing $100 billion Vision Fund, which raised nearly all its cash from Saudi Arabia and Abu Dhabi, the people said.

The fund’s staff is hustling to keep up with the frantic pace of deal making by SoftBank founder and Chief Executive Masayoshi Son, who has invested nearly all the money that the Vision Fund took in just two years ago.

Highlighting the need for new funds: Mr. Son recently returned from China, where he negotiated informal deals worth several billion dollars that the Vision Fund doesn’t yet have, one of the people said.

buying spree chart

Source: The Wall Street Journal

The Vision Fund had planned to invest its money over four years, some of the people said, but will have done so in just over two.

Coming IPOs of companies it is invested in—including Uber Technologies Inc. and WeWork Cos.—will free up some money, but not enough to fund everything Mr. Son wants to buy.

The fund plans to double its staff to 800 people from 400 over the next 18 months, one of Mr. Son’s top deputies said this week at a conference in Los Angeles, compounding the pressure to raise more money so they can be paid to hunt for deals across the globe.

A Vision Fund IPO is the most ambitious of the plans under consideration and would take place after the fund is fully invested, likely by this fall, according to people familiar with the matter.

The hope is to create a smaller version of Warren Buffett’s Berkshire Hathaway Inc. —only loaded with young technology companies, many of which have yet to turn a profit, instead of a stable of well-established utilities, insurers and energy companies.

An offering like this is largely unprecedented. If successful, it would tap into a new pool of money—mom-and-pop investors—who typically can’t invest in venture-capital funds due to regulations meant to protect unsophisticated investors from risky assets.

SoftBank executives are working to overcome those regulations, some of the people said, and it might not happen. Another barrier is that some of the fund’s hottest investments are set to go public themselves this year, which would reduce the allure of its offerings.”

Doubts About the Deal

There could be some problems with getting the offering approved as Bloomberg’s Matt Levine notes, “I mean it doesn’t sound especially legal, at least under U.S. law.

Berkshire Hathaway, for all that we think of it as a Warren Buffett stock-picking vehicle, is actually an insurance company with a bunch of other wholly-owned operating businesses.

A fund consisting entirely of minority stakes in other companies—that is, a venture fund—would seem to count as an “investment company” under U.S. law, and U.S. rules do tend to discourage widely marketed investment companies that buy mainly illiquid private stakes.”

This could prevent Softbank from completing this deal.

Getting In Ahead of the Offering

While there could be concerns about a separately traded investment fund, there is a way to invest in SoftBank which manages the fund through an ADR in the US markets which trades as (Nasdaq: SFTBY.)

Softbank chart

Source: Yahoo

SoftBank is not the Vision Fund although they share management.

SoftBank is described as “a Japanese multinational holding conglomerate headquartered in Tokyo, Japan. The company owns stakes in a number of companies including:

Softbank Corp.
Softbank Vision Fund
Arm Holdings
Fortress Investment Group
Sprint (85%)
Alibaba (29.5%)
Yahoo Japan (48.17%)
Uber (15%)
Didi Chuxing (ca.20%)
Slack Technologies (ca.5%)
WeWork (ca.22%)

There are some reasons to consider buying SoftBank now as the Financial Times recently reported, “

“Mr Son as an opportunistic and even whimsical investor was given fresh ammunition last week with the revelations that he had lost $130m of his personal fortune on a bitcoin investment and poured €900m of SoftBank funds into Wirecard, the German payments group fighting an accounting scandal.

… Armed with cash from the $23.5bn listing of SoftBank’s mobile unit and Japan’s largest-ever corporate bond sale to retail investors, and with Uber’s blockbuster IPO around the corner, Mr Son is finally starting to dispel the notion that his Japanese technology conglomerate is risk-addicted and debt-laden.

So flush is Mr Son feeling that he launched a $5.5bn share buyback in February.

“Until now, SoftBank was viewed as a group loaded with debt and doing dangerous things,” Mr Son said in February. “In time, all that noise will go away.”

Mr Son has consistently complained that investors do not appreciate the group’s true worth. In February, when its market capitalization was ¥9tn ($80bn), he argued that SoftBank shares were undervalued by nearly 60 per cent.

His calculations put the company’s net debt at ¥3.6tn and its trove of equity holdings including Alibaba, WeWork and Uber at ¥25tn, implying ¥21tn of value for shareholders.

Now, more investors are beginning to buy into his view.

Since the public offering on December 19 of stock in its mobile subsidiary, SoftBank Group shares have risen 41 per cent to a 19-year high.

The cost of five-year credit-default swaps to insure against non-payment of debt by SoftBank has dropped by nearly 100 basis points since the start of the year to 170 bps, according to data from Bloomberg, having risen sharply after the murder of journalist Jamal Khashoggi prompted concern about the group’s ties to Saudi Arabia.

Richard Kaye, a portfolio manager at French asset manager Comgest, a SoftBank shareholder with a $50m stake, said that events, including the flotation of SoftBank’s mobile unit and the filing for an IPO by Uber, where SoftBank is the largest shareholder, have given investors confidence in the Japanese group’s ability to monetise its assets.

“This could be the beginning of a rather long reassessment by investors of SoftBank’s potential,” Mr Kaye said.”

Whether the Vision Fund IPO succeeds or not, SoftBank could be worth a look.

Stock Picks

Five Stocks Under $5 That Warren Buffett Might Buy, If He Could

Posted on May 3, 2019May 2, 2019 by Manuel Jesus

Warren Buffett is a great investor, but he really can not do everything that we, as individual investors, can do. Some investors may not realize that we have an advantage over Buffett in some ways.

Let’s say Buffett found a great insurance company with a market cap of $400 million. We know that Buffett loves insurance companies.

One news story recently highlights Buffett’s love of the industry, “Feb. 22, 2019, it will be 52 years to the day since Warren Buffett took his first serious dive into the insurance business when Berkshire Hathaway entered into an agreement to acquire National Indemnity Company and another smaller insurer for $8.6 million.

National Indemnity is still a part of Berkshire Hathaway 52 years later, and one that Warren Buffett values highly. In fact, Warren Buffett told shareholders in 2004 that if Berkshire hadn’t acquired National Indemnity, “Berkshire would be lucky to be worth half of what it is today.”

To put it mildly, Buffett loves the insurance business. Since acquiring National Indemnity, Buffett and his team have made many other insurance additions, including GEICO in 1996, General Re in 1998, and more.”

Insurers invest the money they collect as premiums that have not yet been paid out for claims. This cash flow is referred to as the float in the industry.

Experts note, “Most insurance companies invest the majority of their float in low-risk investments. For an example, think Treasury securities and some corporate bonds. Buffett, on the other hand, takes a somewhat different view and has used the float held by Berkshire’s insurers to invest in equities and acquisitions of other companies.”

Yet, it seems fairly certain that if Buffett found an excellent $400 million insurer, he would not buy it.

That’s less than 0.01% of the value of his investment portfolio. If the insurer does great and doubles in value Buffett would increase the value of Berkshire Hathaway by less than 0.01%.

More realistically, let’s say he gets a 20% return on his investment. That increases his portfolio value by $80 million or less than 0.002%.

Buffett made $500 million a year in dividends on an investment in Goldman Sachs that he made in the depth of the 2008 bear market. This is the kind of return he needs to continue growing Berkshire and given that requirement, he simply can’t look at small caps.

This is where we, as individual investors, have an advantage over Buffett. We can buy small cap stocks because 20% gains mean a great deal to us. One way to exploit this advantage is to study Buffett’s deals and apply his valuation principles to small caps.

Finding Break Out Patterns

We could quantify the kind of stock we believe Buffett likes. In the letter to shareholders he writes every year, Buffett has mentioned that he measures management with an accounting tool called return on equity (ROE).

The is the ratio of net income to shareholders’ equity. ROE measures the percent of profit management is earning with the money shareholders invested in the company. ROE can vary by industry so a detailed analysis is usually needed to understand how well management is performing relative to its peers.

For our purposes, we are looking for the best small caps so we will require companies to have an ROE of at least 15%. This level is better than the ROE reported by about 70% of all publicly traded companies. This limits our search to the best management teams in the country.

We could also require the company to have a higher than average return on assets and a history of increasing sales. By requiring that sales be increasing over the past five years, we are eliminating stocks which have no operating cash flow and that could be headed towards bankruptcy.

Finviz

Source: FinViz.com

For this screen, we selected stocks that Warren Buffett might like and that are too small for him to realistically take a significant stake in.

Stocks passing the screen are shown below.

stocks passing the screens

Source: FinViz.com

Aeterna Zentaris Inc. (Nasdaq: AEZS) is thinly traded but prone to make large moves.

AEZS weekly chart

A stock like this could be bought and sold by aggressive traders looking for small gains. For example, a buy could be made and immediately after that order is filled, a profit taking sell order could be entered. If the stock spike higher, as it has in the past, a strategy like that could deliver gains.

Abraxas Petroleum Corporation (Nasdaq: AXAS) is in a down trend.

AXAS weekly

But the stock is in the energy industry and many experts believe there is bullish potential in this sector.

Harrow Health, Inc. (Nasdaq: HROW) is also in a down trend and could be attractive to value investors looking for a turn around.

PEDEVCO Corp. (NYSE: PED) is in a trading range and could be prone to make large moves on news. This could be a stock of interest to the most aggressive investors.

PED weekly

Luna Innovations Incorporated (Nasdaq: LUNA) is in an up trend and could be a stock that interests momentum investors.

LUNA weekly

These stocks could all deliver significant gains or could all prove to be worthless. That is the risk of any investment but the potential gains in small cap stocks can be large while the potential risks are limited to the price paid at the time of purchase.

Each of these stocks, in particular, could be worth additional research since they display at least one quality Warren Buffett could look for.

Stock market

Here’s What Really Happens In An IPO

Posted on May 2, 2019May 1, 2019 by Manuel Jesus

We often see reports of initial public offering (IPO) tinged with excitement. There is anticipation prior to the first day of trading and then there is often a big price move the day of the trade. CNBC might show a celebration at the company’s offices and the ticker shows a large gain.

But who really makes money on these IPOs?

The Process Is Transparent

An IPO is defined as “the process of offering shares in a private corporation to the public for the first time is called an initial public offering (IPO).

Growing companies that need capital will frequently use IPOs to raise money, while more established firms may use an IPO to allow the owners to exit some or all their ownership by selling shares to the public.

In an initial public offering, the issuer, or company raising capital, brings in underwriting firms or investment banks to help determine the best type of security to issue, offering price, amount of shares and time frame for the market offering.”

The process itself is time consuming, taking months to complete and the steps can be summarized in the chart shown below.

IPO process chart

Source: CorporateFinanceInstitute.com

There are several important points for individual investors to remember.

Pricing is determined by the company in consultation with the investment bankers managing the deal. The investment bankers propose an initial price to the company and then the company completes presentations to large investors in what is commonly called a “road show.”

The road show allows investors to comment on what they believe the price of the stock should be. Using all of that input, the price is finalized the day before the stock begins trading. Shares are then sold at that price to a select group of customers.

This a process known as allocation and experts note, “public offerings are sold to both institutional investors and retail clients of the underwriters.

A licensed securities salesperson (Registered Representative in the USA and Canada) selling shares of a public offering to his clients is paid a portion of the selling concession (the fee paid by the issuer to the underwriter) rather than by his client.

In some situations, when the IPO is not a “hot” issue (undersubscribed), and where the salesperson is the client’s advisor, it is possible that the financial incentives of the advisor and client may not be aligned.

The issuer usually allows the underwriters an option to increase the size of the offering by up to 15% under a specific circumstance known as the green shoe or overallotment option. This option is always exercised when the offering is considered a “hot” issue, by virtue of being oversubscribed.”

The shares that are traded on the first day of trading are the shares that were allocated to large customers the day before. That means by the time an average individual investor can buy shares, the process has already moved beyond the IPO phase. Initial trading is often exuberant and costly to individuals.

Uber As an Example

Uber, according to CNBC, “seeks to raise about $9 billion in cash in its initial public offering next month when it is expected to debut on the New York Stock Exchange under the symbol “UBER.”

The company plans to offer 180 million shares at $44 to $50 per share, according to an updated filing released Friday morning, valuing the company between $80.53 billion and $91.51 billion on a fully diluted basis.

The valuation is well below earlier reports that suggested Uber could be valued as high as $120 billion. At the low end of its price range, Uber’s market cap would be $73.7 billion, which would even fall below its last private valuation of about $76 billion.

Even at the lower end of its pricing, Uber will still be the largest tech IPO to debut this year. The company may have scaled back expectations after seeing excitement around its rival Lyft’s stock quickly fizzle out.

The stock, which has a market cap of about $16 billion, is down more than 27% for the quarter since debuting in late March.

LYFT daily chart

Still, Uber’s IPO is set to make its top shareholders worth billions. Assuming Uber prices at $47 per share, the midpoint of its stated range, SoftBank stands to gain the most from the IPO. Based on its post-IPO share count in the filing, the firm would earn more than $10 billion in the offering.

Even Uber’s ousted former CEO and co-founder Travis Kalanick stands to gain $5.3 billion in the IPO, based on the same assumptions. His co-founder, Garrett Camp, stands to gain about $3.7 billion through LLCs he manages, under these assumptions.

Here’s where each major shareholder will stand after the public offering, based on their post-IPO share counts and assuming Uber prices at the midpoint of its stated range at $47 per share:

Uber's biggest shareholders

Source: CNBC

Not all of these investors are selling. According to Bloomberg, “Benchmark is the biggest seller, offering 5.7 million of its shares, according to a regulatory filing [recently file]. That would fetch about $270 million at the middle of the listing’s current $44 to $50 price range.

SoftBank Group Corp. is offering 5.5 million shares, while Uber co-founders Travis Kalanick and Garrett Camp expect to sell holdings worth $176 million and $147 million, respectively.

Saudi Arabia’s sovereign wealth fund and Alphabet Inc. haven’t offered any of their shares for sale.”

If Uber rises at the open, the initial sellers, including Benchmark, SoftBank and Kalanick, will benefit from the holdings they retained. The shares they sold, to large hedge funds, will be sold by the investors who received shares in the allocation process.

Initial trading will benefit investors who owned the shares less than a day. Individuals will buy shares at the open and may see losses mount as they did with Lyft.

In any event, the insiders can sell all of their shares after a lock up period, typically 30 to 90 days after the IPO and this could drive the price down as it has for other tech stocks.

In short, in an IPO, smart money is selling to less informed investors and the individuals chasing the excitement are among the most likely to suffer losses.

Stock market strategies

The Biggest Trend Investors Should Be Aware Of

Posted on May 1, 2019April 30, 2019 by Manuel Jesus

The biggest trend investors should be aware of might be fintech.

Fintech is the term that is “used to describe new tech that seeks to improve and automate the delivery and use of financial services.

At its core, fintech is utilized to help companies, business owners and consumers better manage their financial operations, processes and lives by utilizing specialized software and algorithms that are used on computers and, increasingly, smartphones.”

Investopedia explains, “Fintech, the word, is a combination of “financial technology.” When fintech emerged in the 21st Century, the term was initially applied to technology employed at the back-end systems of established financial institutions.

Since then, however, there has been a shift to more consumer-oriented services and therefore a more consumer-oriented definition.

Fintech has expanded to include any technological innovation in — and automation of — the financial sector, including advances in financial literacy, advice and education, as well as streamlining of wealth management, lending and borrowing, retail banking, fundraising, money transfers/payments, investment management and more.

Fintech also includes the development and use of crypto-currencies such as bitcoin. That segment of fintech may see the most headlines, the big money still lies in the traditional global banking industry and its multi-trillion-dollar market capitalization.”

Why Fintech Matters to Investors

As Institutional investor recently reported, “Almost a decade after the passage of the Dodd-Frank Act, what keeps bankers awake at night is not regulation by Washington, but competition from Silicon Valley.

At first, competitors took the form of financial technology startups (fintech for short), whose avowed aim was to relegate the banks to the ash heap of history.

Fintech startups ranging from LendingClub (credit) to Robinhood (securities trading) got the bankers’ attention but did not concern them inordinately.

Robinhood

After all, banks have significant advantages over fintech startups, such as preferred access to data and capital, not to mention the advantages conferred by the competitive moat of government regulation.

The real threat, the bankers are coming to recognize, is big tech, not fintech. Unlike fintech startups, firms such as Amazon, Google, Alibaba and Tencent have deeper pockets and better access to data than any bank.

Most important, big tech firms have uniquely intimate relationships with their customers. These factors turn big tech’s lack of regulatory oversight into a competitive advantage, allowing them to operate on the margins of financial regulation at a much larger scale than a fintech startup.”

These trends indicate that investors should reconsider stocks in the financial sector and the tech sector.

By one measure, financial stocks are at new all time highs. The chart below shows the Financial Select Sector SPDR ETF (NYSE: XLF), a proxy for the sector as a whole.

XLF monthly chart

This chart could lead traders to believe that the threat of tech companies is far off. But, CNBC notes, the large firms in the sector are taking the treat seriously.

“The banking industry isn’t sitting still. In 2015, J.P. Morgan Chase CEO Jamie Dimon warned in his annual shareholder letter that “Silicon Valley is coming” to try to eat the industry’s lunch.

So for the past few years, big banks have been preparing for upstarts by building their own applications, reorganizing their tech staffs to innovate faster and partnering with fintech firms.

By offering their own tech solutions, banks hope that outsiders — whether they’re big tech companies like Amazon or fintech upstarts like Square — won’t be able to pry away their customers.

Last year, J.P. Morgan unveiled YouInvest, its answer to free-trading app Robinhood. Citigroup and others have released digital-only banking apps, and Bank of America is planning to unveil a financial coach called Life Plan in the fall, CNBC reported this month.

You Invest logo

By making these moves, traditional banks are acknowledging that in this era of blurring boundaries between industries, everyone is a competitor.”

And the banks have good reason to worry about the threats from outside their industry – customers are comfortable with the tech giants. “Amazon and other tech firms have at least one significant advantage versus banks: Customers enjoy using their products more.

Based on what’s known as “net promoter scores,” customers much prefer Amazon to banks. The e-commerce giant earned a 47 in the score that measures the likelihood a user would recommend a company’s services, according to a September report from Bain. National banks scored an 18, while regional banks came in at 31.

Amazon customers may be open to a potential invasion of their wallets. Bain asked 6,000 U.S. consumers in 2018 if the company launched a free online bank account that came with 2 percent cash back on all Amazon purchases whether they would sign up to try it. About two-thirds of Prime members said yes.

“When big tech companies choose to go into banking, they already have brand reputation and they have the distribution,” said Karen Mills, senior fellow at the Harvard Business School and a former administrator of the Small Business Administration.

“Customers have proven that they will flock to whoever gives them a better experience.”

Trading the Trends

For investors, this means they should not become complacent. Financial stocks have a history of volatility and some of them saw deep losses in the bear market that began in 2008. Those losses were due to risks in the bank’s balance sheet caused by risky loans like subprime mortgages.

One scenario that investors can not ignore is the possibility that banks will seek to offset the risk from competition by easing lending standards. In theory, rules imposed since the financial crisis limit this risk but prudent investors should be aware of the risk and scrutinize quarterly reports for signs of credit problems.

While paying attention to potential risks, investors should also consider potential opportunities. Additional profits from financial services could lead to significant gains in large companies like Amazon or Google.

New entrants into finance should not be ignored but these companies may take time to deliver gains to individual investors. If Robinhood and other new firms complete initial public offerings, investors should consider waiting for the results to catch up to the hype. Like other IPOs, there are risks even in new fields.

Stock Picks

This Could Be the Best Electric Vehicle Trade

Posted on April 30, 2019April 29, 2019 by Manuel Jesus

While very few things seem to be certain in the stock market, there is one statement that seems to hold a high degree of certainty. It is almost certain that Tesla (Nasdaq: TSLA) will always be in the news.

Last week, according to news reports, we learned that “Tesla’s assembly lines slowed and deliveries fell during a rocky start to the new year that is likely to magnify nagging doubts about the company’s ability to post sustained profits.

The company churned out 77,100 vehicles from January to March, well behind the pace it must sustain to fulfill CEO Elon Musk’s pledge to manufacture 500,000 cars annually.

The company only delivered 63,000 vehicles in the quarter, down 31% from 2018′s fourth quarter. It cited a big increase in vehicle deliveries to Europe and China and “many challenges encountered for the first time.”

The lower-than-expected delivery numbers and “pricing adjustments” will take a bite out of Tesla’s first-quarter net income, it said. But it said it ended the quarter with sufficient cash on hand.

Tesla said it still expects to deliver between 360,000 and 400,000 vehicles this year. The first quarter production figures lagged the 86,555 vehicles that Tesla manufactured during the final three months of last year when the company was scrambling to make more cars.

That push helped Tesla post a profit in consecutive quarters for the first time in its 15 year history.

Musk has already warned investors that the company will lose money during this year’s first quarter amid cost-cutting needed to lower the price of its Model 3, its first electric car designed for the mass market.

The company produced 62,950 Model 3s in this year’s first quarter, up 1.6% from 61,934 in the prior three months.

Musk has acknowledged that Tesla’s hopes of becoming a consistent moneymaker are riding on the success of the Model 3 and a sport utility vehicle called the Model Y scheduled to be released next year. And for those vehicles to become hits, Tesla will have to be able to produce them in high volumes.

The news weighed on the stock price.

TSLA daily chart

A Competitor Emerges

Meanwhile, another automaker reported adjusted profit hit 44 cents per share, well above the $0.27 average analysts polled by Refinitiv projected. Ford (NYSE: F) is now at an important resistance level on the chart.

CNBC noted that the company is investing heavily in electric vehicles.

“[Ford] also hopes to become more nimble by learning from some of its partners, including Rivian. Ford invested $500 million in the Detroit-based battery-electric vehicle startup this week. The alliance will let Ford use Rivian’s skateboard-like platform for at least one, and likely several, future products.

“We are learning a lot from this wonderful company and their fresh approach,” said [one analyst], especially when it comes to operating at Silicon Valley speeds.

In turn, Rivian’s CEO R.J. Scaringe expects his own team to learn about high-volume manufacturing from the company that invented the movable assembly line.

The $500 million Ford plans to invest in Rivian comes on top of another $11 billion that it last year said would be spent to begin electrifying its line-up. Ford was an early pioneer in battery propulsion but has fallen behind rivals like Tesla, as well as GM and VW. It will only launch its first long-range electric vehicle – a high-performance crossover influenced by the Mustang – next year.

Ford also has been ramping up its spending on self-driving vehicle technology. Among other things, it invested $1 billion in Argo AI. With the startup’s help, Ford’s autonomous program is now considered one of the most advanced in the industry, according to Navigant Research.

It lags behind only such leaders as Alphabet’s Waymo and GM’s Cruise Automation.

Significantly, Ford is ramping up the number of places it is testing self-driving prototypes, Farley noted during the Thursday earnings call. While places like Phoenix and Silicon Valley have become ground zero for most of those working on autonomous technology, Ford has chosen places with challenging weather and traffic conditions that push the technology to its limits.

“We are picking cities like Miami (and Washington, D.C.) that are very complex,” said [an analyst].

One of the concerns that has nagged analysts and investors has been how Ford – or any of its competitors – will turn money-losing battery car and autonomous vehicle programs into profit centers.

That’s something the recent management realignment is meant to address, [management] said in an interview. The changes will allow it to focus on what it can do to make money now while developing the businesses it will need in the future.”

Analyst caution that the automaker faces a “volatile environment with very strong competition.”

Indeed, a closer look at the first-quarter numbers reveals that while Ford performed well in its North American home – margins there climbing nearly a full point, to 8.7% – it faced significant problems in every other key market, from Europe to China.

While “there’s still some skepticism remaining,” Morningstar’s auto analyst David Whiston said, “sentiment has improved.”

Whiston, who currently rates Ford a buy, points to several positive factors, including the cuts now underway in Europe and South America, which should help profits in the future, and a broad product rollout, which could excite new buyers.

It seems investors are finally cheering the risky bets Ford is making to shift away from sedans and to invest in new technologies. And it comes at a time when the market is growing more wary of rival Tesla, which saw a sharp selloff after its earnings. The result: Ford’s market capitalization is now greater than Tesla’s for the first time since April 2017.

The long-term chart below shows Ford Motor Company (NYSE: F) is in a downtrend.

F monthly chart

Investors should expect volatility as the company enters new markets. However, the investors in F may see better returns and less volatility than investors in TSLA while achieving exposure to the electric and autonomous vehicle markets more closely associated with Tesla.

Overall, F could simply be a safer way to trade these emerging technologies.