Archive for the ‘Investing’ Category

What is the VIX?

Wednesday, October 29th, 2008

The VIX is a measure of market risk, sometimes called the fear index.  It is used to gauge investor sentiment – whether the broad stock market in the United States is bullish or bearish.  VIX actually stands for volatility index.  it is the ticker symbol for one of the volatility indexes created by the Chicago Board Options Exchange (the “CBOE”).  In fact, the VIX is the most widely used volatility index, and was introduced by Duke University Professor Dr. Robert Whalley in 1993.

Volatility is the fluctuation in the market price of an underlying security.  The VIX measures market expectations of near-term volatility conveyed by S&P500 near-term options prices.  Specfically, the VIX presently is calculated by measuring the volatility of out-of-the-money put and call options on S&P500 stocks for the two nearest expiration months.  It anticipates the volatility of the S&P500 over the next 30 days.  A VIX of 30 means, roughly, that over the next 30-day period, the S&P500 will move 30% on an annualized basis (i.e., more info

8.66% over the next 30 days).

Typically, the VIX is inversely related to market tops and bottoms.  For example, a high VIX implies pessimism and usually means a market is bottoming.  Low values imply optimism.  However, using the VIX solely to determine a market bottom or top doesn’t work because the method isn’t foolproof.  However, there’s no cap on how high the VIX can go.  Historically, a VIX reading of 30 has been a high number. but the VIX has traded over 70 in October, 2008.   Consequently, It should not be used in a vacuum, but is best used with other indicators in order to provide investment guidance.

On March 26, 2004, the CBOE began offering futures contracts on the VIX for trading.  On February 24, 2006, the CBE listed options on the VIX for trading.

VIX and More is a blog that follows the VIX.  Volatility Trading is a new book with a CD-ROM on trading the VIX.

Real Estate Investment Trusts

Monday, September 15th, 2008

As a follow up to my last post noting that hard assets, such as real estate, tend to be good inflation hedges, I wanted to provide some basics on real estate investment trusts (“REITs”).  A REIT is an investment vehicle that owns either mortgage notes, real estate or a hybrid that both mortgage notes and real estate.

REITs came into being in 1960.  Most REITs at that time were mortgage REITS – they owned mortgage notes on real estate assets.  However, today, real estate and hybrid REITS are common.  Via securities, a REIT allows one to invest in large, income-producing real property.  That said, REITs come in a variety of flavors and can be sliced and diced a number of ways.

In the United States, three types of REITs as securities exist.  Publicly-traded REITs register with the U.S. Securities and Exchange Commission (the “SEC”) and trade on national stock exchanges.  The are also non-exchange-traded REITs, which also register with the SEC, but which don’t trade on a stock exchange.  Finally, private REITS neither register with the SEC nor trade on a stock exchange.

Additionally, REITs may be distinguished by the type of real estate they invest in.  This can be either broad or narrowly-focused.  For example, there are office REITs, multifamily property REITs, hotel REITs, shopping center REITs, warehouse REITS and storage facility REITs.

Another way a REIT may differentiate itself is for it to focus on a specific state or geographical region.

Companies must qualify to be classified as a REIT.  To do so, they must meet specific requirements of the Internal Revenue Code.  These requirements include the following:

* The REIT must be managed by a Board of Trustees or a Board of Directors.

* The REIT must be taxable as a corporation.

* The REIT must have 100 different shareholders.

* No more than 50% of the REITs shares may be held by five or fewer individuals.

* REIT shares must be fully transferable.

* At least 75% of the REIT’s gross income must be real estate-related, such as from rents or mortgage interest.

* At least 75% of the REIT’s total assets must be real estate assets.

* The REIT’s stock in its taxable subsidiaries may not be more than 20% of its total assets.

* A REIT must distribute at least 90% of its taxable income to shareholders as dividends.

These are some, but not all, of the main limiting characteristics of a REIT. A good book on real estate syndication in general, including REITs, is Samuel K. Freshman’s Principles of Real Estate Syndication.

Inflation and Hard Assets

Sunday, September 7th, 2008

We’ve had many years of low inflation in the United States.  In the past year, however, inflation has increased.  The U.S. economy is complex and many reasons are behind this acceleration.  For example, the industrialization of the economies of China and India have increased the demand for commodities, which are used to build infrastructure.  So the prices of commodities, such as steel and oil, have risen as demand has increased globally.

The law of unintended consequences also has played a part in inflation.  Congress passed and President Bush signed the Energy Independence and Security Act, which mandated a huge boost in the use of corn-based ethanol.  This occurred at a time when world grain stocks are at a 30-year low and prices at historic highs.  With more demand for corn, prices shot up.  Livestock producers and food processors incurred greater costs, as corn is a staple of livestock feed.  As a result, the cost of food rose and now, for example, eggs cost 40% more than they did a year ago.  In fact, even the prices for non-food crops rose as farmers switched from them to grain crops, which are more lucrative.

So what holds value during inflationary times?  Hard assets typically do.  One such hedge against inflation  is real estate.  Despite the housing downturn due to the subprime crisis and resultant credit crunch, real estate historically has been a good long-term investment when inflation accelerates.  Although the market is not at its peak, we haven’t seen a decline in U.S. commercial real estate comparable to the residential slump.  Good value may lie in commercial real estate investment over the next few years.

Capital Ratios of Financial Institutions

Thursday, August 14th, 2008

With the stocks of banks and investment banks imploding in 2008, there’s been much talk of capital ratios.  Regulators require banks to maintain minimum capital requirements.  The reason is to prevent them from failing due to overzealous lending during economic expansions that could result in financial setbacks when the economy turns down.  So just what are capital ratios?

In the United States, there are two primary capital ratios:  Tier 1 and Tier 2.  The Tier 1 capital ratio is the most important one, and that’s what I’ll focus on here.

The Tier 1 capital ratio consists of the ratios of the bank’s stockholders’ equity, preferred stock and retained earnings to its total risk-weighted assets.  Risk-weighted assets are calculated by putting each of the bank’s assets and off-balance sheet items into a basket and assigning a risk category to that basket.  Risk categories range from 0% to 100%.  If the overall risk is lower, then the bank is considered more stable for depositors and more conservative for investors.

The problem today is in determining both the valuation of and the risk relative to the assets.  Some, as I noted in my earlier posting on auction rate securities, are hard to value, but are less likely to default.  Others, such are a letter of credit, may be considerably riskier.  So actually determining the Tier 1 capital ratio involves art as well as science. Thus, bank stocks, which have fallen considerably this year, may still be overvalued.

Regulators use the Tier 1 capital ratio to segregate banks into five categories ranging from well-capitalized  to critically undercapitalized.

The Tier 2 capital ratio includes undisclosed reserves, general loss reserves, subordinated term debt, hybrid instruments, among other items.

Title 12 of the Code of Federal Regulations includes the regulations regarding minimum capital ratios.  A much more detailed compendium of what is included in bank capital ratios is available in Appendix A to Part 3.

A Management Flaw – and Financials Disasters That Shouldn’t Have Happened

Thursday, July 17th, 2008

One critical flaw that has hobbled and even killed companies is not managing growth.  Companies that don’t manage their growth produce unhappy customers, unhappy vendors, unhappy franchisees and sometimes, spectacular flame outs.  Why would a company put itself in this position?  Lots of reasons . . . attempting to grab market share, be the first into a new market and dominate a niche, management hubris or just plain greed.

Here’s an example of management hubris:  I interviewed for an executive position with a $700 million company that started growing extremely rapidly (It had doubled in the past 2 years.).  I spent 1.5 hours with their head of HR.  He told me, “We don’t have competition” and “I’d rather have someone do C+ work and get it done tomorrow than A work and get it done next week.”  Those sort of red flags say to me that when this company falls, it’s going to fall hard.

Two companies that should’ve been category killers, but ended up flaming out, are Boston Chicken (which changed its name to Boston Market) and Krispy Kreme Donuts.  Both had fanatics among customers and captivating products.  Both were loved by Wall Street.  In both cases, there was no dominant national chain in their niche, a la McDonalds in the hamburger category (KFC offered fried, not rotisserie, chicken.).  Both flamed out.

In Boston Market’s case, large loans fueled growth that occurred much too quickly.  Essentially, the company began to see itself as a financial, not food service, company, making money selling franchises instead of focusing on growing steadily and producing high quality meals.  The company failed to build a strong management team and had high executive turnover.  Food quality varied from unit to unit and even in individual units, depending on the time of day and number of customers.  Even its marketing strategy, with constant coupons, led to higher growth and lower margins.  Eventually, it filed for bankruptcy.

When Krispy Kreme opened in new areas, cars waited in long lines.  Although founded in 1937, its downturn came when it saw how lucrative franchising could be.  It sold its first franchise in 1995 and went public in 2000.  Its stock soared.  Yet it grew too rapidly without addressing a fundamental flaw:  stores that were too big – for selling just doughnuts – and cost too much to operate.  Some stores were too close together.  The company later began selling doughnuts to supermarkets, cannibalizing franchisees’ sales and flooding the market with product, lessening its cachet.  Franchisees paid high equipment and supply fees.  Ninety percent of sales were doughnuts, a much higher rate than competitors that diversified their offerings.  In other words, the company grew much too rapidly without first proving their franchise model.

On June 29, private equity firm MGL Asset Management Group LLC bid $7.25/share to take the company private.  But the company once traded at almost $50/share.

China and India Follow up – Investment and Economic Ramifications

Thursday, July 10th, 2008

A month ago, I wrote about the emergence of China and India in the world economy.  Their expansive growth, though, results in their being more greatly affected by global economic trends.  As Investor’s Business Daily notes in U.S. Slowdown Shows In Drop of China ETFs, lower consumer confidence and drops in spending among American consumers has hurt Chinese economic growth.  That’s because the U.S. is the largest export market for Chinese goods.

Technical analyst Michael Kahn, in his Barron’s column, What Happened to China and India?, states that both countries are in bear markets.  While the long-term fundamental stories are sound, there’s no technical reason to expect a recovery in the Shanghai “A” share index, the Bombay Sensex index or the iShares FTSE / Xinhua China 25 Index Fund (FXI) anytime soon.  The latter is a popular ETF that mirrors an index of the largest 25 Chinese mainland companies traded on the Hong Kong Stock exchange.  More information is available on the FTSE / Xinhua website.

Charting Publicly-Traded Securities

Saturday, May 31st, 2008

A great many resources exist for accessing information about securities that are publicly-traded. These securities can range from corporate equity to government debt to commodities futures. In general, if there is a public market, then a chart can be developed to track various aspects of a security.

Charting allows one to technically analyze different patterns in the security’s value and to attempt to predict what future patterns-and valuation-may occur. This is useful for everything from, for example, personal investment analysis and research to corporate due diligence and industry analysis for potential merger candidates.

Quite a number of charts allow you to customize parameters that include timeline, volume, comparison to competitors or benchmark indices, stock splits, dividend payouts, and the addition of various technical indicators.

Some useful websites that offer free charting, among other information, include:

* Finviz – This site offers a wealth of information, including a heatmap of the daily performance of individual equities and market sectors.

* BigCharts – Big Charts is one of the major charting engines and allows for easy customization.

* ClearStation – ClearStation is another site that provides a lot of information.

* StockCharts – StockCharts allows for a great deal of customization.

* Yahoo Finance – This very popular investment site has simple interactive charting options.

* Google Finance – Google has developed an interactive chart that allows you to drag the chart to quickly change time lines.

* MSN Money – These charts are easy-to-use and have good, simple explanations on changing chart parameters.

* – This is another easy-to-use chart.

* Ask Research – Ask Research also allows for detailed customization of parameters.

Fundamental and Technical Analysis

Sunday, March 2nd, 2008

Two analytical models exist to determine the appropriate price of an equity security.

Fundamental analysis focuses on analyzing a company’s financial statements and condition, its management, and its markets and competitive position.

Technical analysis focuses on studying a company’s market action via the supply of and demand for its securities in order to estimate future price trends. Michael Kahn writes for Barron’s Magazine and has an excellent blog, Behind the Headlines, that concentrates on the techinical analysis of securities and markets.