1/11/08

Defensive Stocks -- Are They Really?

Chances are, you've probably been hearing a lot about defensive stocks lately. I have been wondering about them myself, and decided to investigate how they have fared recently and in the last bear market.

To this end, I chose to look at a (perhaps) random sampling of stocks that fall within the "defensive" category. These stocks, most of which you probably heard of are:

Altria (MO) -- tobacco products

Anheuser Busch (BUD) -- Alcoholic beverage producer

Coca Cola (KO) -- beverage producer.

Consolidated Edison (ED) -- A utility company serving New York, and parts of New Jersey and Pennsylvania

Diageo (DEO) -- alcoholic beverage producer

General Mills (GIS) -- packaged consumer foods producer

Johnson & Johnson (JNJ) -- all sorts of products in beauty, health, and household areas.

Kellog (K) -- packaged consumer foods producer

Kraft (KFT) -- packaged consumer foods producer

Pepsico (PEP) -- beverage producer

Proctor & Gamble (PG) -- all sorts of consumer products in beauty, health, and household areas.

Reynold's American (RAI) -- tobacco products producer

All but one of these are in the consumer staples sector--what people buy on a regular basis whether because it's needed like food and soap, it's socially mandated like deodorant and shaving cream, or it's addictive/stress relieving like alcohol and tobacco. Con Ed, in the utility sector, is similar in that having electricity has become a basic life necessity. What all these companies have in common is their large size, dominance in their respective industries, a long history of steady dividend increases, and daily demand for their products that should not disappear because of an economic downturn. They are big, boring stocks that almost everyone has heard of.

I looked for the starting and ending dates of the last bear market, but could not find any firm dates. I've decided to take a different approach: look at the S&P 500 index to find its peak and low, and see how the defensive stocks listed above did during that period. I chose the S&P 500 because I could not find a decent chart for either the MSCI US Broad Market Index or the Wilshire 5000, which aim to track the entire US stock market.

The last major drop of the S&P started in September 2000 and ended in October 2002. As you can see from the chart, it declined roughly 47% over the two year period.

Over the same period, as you can see from this chart, only Coca Cola (KO) finished negative, around 10% down. Had you actually held the stock during this time, your loss would be about 2% less, given that you would have collected 8 dividend payments, amounting to $1.08 a share. While a losing stock, Coca Cola solidly beat the S&P.

The other stocks mentioned above, as you can see from the chart, had positive returns, the great majority of which were between 20 and 40%. That's excellent in a market when the S&P loses almost half its value. And this doesn't count dividends. All these companies offered generous yields and steady dividend increases.

The market had two peaks recently, before heading downward. The first happened in mid July, 2007, then an all time high, and the second happened in October, 2007, the all time high. You can see the chart here.

For the first downward period, as you can see from this chart, all but one of our defensive stocks beat the S&P. However, only four ended the period in positive territory. Not a good result, but certainly better than the broader market.

For the second downward period, from October, 2007 to present, all of our defensive stocks beat the S&P, and the majority were in positive territory. Of course, no one knows what will happen next and how these stocks will do if the broader market continues its decline.

This is all inconclusive, but I would venture to say that buying defensive stocks at market peaks is safer than buying a broad market index like the S&P. Better yet, buying defensive stocks and holding them over the long term seems to be a good strategy. Holding the above listed stocks since the first peak I talked about (September 2000) until now would have given you fantastic market beating returns, with the majority of the stocks listed above returning between 20 and 60%, three of them doubling, and one returning around 240%, all excluding steadily rising dividends. Only Kraft finished flat, excluding dividends. Any of these stocks would have been a better investment than the S&P, or incidentally, keeping the money in the bank (return wise, not risk wise).

To answer the question posed in the title of this post, I would say yes (caveat: from 9/00 to 1/08), defensive stocks are safer than others.

If you're interested in consumer staples, you might want to investigate the following ETFs: KXI, XLP, VDC. Be sure to examine their holdings, as some might not truly be consumer staples. This is debatable, but I don't consider Walmart to be in the consumer staples category.

If you're interested in utility companies, you might want to investigate these ETFs: XLU, IDU, VPU. Because of their defensive nature, these have been bid up recently.

If disclosure is necessary: I own RAI. My girlfriend owns MO and VPU.

1/8/08

How Not to Drive Traffic to Your Blog

I don't know if most bloggers want to make money online, but I'm one who does. A key element in getting people to click on your ads is driving traffic to your site, and that's what I'd like to talk about here--sort of. I'm a newbie, and as yet, while slowly building, my traffic is but a small drip. But I've already figured out how not to get traffic to your site. That's what I'd like to talk about here.

Like many others, I started a blog, put up a couple of posts, and then was disappointed that the hits didn't come gushing in. Off to Google I went, searching for methods to get more traffic to my site. I turned up many recommendations. Yeah, yeah, quality content. But that takes time, and I want traffic now! I don't really care whether people actually read my stuff, I thought, I just want them to click on the ads. (Google, I found out later, does not like accidental ad clicks, which is understandable, especially from the advertiser's perspective.)

To this end, I found sites such as blogexplosion.com, linkreferral.com, and freeviral.com, among many others. They all promise--and deliver--lots of traffic. Their basic functions are the same. You register, submit your site, and then earn credits by surfing other members' sites. This is how they get hits. The more credits you earn, the more hits your site will get, because credits affect how often your page is viewed by other members, who are themselves earning credits.

Blogexplosion has a mechanism by which you must stay at each blog for 30 seconds. Linkreferral just wants you to open a certain number of pages, and review a few. Freeviral has some sort of weird pyramid scheme involving links, pop-ups and pop-unders.

I developed a method of viewing multiple blogs at once, to generate as many credits as possible in as short a time as possible. I'm a slacker, after all. I'd log on to several of the traffic referral sites in different windows, and in each window I opened multiple tabs. I didn't read a single blog, not that I cared to, but got a boatload of credits.

Looking at my traffic stats, which showed a huge spike, I discovered that others were employing the same methods. Sure, I received many new visitors, but they all stayed for 0 to 30 seconds (depending on which traffic site they came from). No one read a single thing, and, of course, no one clicked on any ads.

In retrospect, I'm glad they didn't. Looking over Google's Terms of Service (TOS) for Adsense, it's pretty clear that using traffic referring sites such as the ones mentioned above is a violation. Many people have found out the hard way, losing all their meager earnings.

In short, while traffic building sites get you hits, they are a waste of time--time that you could spend building quality content.

1/7/08

Review: Scottrade Individual Account

Regular Individual Account

Here's the good:


1. If your bid price is between the bid and ask, your order is executed with lightning speed. You confirm your limit order, go back to your account home page, and notice that it's already been completed.

2. You can buy OTC stocks

3. There's a large selection of mutual funds, bonds, CDs, and preferred stocks.

4. Depending on your starting capital, $7 a trade is not too bad.

5. They have a lot of physical locations, so you can always stop in to talk to somebody.

6. Check writing from your cash balance if you qualify.

7. Decent free research--there's a pretty good stock screener, and many stocks have either Reuters, S&P, or Second Opinion Weekly reports.

8. Real time stock quotes, and a streaming ticker (there's also a streaming Java chart), along with a Java based order entry window (for quick orders). It's very simple in design and easy to use--my favorite thing about Scottrade. Images are below.



9. Free account transfers.

10. Depositing money into your account is now same day. It used to take three days. This is a big improvement.

11. No account minimums or maintenance fees (but to open an account you need $500, $2000 for margin, and $25,000 for day trading).

12. Your order history is easily accessible. Just enter the ticker symbol and the date range, and everything is displayed for you (today's orders are displayed in history tomorrow--that is, there is a one day delay for your most recent transactions).

The not so good:

1. No automatic dividend reinvestment, and no fractional share buying (except for mutual funds). If you want to reinvest your stock dividends, you have to make a regular trade, and pay commissions.

2. If you want to take your money out and you don't have check writing whereby you can write yourself a check (only the first 50 checks are free), you have to request a check from Scottrade or a wire transfer. You can call or request the check online. This takes time, from Scottrade writing the check, to sending it, to you having to go to the bank to deposit it. (You can visit a branch and pick up a check, but depending on your location this may be a hassle). The wire transfer costs $20. In other words, there is no free electronic funds transfer to withdraw your money in the same way you deposit it.

3. If you want to buy certain foreign OTC securities, you have to do so through a broker over the phone or in person, which is more expensive. Also, see the bad below.

4. No multi-leg orders. For example, suppose you want to buy a stock and at the same time write a call on it, specifying a net debit. You can't do this with Scottrade. To do a covered call or protective put, you have to make two separate transactions. If you want to do an option spread, you have to make as many transactions as you have legs. As prices tend to wobble around, you might get a bad deal on one of your legs as you're placing orders separately.

5. No naked calls or (even cash secured) puts.

Scottrade does offer multi-leg orders and the ability to write naked options through its OptionsFirst platform, but you must apply for this separately. It is a new account with a separate login. For all intents, OptionsFirst is like another broker unaffiliated with Scottrade (they don't know anything about it at the physical locations).

6. Options are expensive at Scottrade: $7 a trade plus $1.25 per contract. Want to buy 10 contracts? That's $19.50 in commissions to buy, and another $19.50 to sell. There's also a $17 dollar assignment fee if your option expires in the money (most other brokers just charge the regular commission for buying and selling stock).

The bad:

Customer service is terrible.
Everything is designed so you would either come in to a physical location, or call someone at a physical location. If you don't like it or are too busy for the phone, and email is easier for you, good luck.

You may have to wait a week or more for a response. When it comes, it's something vague and does not answer the question. Or, someone leaves you a phone message, requesting you to call back. You call back, only to get that person's voice mail. One of the drawbacks to having a physical location is that when a customer comes in, the customer representative can't answer the phone--or, if he or she does answer the phone, the visiting customer is left unattended.

Customer service also does not seem to be very knowledgeable. When I inquired about whether I could do a multi-leg order, specifically a covered call or a "buy-write" (I wanted to know if I could buy a stock and sell a call on it at the same time), the person I spoke with had to put me on hold three times to go ask her manager because she did not know what a covered call was. In the end, she said, "why do you want to do it all in the same transaction? It's the same commission separately."

Yes, it is, but there are reasons why one would want to do two or more transactions simultaneously. Let's say I think a call is mispriced. Say stock XYZ is trading at $100 on January 15, and the 80 strike call, which expires on
January 16, is trading for 20.50. I want that $0.50. I want to buy the stock for $100, and have it called away from me for $80, while I keep the $20.50, for a profit of $0.50. Doing a buy-write (buying stock and selling a call simultaneously), in leg one I'd buy 100 shares of XYZ and in leg 2 I'd sell to open 1 January 80 strike call contract. Then I'd specify a net debit of $79.50. If my order is filled, $7,950 leaves my account, and I get 100 shares of XYZ and -1 call. Provided the stock stays above $80 a share through the next day, it will be called away, and $8,000 will be deposited in my account. If the $0.50 difference disappears while I'm placing my order, either because the call drops in value or there aren't any willing call buyers, my order expires, and I don't lose anything.

Now suppose I have to do two separate transactions. I buy the stock for $100, and then enter a new order to sell the call. During this time, the stock price will change, and so will the call. If the call now sells for $20, there's no point for me to sell it, and I'm stuck with the stock. It may also happen that no one wants to buy the call. Once again, I've already bought the stock, which I don't even want. Now I might have to sell the stock for lower than I bought it. The entire purpose of the transaction was to get the $0.50; I don't want the stock. If I have to do two separate transactions, things may not go my way, making it too risky to try without multi-leg orders. This is to say, with a multi-leg order I know exactly how much I'll pay if my order is filled, and if it's not filled, I lose nothing.

I tried to explain this to the customer service representative. After putting me on hold to go ask her manager, she once again said that I'd end up paying the same commission. I understand that options are confusing for many people, but someone working for a broker that offers options trading should be able to follow along.

I mentioned in a previous post that I used my last free trade to buy DuPont. My girlfriend did the same in her Scottrade account to buy the Jim Rogers RICI Agriculture Index. My free trade worked. Hers did not, leaving her account with a small negative cash balance. I immediately emailed customer support, notifying them of the error. Several days later, Scottrade sent an email about the negative balance, requesting a deposit and threatening to sell stock.

First, as this is not a margin account, the cash balance should never have been negative. If there was not enough money to complete the trade, it should not have been allowed. The trade was allowed because the $7 trading fee was not included, as it should not have been since it was a free trade. Second, Scottrade completely ignored the email. We replied, reiterating the error and requesting a $7 refund. When Scottrade got around to replying, they said that the free trade was unavailable that day, but was available on the following day, the $7 fee stood, and they again threatened to sell stock (and charging another $7, no doubt) if a deposit was not forthcoming.

Now, $7 is no big deal, but it's the principle of the matter. That trade wouldn't been made through Scottrade if we thought it wouldn't be free. We are firm believers in having broker commissions at under 2% of the trade, and usually go for under 1%.

The Bottom Line

If you're a regular trader with a lot of money, you'll no doubt like Scottrade. The trades are super fast, and stock order fees are relatively cheap. Bigger clients might get better customer service. I wouldn't know. I don't recommend Scottrade.

Free Trades

If you don't already have a Scottrade account you may be wondering about how to get free trades. Scottrade customers can refer others to Scottrade, and in return, Scottrade gives both the referrer and referee 3 free trades which expire after 6 months. I don't recommend Scottrade, but if you'd like to open an account and get 3 free trades, find my email link near the top right corner of this page. Send me an email with Scottrade in the subject line, and I'll be happy to refer you using your reply address.

Scottrade Elite

Scottrade Elite is a platform, which you download and install on your computer, available to all Scottrade Customers who have $25,000 in account equity or over. It comes with many neat features, including a backtester and streaming charts you can draw trendlines on. You can even view a streaming chart tick by tick. It's comparable to Fidelity's Active Trader Pro (which I like very much and have been using recently--a review will be posted in the next few months) and TD Ameritrade's Command Center 2.0 (review coming sometime this year).

Scottrade Elite is very customizable and intuitive to use. It has no faults that I have noticed. One bad thing is that you have to pay a monthly fee for Nasdaq Level II quotes.




This Scottrade Review was last updated on January, 13 2009.

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1/6/08

Dogs of the Dow: Do it yourself vs Mutual Fund vs ETN

There's a somewhat popular simple investing strategy called Dogs of the Dow: at the beginning of the year, one buys, in equal dollar amounts, the ten highest yielding Dow stocks (yield = dividend per share divided by share price). At the beginning of the next year, one replaces these stocks with the ten highest yielding Dow stocks, and on it goes.

This simple strategy of buying and selling once a year has, according to the Dogs of the Dow site, generated a market beating average annual return of 17.7% since 1973.

Now I don't know why the starting year is 1973 (could be because the original study, done by Michael O'Higgins used the period of 1973 - 1989) or what would happen to the average annual returns if the starting year were moved forward or back, but the strategy sounds good in theory for the following reasons. Dividend yields of large companies can be a good measure of the relative worth of their stocks. That is, if a large cap company has a high dividend yield it may indicate that the share price is undervalued. Of course, it may also indicate that the company is in trouble, as is the case currently with Citibank (C). However, taking that into account, it should be noted that companies in the Dow Jones Industrial Average are in the index because they represent the biggest, most solid publicly traded companies in their sector. If a Dow company goes bust, it is replaced by another company in the index. While this may not matter to you if you invest in a Dow company and then see its share price in free fall, investing in Dow companies as a group, and especially in the Dogs, over the long term has shown to be profitable.

Over the years, certain strategies have developed around the Dogs of the Dow, with varying results. For instance, there's one called Small Dogs (the five Dogs with the lowest share prices), and there's one where you invest in only one stock, the one with the second highest yield (the theory being that the one with the highest yield has real problems while the second highest is set for a turnaround). I'll focus on the main Dogs of the Dow strategy here.

If you're interested in the Dogs of the Dow strategy, I know of three different ways of implementing it: doing it yourself, through a mutual fund, or through an exchange traded note (ETN).

Doing it Yourself

This one is fairly obvious. Pick a point in the year, say the first trading day in January, or whenever you wish, and look up the ten highest yielding Dow stocks. There are many ways to do this, one being going to the Dogs of the Dow site. A year later, replace these with the Dogs then.

The advantage of doing this yourself is that it's easy and you avoid mutual fund and ETN fees. Moreover, you get to pick the time of year you commence your investment regimen. Furthermore, if the Dogs drop in any given year, your losses are smaller because you collect dividends four times a year from every stock. Doing it yourself also gives you the flexibility of reinvesting the dividends, should you want to.

The following disadvantages may be relevant. Buying and selling up to ten stocks at a time (up to 20 trades) can put a big dent in your returns if your starting capital is small, because of brokerage commissions. Another disadvantage, particularly if your starting capital is large, is that the ten stocks pay dividends, which are taxed. While dividends can hold up your portfolio in bad times, their tax consequences may hurt during good times.

Minus broker commissions, doing it yourself replicates the strategy most closely.

If you follow this strategy, remember to hold on to the stocks a little longer than a year, so that when you sell them you are taxed at the long term capital gain rate.

Mutual Fund

At the moment, there are two mutual funds that use the Dogs of the Dow strategy. These are the Hennessy Balanced fund and the Hennessy Total Return fund. There was a third, the Payden Growth and Income fund, but it was discontinued.

The advantage of using a mutual fund is that all you have to do is put your money in once. Unlike doing the strategy yourself, the mutual fund manager does all the work for you. Depending on the fund and the method you buy it (through broker or directly from the fund company), as you're only placing one trade instead of up to 20, you're saving on commission fees, particularly if your starting capital is small.

There are a few disadvantages. First, the mutual funds charge you a fee that's taken out of your returns. Hennessy Balanced takes 1.34%, and the Hennessy Total Return takes 1.16%. This may add up to much more than broker commissions if you were to buy the individual stocks yourself. Furthermore, while the mutual funds try to replicate the Dogs of the Dow strategy, they do it imperfectly. This is because it is against mutual fund rules to hold positions in individual stocks that are greater than 5% of the fund's holdings. To compensate, the funds hold treasury bills. Another disadvantage of mutual funds is that you can only sell for the price established at the end of the day. This may be a problem for some people. A further disadvantage is that mutual funds are required to pay out dividends and capital gains at the end of the year. Depending on your starting capital, you may have a big tax bill every year.

ETN

This one is pretty new. The ELEMENTS DJ High Yield Select 10 ETN (DOD) has been introduced at the end of October, 2007.

The advantages are the following. Just like the mutual fund option, you buy once and let the manager do the rest for you. Unlike the mutual fund, the ETN should more closely follow the strategy because its holdings are the ten Dog stocks. Moreover, the ETN is cheaper than the mutual funds, having an expense ratio of .75%. Additionally, all dividends are automatically reinvested without being paid out. This means that you only pay taxes when you sell.

There are a few drawbacks. As this one is really new, it is very thinly traded. As of the previous close the average daily dollar volume was only $111,592.18 (but recently volume has started picking up; the last close had a dollar volume double the average). Moreover, there's no flexibility in keeping the dividends or reinvesting them. While reinvesting dividends is generally a good idea, if a stock keeps falling, your lose money on your reinvested dividends as well, whereas if you kept the dividend your losses would be offset. Another disadvantage of DOD is that it's an Exchange Traded Note, which means that, as unsecured debt, there is issuer risk. Deutsche Bank is the issuer. If it defaults, you lose all your money. If there's a perception among investors that Deutsche Bank is having problems (which isn't very unlikely considering the current credit crisis), there may be a panicked sell off of the ETN that does not reflect the value of the ten Dow stocks it seeks to replicate. As it's already thinly traded, this may add up to a lot of trouble.

Conclusion

So there you have it. In my opinion, the doing it yourself option is most favorable. The ETN option follows in second. I would feel more comfortable with it if the issuer were an institution backed by a rich sovereign. The mutual fund does not seem to be that good a choice.

As with all investing strategies, there are good years and bad years, and those who find a strategy that works most of the time and stick with it tend to do quite well.

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