4/16/12

Reflections on Senate Productivity, Corporate Taxes, and the "Buffett Rule"

Lazy Senate

There was a link at the Drudge Report (Republican leaning news aggregation site) today with the headline "Democrat-controlled Senate laziest in 20 years." The link was to a Washington Examiner article with the same headline.

The gist is that the 2011 Senate "was a do-nothing chamber," being in session 170 days and logging an average "of just 6.5 hours" per day. The Senate only passed 90 public laws, and a total of 402 measures, both figures being the second lowest in 20 years.

Why are the Republicans complaining? Aren't they for less government?

That 90 public laws and 402 measures are low figures speaks to how large a monster the government has become.

The less legislation is passed, the better. Congress is not a law-making factory. Their job, contrary to what has become the popular opinion for both Democrats and Republicans, is not to shell out laws as fast as possible. Yes, making laws is part of their job description, but that doesn't mean that they have to meet at all or pass any laws. It's this attitude that the legislature must legislate every second of the day that has led to the overspending, high taxes (yes, they're lower than at some points in the past--but don't forget that the government did just fine without a federal income tax before 1913), stupid regulations that don't make sense, endless bureaucracy, and corruption (pay to play schemes, laws favorable to the industries that make the most campaign contributions and/or hire the best lobbyists, etc).

A lazy Congress is a good Congress.

Corporate Taxes

Isn't it unfair that some corporations earn billions in profit and yet pay no taxes?

No. Corporations, whether they send the government a tax check or not, do not pay taxes. Only flesh and blood people pay taxes. When a corporation sends the government a tax check, the corporation's shareholders and its customers are the ones really paying. Shareholders pay through reduced dividends and lower stock prices while customers pay through higher prices for goods and services.

We are all shareholders, customers, or both. We are the ones paying corporate taxes. Think about that, along with the fact that the good old USA has the highest corporate tax rates in the developed world.

The Buffett Rule

It's all the rage on cable TV news shows. There's the inevitable debate: Talking head A asks talking head B whether it's fair (implying that it's very much unfair) that a billionaire's secretary pays a higher tax rate than the billionaire.

Talking head B responds sheepishly that while it might be true that the secretary pays a higher rate, she pays a lot less in taxes. A lower tax rate applied to the billionaire's earnings still results in a much larger check to the government.

That's a fair point, but talking head A immediately interjects that that is not part of the issue. It's about fairness. Why should the lower wage earner pay a higher percentage of her earnings than the rich bastard?

The inevitable conclusion is that rich people should pay a higher tax rate than the rest of us. This conclusion is not contradicted by anyone on the idiot box--those seeming to argue against it only make the point that rich people's taxes shouldn't be raised. The way it is framed, the debate is about whether or not to raise rich people's taxes.

Here are a few questions. If it's unfair that the secretary pays a higher tax rate than her boss (and I agree that it is unfair), why not lower the secretary's tax rate? Why keep her tax rate the same and raise her boss'. Why not keep the billionaire's tax rate the same and lower the secretary's?

"But, but, but, but, but," talking head A will stammer as fast as the text is entered into his teleprompter, "how will the government pay for the things we need?"

But that's the point. A large portion of the government's spending is for stuff we don't need. And I'm not just talking about GSA talent shows, overlapping programs (pdf), bridges to nowhere, etc. Why should it pay for anything beyond the bare essentials?

Let the government pay for (that is, let the government take our money to pay for) the things from which we all derive some benefit and would unjustly derive a benefit if we didn't pay our share. These positive externalities include the military (debatable), roads, education (debatable in its current form), and other things of this sort. The list is rather short. That's all we should pay for through taxes.

All the rest, like GSA parties, funding of the arts, funding of welfare, abortions, etc, should be up to private citizens. Why should you pay for someone's party, art work, and so on? If you want to pay, great! Pool your resources with those who share your beliefs and do some good. But why should those others, who couldn't care less about the poor, starving artists, etc be made to pay too?

You have a cause? Good for you. Advance it. But don't make your opponents pay for it too if you want to keep things fair.

If Warren Buffett thinks the government needs more money, let him write a check. Everyone that agrees with Buffett should follow suit. But why should others be made to pay as well?

Let's make a deal, my fellow Americans. I won't make you pay for my version of the good, and you won't make me pay for yours.

3/20/12

Giving Away Copies of My Book

I'm giving away a couple of copies of my book Dividends: Pros, Cons, Sources, and Strategies.

As the title suggests, the book is about dividends: what's good about them, the potential downsides, where to get them, and the pros and cons of the strategies surrounding them. It's not just about common stocks, but also preferred shares and other "dividend" paying investments like master limited partnerships, exchange traded debt, royalty income trusts, business development companies, and the like.


You can enter to win below. You have to register at Goodreads to do so. It's sort of like Facebook, but for readers.




Goodreads Book Giveaway





Dividends by Devin Hobbes



Dividends


by Devin Hobbes



Giveaway ends April 05, 2012.

See the giveaway details
at Goodreads.




Enter to win


3/12/12

Fidelity Review

The Good

1. Relatively easy to use website. It might take a while to get used to, but everything seems to be in a logical place. If you cannot find something, there is a handy search box at the top of each page. Account history is detailed and easy to find.

2. Tons of research tools. These include common stock, preferred stock, closed end fund, exchange traded product (ETFs, ETNs, etc), mutual fund, bond, and option screeners. Most stocks and ETPs have lots of fundamental information (earnings, dividend growth, analyst rating, earnings estimates, all of the commonly used ratios [PE, price/book, etc]). There's also a tool that compares and suggests similar ETPs. You can compare them by fee structure, performance, liquidity, and so on.

Fidelity also provides research reports by Morningstar, S&P, Ned David Research, Zach's and others on both stocks and funds (including closed end funds). The options section of the website provides S&P reports for covered calls and calendar spreads on most of the widely held stocks as well as on those S&P thinks provide the best potential return based on the risk.

3. International trading. Fidelity enables its clients to trade foreign stocks in 17 different markets and in 13 different currencies. More information is here. Some things to note are that margin is not available for these transactions, there is no short selling, and order instructions like “all or none” are not available. Commissions are charged in the local currency. At the time of writing the average is around $25 per transaction, or $50 for the round trip. There are also currency exchange fees, which range from 0.2% to 1% of the transaction, depending on the transaction's size. Be aware that foreign stock trading involves not only the risks associated with stock ownership but also currency and political risk.

4. 24/7 live customer support. If you want to talk to customer service on the phone, you can call at any time. In my numerous calls I've never had to wait, whether it was during the trading day or late on a weekend. The phone operators are friendly. I've also found them to be more knowledgeable than representatives at other brokers. If you want to talk to them about a condor or diagonal spread they'll know what you're talking about without having to put you on hold, or quickly transfer you to someone more knowledgeable than themselves.

Fidelity is also pretty good at making followup calls to make sure you're satisfied. That doesn't mean you will always be satisfied, but they do try. If you hate the phone, you can use instant messaging. When I tried this feature I had to wait a few minutes before someone responded. Fidelity also responds to email, but as you would imagine this takes longer.

5. Competitive commission rates for domestic trades. Online stock trades are $7.95 while phone orders are $12.95 and representative assisted orders are $32.95. Options are an additional $0.75 per contract (so the total fee for buying one option online, for example, is $8.70). Bond and CD commissions range from none to 2% of investment amount, depending on the type. More detailed information can be found here. Note that the link is a PDF document.

If you've been a customer for a long time, have lots of trades (at least hundreds per year), and/or have a large account, Fidelity will offer you lower rates if you ask them. They say that this is determined on a case by case basis, so lower rates are not a guarantee (but it never hurts to ask).

6. ActiveTraderPro. Fidelity has a few pretty good streaming programs: ActiveTraderPro, which you install on your computer, a browser based version, and OptionsTraderPro. They offer streaming quotes, level 2, real-time charting (with many technical analysis tools), complex options orders (which can tell you your max gain and loss), streaming options quotes, and news from around two dozen sources (including Market Watch, Dow Jones, Business Wire, MidnightTrader) that can be set to report only on your holdings or on stocks on your watch list. You can set up a number of watch lists and edit what you want displayed, from your gains and losses, to quantity of shares, to day's and year's price ranges, to options Greeks.

The platforms are pretty stable. They disconnect sometimes (the desktop based one is more prone to this) but I haven't had a crash in over a year. Fidelity doesn't charge anything for its streaming platforms, but in order to use them with full functionality you must make at least 120 trades per rolling year. That comes out to $954 per year.

7. Wealth-Lab Pro. This platform allows you to do back testing as well as to design your own trading system (or just use or customize one of the presets). It is available to customers who make at least 120 trades per year and have at least $25,000 in assets at Fidelity. More info is available here.

8. Free dividend reinvestment. You can specify, for your entire portfolio and for individual holdings, whether you want to reinvest the dividends or not. Note that new holdings are automatically set for dividend reinvestment based on the status of the last holding you bought. That is, if you buy a stock and mark it for dividend reinvestment, the next stock you buy will automatically be marked for dividend reinvestment. If you don't want to reinvest dividends in the second stock, you will have to change your preference. If you do so, the next stock you buy will not be marked for dividend reinvestment as a result (so if you want to reinvest the third stock's dividends, you'll have to change your preference for it).

9. Lots of different order types: contingent (if x criterion is met, then y order is placed), multi-contingent (if x happens, and at the same time y happens [or y happens], place z order), one cancels the other (if A order executes cancel order B; if B order executes, cancel order A), and one triggers the other (if x order executes, place this second order).

10. Various different choices for money market accounts, including tax free core cash options.

11. A very wide selection of mutual funds.

12. A decent selection of 30 iShares ETFs that have no trading fees. The caveat is that, as with mutual funds (and all iShares ETFs), you have to hold them for 30 days before they become margin eligible. (Most other brokers have commission free ETFs too. For example, TD Ameritrade offers over 100 ETFs, and unlike Fidelity, includes other issuers, like Vanguard.)

13. Fidelity has lots of physical locations if you want to talk to someone face to face or have a professional manage or help you manage your portfolio.

14. Check writing is available.

The Bad

1. Slow order execution. Suppose you're an active trader. You are watching a very liquid stock or ETF drop and you are fairly certain it will bounce off $50 per share, go past $50.30, and then head below $50. You want to buy 1,000 shares at $50.02 and sell at $50.30. Let's say you're dead on about the stock's movement. In an ideal world you would make $280 minus commissions. More often than not at Fidelity you wouldn't make any money because your order to buy at $50.02 wouldn't be executed.

Quite often nothing happens even when a stock trades below your bid. Whether your order is executed often depends on how long the stock you want to buy stays at a certain price. The shorter it stays at a certain price, the less likely your order is to be executed. I've often had my order executed after the stock fell through my bid and returned to it. For example, I wanted to buy something for $100 per share. I placed a limit order for $100 per share when the stock was $100.25. The stock fell to 99.95 per share. My order wasn't filled until after the stock rose back up to $100 per share. This can be very frustrating. (This happens with options orders too, especially if you include "all or none" instructions).

2. Stupid error messages that prevent order placement. Say you place a limit order to buy a stock. As you are doing so, the stock drops below your bid. Any normal broker would just fill your order at the current market price—you were willing to pay more, so you should be happy with a lower price. What usually happens at Fidelity, however, is you receive a message telling you that your bid is higher than the current price of the stock. So you have to change your order lower, but now the stock is higher and in all probability you won't be able to buy it for your originally intended price for the rest of the day, or ever. This problem occurs most frequently with contingent orders (for example, you place two orders at the same time: buy 100 shares of XYZ for $100 per share, and if this order executes, sell 100 shares of XYZ for $102.50. If XYZ is below $100 when you try to place the order, you will get an error message).

3. No execution at all. One of the great things about Fidelity is the different multi-leg option orders it offers. The trouble is that these are very rarely executed.

If you are initiating a net debit position, the order ask can be well below your bid and your order still won't be executed. If you're initiating a net credit position, the order bid can be well above your ask and your order still won't be executed. It just hangs there. Fidelity blames the CBOE or the market makers. I don't know whose fault it is, but it really stings when the order is finally executed at your original bid or ask when the current market rate would have given you a better deal.

For example, suppose you want to write a covered call by buying 100 shares of stock at $100 per share and selling one call for $5. You want your net debit to be $95 per share. The stock might fall or the call might rise so that the market ask becomes $94.80. One would expect that your order would've been filled by now. Most often it's not. And when it is, even if the ask is $94.80, your order will be filled for $95. This doesn't happen all the time, but it happens enough that it's far easier to just do separate orders—one to buy the stock and one to sell the call. You pay a higher commission, but it's far likelier that your orders will be executed.


Here's a screenshot to illustrate. In the screenshot, I'm attempting to buy 100 shares of Baidu and write a call on it of a net debit of $90.50 per share. That is to say, in the screenshot I've placed an order to buy 100 shares of BIDU and sell one call. Now I'm waiting for it to be executed. Notice that the current market bid for BIDU is $99.28 and ask is $99.30. The current market bid for the call is $8.85 and the ask is $9. And again, recall that the order I've already placed is for a total debit of $90.50.

If, instead of the multi-leg order, I bought BIDU at market, I'd pay $99.30. And, if instead of the multi-leg order I'd sell the call at market, I'd get $8.85. This would result in a net debit of 90.45. My order is for $90.50--I'm willing to pay $0.05 more than the market ask, but my order isn't filled.


Here's another screenshot. Above, I'm trying to sell a straddle on IWM, the ETF that tracks the Russell 2000 index. The net credit I want to receive is $2.11. As you can see in the screenshot, the net bid is $2.12, but my order hasn't been filled. In other words, I'm trying to sell something for $2.11, buyers are offering to pay $2.12, and Fidelity isn't executing my order. This order was never filled.

4. Glitchy order placement and replacement. Let's say you are long or short an option and you want to roll it to a future month. For example, suppose you sold 10 puts that will expire in 30 days and you want to buy these puts back and sell 10 puts of the same strike and on the same stock that will expire in 60 days. You go to the multi-leg trading screen, select the roll option order, enter in all the information and hit preview. It will work half the time.

The other half you'll get a weird error message about how it's an invalid order, one of the option symbols doesn't exist, or something similar. When this happens it is sometimes possible to place the order anyway, the error message notwithstanding. Other times it doesn't let you proceed to the next screen. A way to get around this is to place the order via the spread order screen: in the example above you would buy to close the 10 puts for the front month and sell to open the 10 other puts for the later month. It's the same order, but since you didn't specify that it's a roll, it'll let the order go through just fine.

Now let's say something like #3 above happens, where your ask is lower than the current market bid. Let's say you wanted a $1 credit on the roll and the current bid is $1.10. You decide to cancel and replace your order with a credit of $1.10 (because from prior experience you know that if your order is ever executed it will be for $1, regardless of the current market price). You go to the cancel and replace screen. There you have to re-enter the number of contracts you are trading (in our example 10 of each) and your credit/debit (in our example you change the credit from $1 to $1.10). So, in effect, all you are really changing is your net credit in this example. All of the option symbols are already entered for you and you cannot change these even if you want to. Nevertheless, half the time after you hit preview you will get an error message stating that one of the option symbols is invalid or doesn't exist. So you have to either try again (it might work eventually, despite what Einstein said about insanity) or cancel the entire order and start from scratch. There is a similar problem with contingent orders when you attempt to change the trigger price for one of the events.

These have been problems for a very long time. Fidelity should be aware of them, as people do complain (I know I have), but so far they've done nothing. If you complain enough someone with a high sounding rank will eventually call to apologize and offer you some free trades.

5. Not many shortable stocks/ETPs. Delta neutral and bearish traders beware. If you short sell stocks and ETFs note that these can be quite limited. For example, while you can almost always short SPY (SPDR S&P 500), you usually cannot short IWM (iShares Russell 2000), even though both are widely held, very liquid ETPs. Most of the widely held stocks can be shorted, but if you are looking to capitalize on a company in trouble, chances are there will be no shares for you to borrow. If your trading strategy involves shorting, look to another broker.


The Bottom Line

With its research tools, bond, stock, ETP, foreign stock, and mutual fund offerings, along with free dividend reinvestment, relatively low commission rates, and good customer service, Fidelity is great for long term investors and infrequent traders.

Despite its robust active trading platforms, however, Fidelity isn't very good if you are a frequent trader. There is really no point in having complex option orders and various stock trading tools if your orders are not executed in a timely fashion or for the best price. Fidelity needs to hire some decent computer programers.

2/7/12

Stock Splits: much ado about nothing

There are lots of people talking about stock splits nowadays. “Will Apple [AAPL] split, do you think? I hope so, cause that'll make me rich!” “It would be so awesome if KMP [Kinder Morgan Energy Partners] did a stock split so we could get more shares and a bigger dividend!”

These kinds of statements, rife on the various finance message boards, make me shudder and put in stop loss orders. And not just because KMP has units instead of shares.

It's because stock splits are mostly meaningless. And when people who don't know this invest in the same things I do, I get nervous.

A stock split occurs when a company divides each of its existing shares into more shares. For example, suppose that corporation XYZ declares a 2-for-1 split. This means that if you own 100 shares before the split, you own 200 after.

Many people are unfortunately under the misapprehension that if this were to happen with the shares of a company that they own, they would double their money. And that if the company pays a dividend, if the rate stays the same, the dividend would also double.

Wouldn't it be awesome if it were true (putting aside the worry about where the company would find all that extra cash)?

Here's what happens with a stock split. Suppose corporation XYZ declares a 2-for-1 split. Let's say it has 20 million shares outstanding before the split and trades at $40 per share. That makes its market capitalization (the total market value of all its shares) $800 million.

After the 2-for-1 split, XYZ will have 40 million shares outstanding. Its share price, on the other hand, will be $20. Its market capitalization will stay the same, at $800 million. It'll have twice as many shares and these shares will cost half as much as before the 2-for-1 split.

Had XYZ done a 3-for-1 stock split, it would have three times as many shares (60 million) and its shares would cost three times less ($13.33333) than before the split. The company's market capitalization would stay the same at $800 million.

If XYZ paid a dividend of $3 per share before the split, it would pay $1.50 per share after a 2-for-1 split or $1 per share after a 3-for-1 split if its dividend rate ($60 million) remained the same.

So what the hell is the point of a stock split? If nothing changes, why do companies do it? There are a few reasons, but they're nothing to get excited about.

Stock splits can make the shares more liquid, as there might be more buyers for 100 shares at $20 than 50 shares at $40. Also, the split might signal to investors that the company is optimistic about the future (but wouldn't a good earnings report do a better job of accomplishing that? And wouldn't it be clearer if the company simply said, “we expect growth to the tune of x% for y number of years?). Finally, there's a psychological effect. A lower share price looks cheaper and might tempt more people to buy it, thereby increasing demand and sending it up. To the extent these are true, they only influence small investors, who have a negligible effect on the share price. That's about it. Studies haven't shown, as yet, that stock splits increase shareholder value.

In some sense share splits make it easier for smaller investors to buy a stock. This was especially true when investors could not buy odd lots (anything less than 100 shares). So, for example, if an investor had $1,000 and a stock he wanted to buy cost $1,000 per share, he wouldn't be able to buy it because he couldn't afford 100 shares ($100,000). If that stock did a 100-for-1 split, on the other hand, the investor would be able to use his $1,000 to buy 100 shares for $10 each.

Today, however, investors can buy odd lots. Through certain brokers they can even buy fractional shares. If you want to put $1,000 into Berkshire Hathaway's class A shares, currently trading somewhere north of $100,000 each, you can get a hundredth of a share through certain brokers. Remember, it doesn't matter how many shares you own. What matters is the monetary value of these shares and, in terms of voting for company directors and the like, what portion of the shares outstanding are under your control. Whether you own one share or a million, if it constitutes the same monetary value or stake in the company, the number doesn't matter. $1,000 in Apple is $1,000 in Apple, whether the stock costs $500 and you own two shares or the stock costs $20 and you own 50 shares.

So there's really no reason to split shares today. Moreover, it can be to a company's and its investors' detriment. The investment banks involved in the share splitting process don't do it for free, after all. Also, if your broker charges a per share fee for buying or selling, a stock split will increase your transaction costs.

So why do people tend think that share splits are a good thing? Stock newsletter ads and financial blogs are at least partly to blame for the misapprehension. When newsletter copywriters give their spiel about why you should spend your hard earned money on stock advice from people smart enough not to invest in the recommended stocks themselves, they often tell you a long story about how “Jim from Omaha bought 100 shares ABCD in 1890 and now, thanks to stock splits he has 2,395 shares!” and how “Mary from Springfield bought just one share of WXYZ in 1923 and now, thanks to stock splits has 400 shares!,” and so on. This makes it seem like it was stock splits that turned Jim and Mary into millionaires or whatever the ad says they or their relatives are now. But it wasn't. It was the companies' market caps increasing that generated the capital gains.
***
While traditional stock splits may be neither good nor bad, reverse splits usually do not bode good things. A reverse split, as its name suggests, is a stock split in reverse. For example, a 1-for-2 split reduces the number of a company's shares outstanding in half and increases its share price by a factor of two. So if ZXY trades at $5 per share, has 100 million shares outstanding, and does a 1-for-2 split, it will trade for $10 per share and have 50 million shares outstanding.

Reverse splits are often done to comply with exchange regulations which require share prices to be above a certain threshold. Moreover, companies seem to think that people are less likely to buy their shares if they are under $10 (or $5 or whatever).

It's hard to think of any examples of a company's market capitalization going up after a reverse split. There are plenty, however, of the stock going down: Sun Microsystems (now part of Oracle), AIG, and Citi come to mind. If a company's stock price falls low enough to warrant a reverse split, that means its prospects aren't very good. A reverse split does nothing to fix this. It's like putting a smiley face bandage on a gunshot wound. It's quite amusing to watch, as long as you don't own the shares, the share price after the reverse split descend down to the price at which it started.

Stock splits, regular and reverse, do not change a company's prospects. They are cosmetic only.

1/2/12

Buy and Hold Forever Dividend Stock Update

After a couple of years I've finally gotten around to updating the Buy and Hold Forever Dividend Portfolio.

To refresh your memory as well as mine, the idea was to find a couple of dividend stocks from most industries, on the basis of familiarity rather than research. That is, the criteria for stocks making it into the portfolio were: the stocks were in the news at the time and/or their products were ubiquitous. Absolutely no research was done other than to make sure that the stocks picked paid a dividend.

The point of this exercise was to see how well a relatively uninformed investor could do if his investment thesis was that buying and holding dividend paying equities forever isn't dead, as most of the talking heads have been telling us since the financial crisis began.

At the time the experiment was initiated, SPY was designated an alternate and benchmark buy and hold forever dividend portfolio.

Changes to the portfolio since the last update

Verizon (VZ) spun off shares of Frontier Communications (FTR) in 2010. These were added with no cost basis.

Berkshire Hathaway bought Burlington Northern (BNI) and inBev bought Anheuser-Busch (BUD). The original cost basis of each acquired stock was rolled into a new holding (UPS replaced BNI and TAP replaced BUD). The realized capital gains were put into cash. However, to track these gains more easily, I instead put them into the Lehman Short Treasury ETF (SHV) at a 0 cost basis (so their gains would show up and not simply count as cash deposits).

Part of the reason (besides my laziness) why it has taken so long to update the portfolio is that keeping track of all the dividends was just too time consuming and boring in the spreadsheet I had created. It left no time for anything else. Improvements to Google Finance, fortunately, now allow dividends to be tracked automatically. So I've changed the spreadsheet to incorporate this. Unfortunately, I haven't figured out how to share a Google Finance portfolio, so we're still left with spreadsheets (which means that I still have to do manual updates).

The Results so Far

Since inception, the buy and hold portfolio is up 29.19%. The original cost basis was around $15,400. That has grown to over $21,600. The dividends received so far total about $1,720, or just over 11% of the original cost basis. That's a yield of about 3.48% per year (3.167 years--November 2008 to January 2012)--nothing to brag about but it will be interesting to see how this grows as time passes.

SPY, on the other hand, is up a little more: 29.61%. The original cost basis of $15,550 has grown to $21,184. Dividends received total around $1,029 or 6.6%, for a yield of about 2.08% per year. This too should grow as companies raise dividends.

The spreadsheet is below and can also be accessed here.

I'll try to update more often, now that it's easier.