Blyth (BTH) calls itself a ?home expressions company?. Most people call it a candle company. Neither description is entirely accurate.
Blyth can rightly be called the world?s largest scented candle company, because larger competitors like S.C. Johnson and Sara Lee (SLE) are primarily engaged in other businesses. Like its smaller rival The Yankee Candle Company (YCC), Blyth is primarily a scented candle company. However, unlike the Yankee Candle Company, Blyth has substantial non-candle related operations ? hence the ?home expressions? designation.
I?m not sure what a home expression is; but I?m pretty sure coffee doesn?t qualify. From that fact alone we can safely say Blyth isn?t really a home expressions company (last year, Blyth acquired Boca Java, an online retailer of coffee, tea, and hot chocolate). Blyth may not be a pure play scented candle company or a pure play ?home expressions? company; but, that doesn?t mean it?s merely a hodgepodge of unrelated businesses.
There is a method to Blyth?s madness. From the manufacturer?s perspective, candles, ceramics, frames, vases, coffee, and gourmet food are very different products. But, from the customer?s perspective, they serve a similar purpose. Essentially, Blyth sells personal indulgences to women at affordable prices. That?s a big business in the U.S., Canada, and Europe. It also happens to be a good business.
Profitability
Since 1998, Blyth has had an average return on assets of 10.33% and an average return on equity of 18.55%. One of the best ways to measure the inherent profitability of a business (independent of its current capitalization structure) is to use the pre-tax return on non-cash assets (PTRONCA). Over the past decade, Blyth has had a PTRONCA of about 19.21%, which is very good ? although far from great.
To put that 19.21% PTRONCA into perspective, think of it this way: independent of its capitalization structure, Blyth generated a little over nineteen cents for every dollar invested in the business (before taxes).
Essentially, this means that if Blyth hadn?t utilized any debt whatsoever it would have had a return on equity of roughly 12% (after taxes). Although a 12% return on equity doesn?t sound all that impressive, achieving a 12% ROE without using any debt would actually represent a solid performance for most public companies under most economic conditions.
Of course, over the last decade Blyth actually averaged a much higher return on equity (18.55%). During this period, Blyth utilized a material (but far from egregious) amount of debt. As a result, the company surpassed its own stated goal of achieving a 15% annual return on equity.
Based on Blyth?s past ROA and PTRONCA, it appears to be a good business. If we put aside GAAP accounting for a moment and look at the economic earnings of the business, we?ll see that Blyth has actually performed a bit better than its reported net income figures suggest.
Cash Flow
Blyth?s free cash flow margin was excellent in each of the last several years. For the past five years, the company?s FCF margin has ranged from 5% to 12%. Many businesses would be satisfied with a 5% free cash flow margin. So, even when Blyth was at the bottom of this range, it was generating plenty of free cash flow.
Blyth?s free cash flow has been very high relative to its reported net income. Over the past ten years, Blyth had an average reported net income of $70.2 million versus an average free cash flow of $79.5 million.
Unfortunately, this gap would be entirely erased if free cash flow was reduced by the amount Blyth has spent on acquisitions. From a shareholder?s perspective, such a reduction is appropriate. Acquisitions eat up cash in exactly the same way an investment in a new plant does.
However, it?s worth considering the two lines separately, because it?s much easier to match cash outflows with specific acquisitions than it is to match cash outflows with specific investments in an existing business. This is especially true when looking at a company like Blyth, because some of the acquisitions are in different businesses (and different geographic locations).
Blyth has been able to consistently generate quite a bit of free cash flow. Over the past ten years, cash flow from operations (CFFO) has averaged $93.65 million. The latter half of the past decade has been even better as a result of sales growth. During the past five years, Blyth?s CFFO has averaged $142.64 million.
During that same period, free cash flow averaged $125.18 million before acquisitions but only $60.52 million after acquisitions ? which is even less than the company?s average reported net income of $72.16 million during the same period.
What does all this mean? For one, it means Blyth?s free cash flow has grown far more than its net income over the past ten years. This isn?t surprising, considering Blyth invested much more heavily in cap-ex from 1997-2001 than it did from 2002-2006. That?s normally a good sign, but there are a few problems here.
Slowing Sales
Blyth?s sales growth has slowed considerably during the last five years. Before 2001, the company had been growing sales at 20% or more a year ? without a lot of spending on acquisitions. After 2001, sales growth slowed to the mid single digits, despite an increase in the amount of cash being used for acquisitions. Slowing sales growth is clearly a concern. However, it may not be entirely specific to Blyth.
During the early and mid 1990s, the growth in scented candles within the United States was tremendous. By 2000, more than 75% of all candles sold in the U.S. were scented. At that time, Blyth estimated that only 5% of all candles sold in Europe were scented. So, a very large part of the growth in scented candles within the U.S. was simply a one-time migration from non-scented candles to scented candles.
In an August 1999 interview with The Wall Street Transcript, Blyth?s Chairman & CEO, Robert Goergen, illustrated the degree of penetration within the U.S. by citing a study conducted by his company: ?Blyth has done research the last two years that indicates that when asked of women ‘have you purchased candles in the last six months?’ 67% of a random sample will say that yes they have. That percentage ranks with women’s purchases in the last six months very close to lipstick and face makeup, which means that candles are a fairly broad and relatively routine part of everyday life.?
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Once a product has achieved such penetration, it is inevitable that the rate of sales growth will slow. Sales of candles are limited by the number of women in the United States, because men will not buy scented candles (except perhaps as gifts for women).
So, once more than two-thirds of American women say they?ve recently bought a candle and more than three-fourths of all candles sold in the U.S. are scented, the fact that the growth in sales of scented candles is slowing should be seen as inevitable rather than remarkable.
It?s hard to track total sales of scented candles, because they account for a very small part of a great many different retailers? sales. Also, while Blyth and Yankee Candle are public companies, many of their competitors are privately held. The rate of sales growth at both Blyth and Yankee Candle has slowed noticeably in the last few years. So, Blyth?s recent experience is clearly not unique.
Troubled Times
Morningstar?s website lists Blyth?s stock type as ?distressed? ? which strikes me as a tad extreme. However, there?s no denying Blyth is now facing some of the toughest challenges it has had to contend with in many years.
Blyth?s Chairman and CEO began his most recent letter to shareholders as follows:
?Fiscal 2006 was a very challenging year for Blyth ? in many ways, the most challenging in our nearly 30 year history. Sales growth across North America and Europe was difficult to achieve as consumers, faced with record energy prices, had fewer discretionary dollars than in years past. Moreover, the impact of double-digit cost increases in all of our major purchased commodities and freight had a dramatic impact on our financial performance.?
Later in his 2006 letter to shareholders, Mr. Goergen put the increased commodities cost into perspective:
?Let me offer some context on what the doubling in price of a barrel of oil means to Blyth. The cost of paraffin wax, a byproduct of the petroleum refining process, increased approximately 20% over the past year, as strong demand continued while capacity declined following the impact of hurricanes on Gulf refineries. Approximately 100 basis points of Blyth?s fiscal year 2006 gross margin decline resulted from higher paraffin, freight, and other commodity costs.?
Blyth has three stated long-term corporate goals:
- 5-10% annual sales and earnings growth
- 10-12% operating margins
- 15%+ return on equity
For the year, Blyth experienced a slight decline in sales and a steep decline in earnings. The company?s operating margin was 3.6% (well shy of the 10-12% goal). Blyth?s return on equity also plunged, falling from 17.42% to 4.90%. In other words, the company fell far short of each of its three goals during fiscal year 2005.
Second Quarter
During the current fiscal year, Blyth?s results have only worsened. On August 31, 2006, the company reported a second quarter operating loss of $27.7 million compared to a $16.9 million operating profit in the year ago period. All of last quarter?s operating loss (and most of the difference between this year?s results and last year?s) was attributable to a non-cash goodwill impairment charge of $36.8 million.
Last year?s second quarter was also helped by a $5.5 million reserve reversal. Excluding these items, second quarter operating profit was $9.0 million in the second quarter of this year versus $11.4 million in the second quarter of last year.
Blyth also took a $68.6 million loss on the discontinued operations of its European wholesale business. In all, Blyth reported a net loss of $89.4 million during the second quarter of this year versus net income of $4.2 million during the year ago period.
Net sales for the last six months were essentially flat. Sales for the first half of the fiscal year fell by 0.40%, dropping from $545.1 million a year ago to $542.9 million this year.
The Good News
The company is in much better shape than these recent earnings reports suggest. Blyth?s Restructuring efforts have obscured its relatively normal operating results. Excluding the restructuring, Blyth?s performance has still been far weaker recently than it had been from 1997-2001.
However, the company will not continue to report losses for years to come. Even over the last twelve months, Blyth has generated nearly $100 million in cash from operations and over $80 million in free cash flow. So, the net loss is actually somewhat deceptive when considering the company on a continuing basis. These losses will not continue.
The Bad News
Blyth does face real challenges ? and not just the short-term challenges presented by higher commodity costs.
Blyth also faces the prospect of declining direct selling revenue within the U.S. Over the last year, the number of independent sales consultants in the company?s U.S. PartyLite business fell by more than 7%. There were approximately 24,000 independent consultants this year versus 26,000 a year ago.
This decline in the number of active independent sales consultants caused a 5% decline in sales for the company?s U.S. direct selling operations. While the number of consultants in Canada was flat and the number of consultants in Europe was actually up this year, no one would be surprised by a continuing trend towards fewer active independent consultants and thus lower sales within the direct selling business as a whole and the U.S. segment in particular.
Direct Selling
Blyth has long been involved in the direct selling business. The company acquired PartyLite in 1990. That was four years before Blyth?s 1994 IPO; so, PartyLite has been a part of Blyth for the entirety of that company?s history as a public company.
Direct Selling accounts for approximately 44.7% of Blyth?s total revenues. The company?s PartyLite subsidiary has more than 45,000 active independent consultants selling in the U.S., Germany, Canada, the U.K, Austria, France, Switzerland, Finland, Australia, and Mexico. Approximately 24,000 of these 45,000 consultants sell within the United States. These consultants sell scented candles and other accessories via the party plan method of in-home selling.
In addition to its PartyLite subsidiary, Blyth now owns two other party plan marketers: Two Sisters Gourmet and Purple Tree. Two Sisters Gourmet is a gourmet food company. Purple Tree is a crafts oriented business. At present, these businesses incur multi-million dollar operating losses as Blyth invests to grow them into larger, more profitable businesses.
Regardless of their current operating performance, these businesses do seem to be a good fit with Blyth?s existing PartyLite business and appropriate new ventures for the company to pursue. Of course, only time will tell if any of these ventures develops into the kind of larger, more profitable direct selling business Blyth is hoping for.
Valuation
Blyth?s current price-to-earnings, EV/EBIT, and other such ratios are meaningless, because of the company?s recent losses.
During the last ten years, Blyth has had an average EBIT of $113.47 million. During the last five years, Blyth?s EBIT has averaged $113.77 million ? essentially the same as the company?s ten year average EBIT.
Blyth?s current enterprise value-to-EBIT ratio is very high, because the company only reported $32.03 million in earnings before interest and taxes during fiscal 2006.
Blyth?s EV/EBIT ratio would be much more reasonable if computed using the average EBIT from past years. Depending on exactly how you calculate both the company?s current enterprise value and its average EBIT from past years the ratio will vary slightly. Regardless, this ?normalized? EV/EBIT ratio would be around 8.7.
That?s a fairly low EV/EBIT ratio, but not an absurdly low one. To put it in perspective, invert the ratio to get the EBIT/EV yield (essentially a pre-tax earnings yield comparable to the yield on a taxable bond). An EV/EBIT ratio of 8.7 translates into an EBIT/EV yield of 11.49%. Obviously, that?s a good yield ? especially in the current low yield investment environment. However, there are better yields out there.
To be fair, the average EBIT numbers I gave may be unduly conservative as normalized numbers, because they include Blyth?s abysmal EBIT of $32.03 million in 2006.
A better normalized figure would probably be Blyth?s average EBIT from 1999 ? 2005. Those seven years may be the most representative, because they neither penalize Blyth for its extraordinarily poor 2006 performance nor for its far lower total sales prior to 1999 (remember, Blyth had once been quite the growth story).
During the seven year period beginning in fiscal year 1999 and continuing through fiscal year 2005, Blyth?s average EBIT was $134.40 million. If this average were used as Blyth?s normalized EBIT, Blyth?s EV/EBIT ratio would come in a bit lower at 7.34. That translates into an EBIT/EV yield of approximately 13.63%.
Buying a Company vs. Buying a Stock
As a business, Blyth is clearly underpriced. If I were drawing up a list of businesses selling for less than they?re worth, Blyth would be near the top.
If you could buy the entire business by merely paying the current enterprise value, you?d have yourself a very nice deal. But, you can?t. You can only buy small pieces of the business via the stock market.
No one could buy the entire business at the price at which each piece is selling in the open market. So, in that respect, you?re actually getting a better bargain than you would if you had to acquire the entire business.
Unfortunately, there?s a downside. Buying the entire business is an attractive opportunity, because the acquirer could use the company?s cash flow as he saw fit. Buying a small piece of Blyth in the stock market doesn?t offer this kind of control over the allocation of capital. That?s potentially a very big problem, because cash can be squandered.
Has Blyth squandered cash in the past? Not really. While it has acquired other companies (and so far has little to show for some of those acquisitions), it has generally made these deals at reasonable if not rock bottom prices. There are many other public companies guilty of paying far more for far less.
On the other hand, from the perspective of a 100% owner, Blyth?s free cash flow has not been successfully reinvested in the business during the last several years. The returns produced by additional capital (in the form of acquisitions financed with free cash flow) have been meager at best ? at least in terms of creating additional free cash flow.
Over the last five years, Blyth spent $323 million on acquisitions, $230 million on share repurchases, $86 million on dividends, and $66 million on capital expenditures.
Right now, the best use of cash would certainly be to buy back stock. At these prices, investing in Blyth makes a lot more sense than investing in another business via an acquisition. Hopefully, Blyth?s management recognizes that fact and will act accordingly.
Conclusion
But, should you invest in Blyth? As always, that?s ultimately a personal decision. A lot of people don?t want to invest in companies in the midst of such upheaval. That?s fine.
However, failing to see the value in Blyth, simply because of its most recent reported results is not fine. In fact, it?s a very common and very costly mistake.
You will always overweight the last datum in a series. It?s nearly impossible not to. Just as it?s nearly impossible not to believe the current economic cycle will be different from all the rest.
If Blyth?s most recent results occurred five years ago, you would see them for what they are ? an aberration. But, because they are the company?s most recent results (and the very last bit of information you have to go on) you?ll likely see them as the beginning of a new and terrible trend.
Human history favors the interpretation that years of past data are more informative than a single year of ?current? data. Unfortunately, human history also favors the interpretation that this fact will only be obvious in hindsight.
Future operating results will determine whether Blyth is a good buy today. I don?t know what those operating results will be. However, I do know they don?t have to be particularly good to justify buying the stock at its current price.
Considering how great Blyth?s cash generating ability is relative to its current enterprise value, an average operating performance from Blyth will lead to above-average returns for the company?s shares.
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Geoff Gannon writes a daily value investing blog and produces a twice weekly (half hour) value investing podcast at =>http://www.gannononinvesting.com
On Monday, Sumner Redstone fired Viacom?s CEO, Tom Freston. Yesterday, Viacom announced that its Board of Directors had appointed Philippe Dauman President and CEO and Thomas Dooley Senior Executive V.P. and Chief Administrative Officer (a newly created position). Mr. Dooley?s role is expected to be similar to that of a Chief Operating Officer.
Both Dauman and Dooley are members of Viacom?s Board of Directors. They served in key positions within the previous incarnation of Viacom, which was split into two separate public corporations, Viacom (VIA) and CBS (CBS), approximately eight months ago. Sumner Redstone is the Chairman of each company. Viacom?s new CEO, Philippe Dauman, will report to Mr. Redstone. Thomas Dooley will report to Mr. Dauman.
Although The Financial Times went with the no nonsense headline ?Freston Removed as Chief of Viacom?, I fear The Wall Street Journal may have had the more accurate headline: ?Ouster of Viacom Chief Reflects Redstone?s Impatience for Results?. In fact, I couldn?t have said it better myself. Of course, I was planning on writing more of a personal opinion piece than a front page article (the story made the front page of both the FT and the WSJ). Still, I can?t fault The Wall Street Journal for putting the painfully obvious in big print.
The Journal article (which is a good outline of the whole affair) won?t encourage faith in Sumner Redstone among Viacom?s shareholders. It begins by quoting Mr. Redstone?s assurance (given just six weeks before) that he could imagine ?no circumstance? under which he would fire Mr. Freston. Cut to Monday, at Sumner?s estate, where Tom Freston, a 26 year company veteran, is told he has managed to lose his job, just eight months after being given the helm of the new (CBS-less) Viacom.
The most obvious objection to Mr. Freston?s firing is simply that he wasn?t given enough time. There are billions of people on this planet and it took more than eight months to produce the majority of them; so, I imagine doing something truly remarkable, like steering a media company through troubled, transitional waters, takes quite a bit longer.
The other objection is that Freston had already proved himself a capable executive. He may not have been able to answer the question ?What have you done for me lately??. But, he had built up quite a reputation at MTV. Recent results have taken some of the shine off that golden boy (the channel, not Freston, who is no golden boy at age 60).
Actually, MTV is more than a golden boy; it?s Viacom?s crown jewel ? accounting for about 70% of the company?s revenue and nearly all of its profits. The aforementioned Journal article fears ?Mr. Freston?s departure could lead to a wider shake-up at the company, particularly within MTV networks, much of whose management has been with the company for years and is intensely loyal to Mr. Freston.?
Those fears are rational. Any time an executive this connected to a particular division is lost there is a danger others may follow ? especially when such an unceremonious exit is forced upon a company vet by the powers that be. In this case, the (perceived) motives of those powers is also a cause for concern.
There?s no doubt many at Viacom now see the long, decrepit arm of Sumner Redstone reaching out from his Beverley Hills estate and reasserting his grip on the cable properties that were once buried deep within his corporate behemoth.
At the time of the CBS / Viacom split, I knew Viacom would trade at a price that would keep it well off my investment radar. If anything, I thought CBS would be the more likely opportunity. Right now, I?m not tempted in the least by either stock. But, I have found myself much more interested in Viacom as a business.
The one really exciting aspect of the CBS / Viacom split was the idea that an MTV native would be running the new company. Viacom?s properties are very different from those owned by CBS. There was (and still is) an opportunity here for Viacom to become a content focused company.
CBS really isn?t content focused ? and it shouldn?t be. That company?s biggest competitive advantage is owning a U.S. TV network. There are only a handful of such networks and each is a franchise (albeit a waning one).
Simply controlling a network, regardless of the quality of its current programming, has value. The situation is analogous to owning a Major League Baseball team, which has some value regardless of the quality of the players currently under contact.
Broadcast networks are in a very different position from cable properties, where excluding a handful of properties (e.g., ESPN, Discovery, and the Food Network) competitors have no real advantage in attracting good programming. Many large media companies are built around delivery (though they have managed to delude themselves into thinking otherwise).
Content and delivery are two very different businesses that owe their marriage more to the egos of media moguls and the capital of the investors who buy their securities (both equity and debt) rather than to any natural economic synergy.
The origin of good content is always a choke point; the delivery of such content almost never is. It takes only two competing buyers to make a market. I?ve never been convinced that serving thousands of small customers is really a safer and more profitable business than serving a few big ones (except in high volume, low margin businesses where a large customer playing hardball can force you to eat your unused capacity). In cases where the product is unique and the right to use that product is exclusive (as is often the case in the media business), the number of different owners of the various delivery systems becomes an unimportant point.
The broadcast networks are an exception ? a living relic of a bygone era. They have a competitive advantage that isn?t derived solely from controlling content. They have an established network, which acts much like a large installed base by providing a beachhead of access and familiarity from which an offensive of solid programming can be launched into millions of American homes.
Cable properties can?t emulate the networks. But, they can build finite competitive advantages through bits of good content that can be milked for a time. Changes in technology will never eliminate the choke point that accompanies good content. It will exist online and offline just as it has existed in print and pictures.
Maybe Viacom?s new management will be focused on providing good content ? but, I doubt that. Somehow I suspect they will be more interested in doing deals and selling Wall Street on Viacom?s future prospects. Such actions would be consistent with both their own backgrounds and with Sumner Redstone?s expressed tendencies.
A Financial Times article entitled ?Jumping Jack Crash: Digital Kills the Video Star? ends with a quote from Mr. Redstone: ?We will seek out every sensible deal ? whether in the digital space or otherwise?And?we are determined not to let it get out of our hands.?
Those are scary words for investors who have entrusted their capital to Viacom. When a public company convinces itself it can?t afford not to do a deal, it usually gets the deal ? and shareholders pay the price.
There are real problems at MTV ? and real challenges at Viacom. Both The Financial Times and The Wall Street Journal noted that ratings for the MTV Video Music Awards were down 30% this year. That?s on top of a decline in ratings the year before. The internet also presents challenges (and opportunities) for Viacom. But, are Dauman and Dooley really any better equipped to tackle these problems than Tom Freston was? It?s difficult to imagine anyone better suited to run the new Viacom than Tom Freston was.
This is a big step backwards for Viacom. The benefits of autonomy that might have been reaped under Mr. Freston are unlikely to flourish under Dauman and Dooley, who are, by all accounts, legates of Chairman Redstone. The leash has been tightened.
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Geoff Gannon writes a daily value investing blog and produces a twice weekly (half hour) value investing podcast at:
http://www.gannononinvesting.com
January 27, 2008
It doesn?t matter whether you are a seasoned real estate investor or a newbie, you can never learn too much about investing or wealth building. If you haven?t already you need to find your local association or club today. Here?s why:
1.Guidance. Real Estate Associations and Clubs can provide unlimited support and guidance. Members are interested in what your goals are because theirs are the same. They want to make money and build wealth through real investing.
2. Mentors. Find out who has been investing the longest or who has had the most success in the type of investing you are interested in and make contact with them. Learn from someone who is doing, not from someone who is reading or just talking about doing.
3. Deals. If you are seasoned or new, members are always looking to buy or sell something. They know how to help you with the financing and most of the times the deals are geared towards a fast sale.
4. Education. A good Real Estate Association or Club will fill your meeting time with important topics and offer ways to improve your education. Lots of Associations and Clubs also get discounts to national speakers and may even host one at a local meeting or event.
5. Networking. The members of Real Estate Associations and Clubs are often in the real estate business in one-way or another. So imagine being able to build your investment team all in one place. Members often include real estate attorneys, bankers, brokers, contractors and realtors.
You can find a great list of Real Estate Associations and Clubs at the Real Estate Info Network.
www.realestateinfonetwork.com
If you can?t find one there you next best bet is to search the internet for real estate forums. These are also filled with likeminded people and often have topics changing every day.
In the words of Thomas Edison, ?If there is a way to do it better… find it.?
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Robb Beltran is an active real estate investor and publisher of the Real Estate Info Network. The Real Estate Info Network promotes real estate education through real estate seminars, e-books and real estate investing courses.
www.realestateinfonetwork.com
www.belstarproperties.com
January 25, 2008
Remember back when George Bush Sr. was defeated, in large part because people felt he did not address the tough economic conditions that voters faced? In fact, there became a slogan that reminded him ‘It?s the economy, stupid!’ Since the voters felt like he did not properly address those issues, he was replaced.
As real estate investors, we are facing a similar situation today.. ‘It?s the real estate market, stupid!’ Read most any news source and you will rapidly convince yourself that these are not the exploding markets seen during 2003, 2004, and parts of 2005. So as a real estate investor, what are you going to do? While I let you mull over that question, let?s digress a little.
In our next article, I highlight two trips that I took last week; one to a resort location in Florida and one to resort location in Texas. Want to talk about a Dr. Jekyll and Mr. Hyde scenario. In one location, I wouldn?t wish a property there onto my worst enemy (even though I love the location) and in the other, I would buy the right property there without a second thought.
An interesting discussion ensued as my staff and I discussed bringing out a project from the second location. What we discovered was that even though it was a great opportunity, we also realized it does not have the ’sex appeal’ that many properties have had in the past. Yet, when we analyzed what we considered to be solid opportunities, we came to the conclusion that many fit this category: very solid, no brainer opportunities even though they have a very low sizzle factor.
After continued discussions, my staff encouraged me to put the Florida/Texas article on hold for a week and write about what is probably forefront in many real estate investors minds.. What now for real estate investors?
THE MARKET CHANGE
Here is a news flash for you:
Explosive Growth In The National Real Estate Market Has Slowed Or Reversed
Hopefully that does not surprise or concern you. The period of time that we have traveled through was phenomenal for investors.. Off the charts. IT WAS ECONOMICALLY IMPOSSIBLE TO CONTINUE THAT GROWTH RATE.
On the other hand, experienced real estate investors KNOW that there are still perfectly good opportunities out there now, will be 6 months from now, 1 year, etc. However, for many investors, they must come to grips with what were unrealistic expectations fueled by the explosive market. Let me give you an example.
I can show you several projects where you can walk into $20,000 of real, no BS equity and be able to cashflow the project. But, in the day and age of fast, easy money in real estate, unless somebody thinks they are going to score a quick $50K -$100K, then they just YAWN at $20K in equity.
But let?s put this in perspective. Suppose I could show you a very low-risk, cash flowing opportunity that puts $20K equity in your pocket and has good upside. YAWN, right? How much money would you need to invest in CD?s to accomplish that? Right now, CD?s are paying around 5% so you would need to tie up $400,000 to create the same net effect. Ok, forget the CD idea. Let?s consider investing in an index fund or its equivalent. Historically, this has AVERAGED 11% returns but we all know it may take 10+ years to ‘average’ to 11% with many down years in between. So, you would need to invest about $180,000 to ‘average’ that $20K return this year.
Bottom line is that if we get NORMAL appreciation, we get reasonable CASHFLOW, and we BUY RIGHT, we can far exceed the returns of other available investments and we can do this with very low risk (depends on property choice). This is how plain Jane real estate investment has worked for ages.
BREAD & BUTTER INVESTMENTS
In exploding markets, one of the great things is that you can buy just about anything and it will work out in your favor.. At least, until the music stops and you are left without a chair. In more normal (or even declining markets), there are still PLENTY of opportunities but we just have to be a lot more selective.
Do you want to know the major difference between a new investor and a savvy, 20-year veteran with lots of battle scars? They focus on different things.
New Investor: How much money will I make? Savvy Investor: What is upside potential relative to downside?
As I will show in an example below, the savvy investor works hard to put themselves in situations where there is MINIMAL RISK but yet VERY HIGH UPSIDE POTENTIAL. They are not na?ve enough to think that all their investments will explode. They just know if they put themselves in enough good reward/risk situations, then some investments will break even/lose a little, some will make reasonable returns, and some will explode and make them more money than they ever dreamed possible.
An interesting side point is that this is the same formula that many successful stock traders use. They develop a system by which they minimize any money at risk (by placing stops and covers) while letting the upside potential be great; a high Reward to Risk ratio. With real estate investors, it is the exact same concept. The bread and butter basic for any investing is not ‘buy low and sell high.’ Rather, it is buy with minimal risk and with high upside potential. For real estate investors, the ingredients for creating this bread and butter investment are simple:
Buying Right: They like to buy below market to add safety. In many cases, they know 5-20% or more below a stable market provides tremendous security.
Appreciation: They base their purchase decision on conservative appreciation estimates. They look for the RIGHT INGREDIENTS for explosive growth but never count on it occurring. When it does, they get a homerun.
Holding Costs: Using rents & cashflow, and possible appreciation during a construction phase, they try to either minimize their holding costs or create a slight positive cashflow.
Natural Demand: The want to see that there should be lots of natural demand for their investment whenever they are ready to sell or to rent out. This way, they know they have a good exit whenever they chose.
When these components are present, and the numbers make sense, they buy the investment. Successful investing is a simple, and boring, as that.
A BORING EXAMPLE
Let me give you an example of a personal investment that I did in the Destin FL area. This occurred before GetPreconstructionDeals.com was formed but illustrates several key points. Here are the details:
Preconstruction Townhomes Purchase Price: $200,000 Fair market value at time: $210,000 Build Time: 9 Months Market Rents: $1,200 - $1,300 ‘Expert Estimates’ Of Value $235,000 after construction Down Payment $20,000
If you looked at the property, the plans, etc., absolutely nothing remarkable about this project. For most, this property was a first class YAWN! The people buying high flying condos on the beach laughed at this ‘opportunity’. Unfortunately, many of these same high flyers are now facing -$10,000 or more negative cashflow, per month, on the beach. What we knew was that there was a need for this type of product and that getting this rented would be easy if we did not sell it immediately.
From a risk standpoint, we knew there was almost zero risk since at worst, we could rent these out and break even. We saw no way that the prices would likely reverse backwards from this point. From a reward standpoint, it looked like that if everything played out as planned, we could probably net $20K from a $20K investment, over a 9-12 month period. YAWN! Not bad but not substantial.
From a homerun side, yes the ingredients were in place for Destin to keep exploding but Destin had already seen 2 years of substantial appreciation. Would it continue? I was not counting on it. Long story short, the explosion did occur and the value of those townhomes exploded to $315,000.. That was pure ‘luck’ but was created by investing when all the right ingredients were in place. When you do that repeatedly, then sometimes you will get ‘lucky’. Since the peak, the value of these units has fallen back to around $270,000 which is still great when you paid $200,000 for them and they are cash flowing.
Copyright 2006 GetPreconstructionDeals.com
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Dr. Chris Anderson is the founder of http://www.GetPreconstructionDeals.com and is referenced in many venues including the New York Times and USA Today. Get his weekly, thought provoking articles by signing up today!
January 22, 2008
The third key to a winning swing trade is to define your goal. You need to set a well defined goal to measure yourself. This not only show you how your doing currently, it does also allows you to have a reasonable, standard expectation of normality and what types of gains/losses are abnormal for you. Examine the deviations carefully and understand that quick huge gains are not the norm, nor do they need to be. Modest percentage gains compound quickly and the better you get, the less likely your losses will offset even minimal gains. People think that astronomical stock gains in short periods of time is the way most traders stay alive, but the truth is, steady small gains work much better and hold much less risk. You don’t want to swing between home run stock trades and strikeouts where you lose a bundle. If you’re looking for all or nothing situations, go to Vegas. If you want a career in trading, take regular gains, and smaller losses.
The fourth key to a winning swing trade is one that I feel should be considered the most important. CHECK THE CHARTS. Charts are a non biased guide to a company’s stock history. If you don’t know how to interpret charts, learn. Buy books, watch videos, ask another trader, any way you have at your disposal will help you tremendously. Charts not only give you a better insight into the current action in a stock, they also tend to take some of the emotion out of trading (which is good). Identifying patterns that have a good chance of working out in your favor also ultimately gives you a better chance of making more money with less risk. While fully explaining chart reading in itself is beyond the scope of this article, it is nonetheless very important, and a skill that most failed traders decided to go without.
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Mr. Jenkins is a full time trader and author at : www.equitychallenge.com
Key five is to read the company’s press releases. Most people use Yahoo Finance, Google Finance, or their broker’s news service. Dow Jones Newswire also has a reliable pay service. There are many others out there and some may be worthy of mention, but the ones listed above seem to be the most widely used by the typical trader/investor. Do not trust your researching to just one news source. Sometimes typical sources, for whatever reason, don’t hold some company headlines in the history and can be found from other sources. Don’t just read the latest headline; older headlines can keep a stock down for large periods of time.
Things like share dilution, earnings warnings, discontinuation of dividends, main company officers resigning, loss of large clients or general industry woes can keep potential institution investors (the big money) and day traders away from a stock. On the opposite spectrum good news like share buybacks, increasing number of contracts/customers/sales, and improving earnings guidance can all keep cash flowing into a stock for long periods of time. Also take into account the frequency of the press releases. A company that has a good public relations team and keeps investors interest is more likely to get frequent moves up or down based on news. Analyst comments also tie into this. While largely biased and generally unreliable, Wall Street analysts do have access to the best information out there. Their comments may give you insight into situation not previously discovered in your prior findings and give you a reason to study further to validate or dispel their hypotheses about the company’s immediate future.
Key six is to know the companies upcoming events. Find out when the company’s next earnings are, if the company is in the retail business; know when same store sales come out. For energy stocks; know when oil and natural gas inventories come out. If it is a biotech or pharmaceutical company, know the stages of their drugs and when FDA results are expected. Find out about trade shows or conferences that a company is attending. Trading has enough potential surprises without being caught off guard by information that is easily accessible.
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Mr. Jenkins is a full time trader and author at : www.equitychallenge.com
The seventh key to winning swing trading is to read the S.E.C. filings. Companies often put out news releases but leave out key components that can give you keys to what a company is up to and how their business is doing. Check the quarterly earnings reports closely for positive things like increasing backlogs and debt draw downs. Being that the officers usually hold stock, most companies will brag the positives in any form of press that the company releases. The main thing you are looking for is warning signs. Things like one time gains and cost cutting can artificially inflate the earnings per share number and growth stats. A company that reports a twenty percent increase in earnings per share and has a flat revenue base and cuts costs by twenty percent is not really growing, it’s only improving its own inefficiencies. Be conscious of proxy filings also. These will often describe what is to be voted on during the next shareholder meeting. New officers to be elected and proposed mergers are often spelled out in these filings. The one red flag that you want to be sure to check for is for a vote about dilution. A good acquisition can often excuse a reasonable amount of dilution, but be careful when companies are selling shares just to stay afloat because their business model is failing.
The eighth key to your swing trade stems from your research in the filings. After you have read the filings you will no doubt have some things that you may not understand or questions that were not answered. The first step to find these things out is to listen to the most recent conference call replay or web cast. The analysts on these calls may bring up issues that you came across and bring up others you may not have caught in your own research. Normally a question and answer session will give you a good idea of what the street things about the stock, just by their tone and general attitude towards the company officials. If after listening to the conference call you still have questions, call the company! You can usually find a phone number or at least an email address on the company’s website or on Yahoo Finance pages. Most companies have people dedicated to fielding investor questions and will be more than happy to do what they can to help you out.
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Mr. Jenkins is a full time trader and author at : www.equitychallenge.com
The ninth thing that you should do is to assess the value of the stock. This can be done in a few ways, it is important to keep in mind that certain industries are valued differently. For instance, an internet stock will almost always have richer valuations than home builders. Not that it is right, but it is just one of the things in the stock market that you have to deal with. The most common way that Wall Street values a stock is the price to earnings ratio or P/E. This is broken down to trailing P/E and forward P/E. Trailing simply means that it’s based on already proven earnings going one year back, and forward P/E is simply and estimated number one year going forward. Price to sales is another metric that is often employed to calculate valuation. P/S is used less often by day traders and more by value investors. The third way stocks are valued is by growth. Rapidly growing stocks can often get away with lofty P/E and P/S ratios and still continue to go up. When you’re swing trading these things doesn’t have to be instrumental in your decision. You should, however be aware of them as richly valued stocks have a tendency to have nasty crash landings when anything goes wrong.
After you have determined the valuation of the stock, you need to go look at its industry peers. Stocks tend to move with their respective groups and if possible you don’t want to fight the general trend. Events from same-industry stocks can also have a large effect on your stock. For instance if, Intel has a horrible quarterly report and your holding AMD, you can guess what happens the next day, your stock is going to fall because of INTC. Holding through these events is entirely dependant on your level of risk tolerance, and your confidence in the industry in general, but it pays to be aware of them ahead of time so you’re not caught off guard with a large gap down in your stock position.
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