Capital Gains

The Power of Diversification

2007-07-17T06:52:00.000-07:00

Not everyone believes in Walt Disney's first rule of business that "the customer is always right." At least one point in everyone's life, there will be a situation where they aren't happy with their customer service, and the company just wont care. The reason often boils down to that you're one customer and they have millions.

The reverse happens at work, where your boss is really your customer paying for your services. Often people feel that their boss-customer has too much power and exploits their labor. The reason for this is that you only have one boss and your boss can find thousands of other people providing the same service.

These situations are described as the little guy being pushed around. What makes a little guy little, and how can you become a big guy? The answer is manipulating diversification. As I wrote about in An Argument against Diversification: Pareto Principle, people worry too much about diversifying their portfolio when they need to focus on diversifying their income.

People should try to smash the Pareto Principle as much as possible in their life. Instead of having 80% of your income (typically more) come from one employer, attempt to have no source of income be more than 20% of the total. Now, I'm not saying you have to take five 40hour/week jobs, but you will have to do more work.

The flip side to this is when you purchase services from a company, pick smaller companies. If you can provide 20% of their income, you're in a very powerful position. Of course I suggest that you use this power to build a relationship. Sure, not shopping at Walmart may cost you more, but you're also paying for better treatment.

The Difference in Millionaires

2007-05-11T06:09:00.000-07:00

When you picture millionaires at work, visions of private board room meetings spring to mind. However, when you look at the average salary of a football player, these visions should also include dodging human semi-trucks on a grass turf in front of thousands of spectators. Picturing Bill Gates on a football field certainly brings a smile to my face.

Society is seems to focus on making wealth, rather than the various of ways to make wealth. I believe that people should discuss how one should make their wealth. While there is little difference in the end result, illuminating the choices assists in selecting the best path. Just as winning the lottery is sure to make a millionaire, most of us (I hope) do not depend it. The next couple entries will focus on what I've learned.

One Dollar Miracles

2007-05-03T21:16:00.000-07:00

My father introduced me to finances and while he wasn't a expert, he had a unique view. One of the things my father taught me was the One Dollar Miracle. To him, it was a literal miracle to get someone to reach into their pocket, pull out a wallet, and give someone else a dollar. This type of transaction isn't as common as we assume. Think of all the people you meet each day, and then count how many you actually give money too. I'll assume that you're not giving money to just everyone.

While my father wasn't successful at making these miracles happen, I'm reminded of it with each dollar I touch. It brings an almost spiritual touch to capitalism, may it help us all in our transactions.

Vacation Post.

2007-05-01T19:11:00.001-07:00

I went to Cleveland, Ohio for the weekend and I need to catchup on life. So no updates until Thursday.

An Argument against Diversification: Research Costs

2007-04-26T12:35:00.000-07:00

Warren Buffet is someone whom I study because he says what I know to be true, but with clarity that I lack.

"Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing." Warren Buffet [1]

My investment style is heavy on research. I start with a large list of companies whose products I've used or heard about. I hang out with people who are interested in stocks and I hear their stock choices. I then expand the list to include their competition. Then I go through and start research each one until I find the reason not to invest in them. In the end I find a few companies that are quality companies. In any given year, I find only 2 or 3 companies that I would bet my life on, and perhaps I should narrow even that down.

Even if I worked full time on stocks, I don't believe I could find 10 quality companies at fair or discount prices. Anyone who buys a handful of companies in year either has too much time or has done too little research.

Next week, I'll switch to a different series.

[1] Quotes by Warren Buffet, Wikiquote

An Argument against Diversification: Pareto Principle

2007-04-24T14:17:00.000-07:00

Pareto principle applied to finances: 80% of your income comes from 20% of the sources. Let's say your income comes from a job, stock portfolio, house, savings account, and blog ads. The Pareto principle would assume that 80% of your income comes from your job. So why is it that most people focus on diversifying their stock portfolio, which counts for perhaps 15% of your income?

While the stock crash at the turn of the century emphasized the impact of losing one's portfolio. This occurred at the same time as many people were losing their jobs. While the stock market crash did sell more newspapers, people would do better to become less dependent on their jobs.

If your portfolio does provide the majority of your income, then I can see the argument for diversification. However, I still have one more argument to make on Thursday.

An Argument against Diversification: Commissions

2007-04-19T10:43:00.000-07:00

For each trade you must pay the piper, or the broker in this case. If you're a billionaire making trades that are worth 500,000 dollars or more, then commissions aren't going to affect you. This is due to economies of scale. If you're reading this blog then you're probably trying to squirrel away a few nuts each paycheck. In this case commissions are going to impact you.

Lets say you have 100 dollars to invest and commissions are 10 dollars per trade. If you invest it all into one stock, then it counts as one trade. In this scenario the commission costs you 9% of the total 110 dollars. Remember that it costs another 10 dollars to sell. This means is that your stock has to grow 17% in value before you make a single penny in profit. If you think this sounds bad, lets look at diversifying.

You still have 100 dollars to invest and commissions are still 10 dollars per trade. However, you invest evenly into five companies. This is now five separate trades costing you 50 dollars. Since selling will cost you another 50 dollars your stock has to double before you see a single penny. Simply, the larger your trades the lesser commissions affect your profit.

Diversification protects you from risk, right? It may look like that, but if you calculate commissions as a loss, then the non-diverse portfolio can lose 33% of its value and still be even to the initial investment of a diversified portfolio. The commission on a diversified portfolio would be the same thing as if you payed face value for your shares, and watched them dive 50%. Doesn't feel too comfortable, does it?

Does this mean that you throw diversity out the window? I'd like to say yes, but if you're still want to be divested then buy index funds. Index funds are the easiest and most thorough way to be diverse, and since it's considered one trade, also the cheapest.

Stock Selection: Innovation

2007-04-16T22:47:00.000-07:00

Vonage (NYSE:VG) and Verizon (NYSE:VZ) provide today's lesson on stock selection. My first stock review was on Vonage and I once owned shares of Verizon. My reasons for purchasing Verizon stock was the same as my reasons for not buying Vonage stock. Both companies are listed on the New York Stock Exchange, have perplexing names starting with "V", and share the same industry. If there ever was a telecom tale of two cities, this would be it. Coincidently, they were also sharing the same technology, Verizon's.

The first time I wrote about Vonage, I wrote that it needed a unique patented technology to survive competition. When I bought Verizon, it was because of Verizon's (GTE's and BBN's) track record for creating new technologies. Coincidently, a week after I bought Verizon, they unveiled their FIOS technology designed to compete with the encroaching cable industry. While I could not predict the future for either company, I knew that an innovative company is a growing company. Looking back, it's plainly clear to see that the value of both companies took the path they were destined to take.

When choosing a stock, it's important to keep in mind the company's repeated ability to reliably create successful innovations. Either new technologies, new products, or new markets. Change is constant, stagnation is death for a company. If you can handle the risk, look for really risky innovators, the greater the risk, the more life changing the results.

Also keep an eye out for companies that hide their innovations through subsidiaries. These are often used to mitigate risk to the parent company. If they subsidiary makes a successful innovation, then often it's absorbed or sold for a nice profit. If it fails then the parent can shed it off with little impact on its own reputation.

Be careful of those companies that got big off some innovations, but then used their cash to buy other innovative companies. Unless they purchase a company to do their R&D and not for its R&D. When GTE bought BBN, it purchased a strong R&D arm. When Google bought YouTube, it bought someone else's R&D. Yet, Google still maintains its own R&D with Google Labs, and fosters other projects with its Summer of Code program.

Status Update

2007-02-05T06:58:00.000-08:00

It's been over six months since the last post to Capital-Gains, but the blog isn't dead, it merely had a bad start. The idea for Capital-Gains came about from having multiple discussions about investing in various companies. I figured we could run a successful blog if we each wrote down and contributed our ideas. Sadly, things never work out as planned.

I'm still interested in maintaining an investor's blog, but I doubt I could find twelve good stocks a year as I'm usually happy to find one. So I've planned a few changes to the format. It will be my personally investment blog instead of a group blog, and in addition to the research on the outlook of various companies, I will include my thoughts on investment. I have several post drafted up and I plan on posting them regularly.

So, stay tuned =D

Jones Soda (NASDAQ: JSDA)

2006-06-18T17:18:00.000-07:00

Consumer Goods: Beverages – Soft Drinks

The soft drink industry is a highly competitive bunch constantly attempting to upstage each other with new products and catchy marketing. In an industry of big name and big-budgeted Hollywood-like soft drink companies, there is one “indie” gaining a loyal fan base. Jones Soda, the company that reminds us the soft drinks should be fun.

Soft drink companies are constantly trying entice us with new and exciting flavors, but most of the time these products turn into big flops. New Coke[1] is a lesson to all soft drink execs as an example of what not to do, but it also made them too cautious. They make safe choices such as adding Vanilla and other 60's style additions (personally I'm waiting for Coke Chocolate to make a comeback).

Then, there is the big budget marketing. Signing up new talent to make their product seem “hip” to a new generation of consumers. Coca-Cola has even gone so far as to make a movie based on one of their commercials[2]. With a few exceptions these ad campaigns leave a bad taste of propaganda made for consumers.

In a market were success is defined by developing new flavors and a strong brand, Jones Soda has successfully been able to do both. They have been able to take flavors, like “Turkey and Gravy[3]", that are too risky for industry leaders and turn them into an overnight success. Making soda fun again with a spirit that reminds us of our own messy kitchen experiments.

Instead of propaganda targeting consumers. Jones Soda's encourages people to submit their own photos and fortune cookie like quotes to be used for their labeling. No rock stars trying to convey an image of youth and independence. Just everyday people in their everyday life.

Now Jones Soda is looking to grab nation wide exposure through a number of retail contracts. Target now carries Jones Soda in twelve-pack cans[4]. While Coca-Cola and Pepsi use fast food restaurants to expand. Jones is included in a number of quality restaurants such as Starbucks and Panera[5].

Jones Soda is set to establish themselves as the quality soft drink. I definitely see them entering a high-growth phase through the next five years, and it will be interesting to see how they will handle the growing pains. Who knows we may even see Jones Soda vending machines in the near future.

“Run with the little guy... create some change”

[1] The Real Story of New Coke, Coke Lore
[2] The Steeler and the Pittsburgh Kid, IMDB
[3] Thanksgiving in a bottle: Turkey and Gravy soda, USA Today
[4] Annual Report 2005, Jones Soda
[5] Follow the Trail of success, John Bluis; Motley Fool

Tecnorati Tags: stocks, investing, Jones Soda

Vonage (NYSE:VG)

2006-06-04T14:05:00.000-07:00

Technology: Diversified Communication Services

Vonage has been the talk of the market for the last couple of weeks. Sadly, none of that talk has been good. Vonage currently holds the record for having the worst IPO debut this year and the second richest in 5 years [1]. While some investors are pondering if Vonage's stock can be had currently at a discount. The market has replied with a resounding “no”, citing Vonage's large deficit and the strict competition it faces.

VoIP is quickly becoming a commodity market, in which one company's offerings are comparable with another company's offerings. In a commodity market, a company's options in gaining and keeping a client base is price and branding. Currently Vonage's key strategy is branding via mass advertising.[2] However this strategy has a high chance to back fire on Vonage by creating a large deficit without shielding them from larger telecom companies with established customer loyalty.

Vonage as it stands will not stand for long. The market knows this, shareholders know this, and hopefully Vonage knows this. What no one does know is what Vonage is going to do next. While Vonage has a huge deficit, they just raised even more money from their IPO. This money could just stave off the inevitable or it could give Vonage the opportunity to develop into a true market leader.

The signals investors need to watch for to determine if the stock is worth buying is in the company's expansion. In order to keep current customers, Vonage needs to offer unique services to them. One patent technology that redefines telecommunications is worth more than a thousand ads that merely claim it. Vonage needs to also target new markets that its competition is ignoring, such as rural markets.

This new cash infusion can either go down the drain called “branding”, or revitalize the company. I expect that if the company is looking to last then we should expect to a press release in the next two quarters discussing Vonage's new direction.

[1] Vonage trades at discount in debut, by Steve Gelsi, MarketWatch
[2] Prospectus, Vonage Holding Company

Tecnorati Tags: IPO, stocks, investing, Vonage

Introduction: Capital Gains

2006-05-28T13:41:00.000-07:00

Welcome to Capital Gains, a financial blog focused on stock analysis for the working investor.

Today's market intimidates the working investor. Instead of not having enough information, we are flooded by it. Never certain that someone has manipulated the information until it is too late. With each corporate scandal, trading is becoming more like taking a leap of faith.

I am not a professional analyst, financial manager, or speculator with large bank rolls. Like other working investors, I have a day job and set aside personal savings for long term investing. My aim is to provide research that is clear and to the point. Eliminating the guess work and arming the working investor with confidence in his trading.

My philosophy is about investing into stocks that I know best. This includes limiting myself to sectors that I am most comfortable with. Like many people my day to day life forces me to brush up against several companies in the Consumer Goods Sector. While my work and hobbies are in the Technology Sector. So it should be no surprise that I plan to write mostly about companies in these sectors.