Blog Archives

December 2013 Investing Articles

12/31/2013

Associate Member - The DIV-Net
WalMart, Target and Family Dollar
Triple Witching Hour
Getting Paid To Do Nothing
Prospect Capital Corporation Redux
The Gladstone Company
Culling the Herd
Santa Claus Rally
When Averages Change
If You've Been Reading My Website….
Master Limited Partnerships
Monthly Dividend Payers
Bollinger Bands
Leggett and Platt (LEG)
Everyone Should Have a Goal
Income, Security and Independence

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Associate Member - The DIV-Net

12/24/2013

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Today it was announced that my website has joined The DIV-Net, The Dividend Investing and Value Network, as an Associate Member. It’s quite an honor for me to have my site recognized in this manner. Hopefully I can contribute in a positive way to the ongoing discussions of dividend growth investing.

The DIV-Net is a network of investors focused on dividend investing, value investing and a long term buy and hold philosophy. It’s an investing philosophy that I sincerely believe in and adhere to almost religiously.

I am first and foremost a dividend growth investor and I seek out companies with a long history of increases in revenue, earnings and dividends. I then enhance those dividends to increase my income through the use of a proactive option strategy of selling puts and calls. I believe this is the best method for me to obtain wealth and financial security in my lifetime. My ultimate goal is to create a stream of passive income that will provide me with a life of independence, financial stability and security.

Please take the time to visit The DIV-Net website and read some of the interesting and educational articles listed there. There’s a lot of research and work that went into producing these articles and they’re well worth your time reading them. These are articles written by both the group’s Core Members as well as the group’s Associate Members. Hopefully in the future you’ll even see some of my articles listed there. If you like these articles, realize that they are only a few of the many articles written by the Members. By visiting each of the member's individual sites you’ll be able to read additional articles concerning dividend growth investing and wealth creation.

Below you’ll find a list of The DIV-Net Members with links to their individual sites. I highly recommend taking the time to visit their sites. You’ll find a wealth of information and you just might find the path to a successful life of investing.

Good Luck and Good Trading.

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WalMart, Target and Family Dollar

12/22/2013

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I get a lot of ideas for investing in a lot of different ways and at a lot of different times. Most of my ideas come from the time spent researching financial data on websites but occasionally a great idea enters my consciousness during simple conversations with friends. I don’t mean those instances when a close friend gives you his latest “hot stock tip” or his latest great idea. I dismiss those suggestions immediately upon hearing them. Those are usually nothing more than someone looking for confirmation of their own bad idea. I listened to those “hot tips” when I was younger and I lost more money acting on those “hot tips” than I care to remember. It’s those kinds of loses that have taught me over the years to do my own research. And everyone should understand that lesson without having to experience those losses.

Recently I was having one of those innocent conversations that all of us have every day of our lives when I mentioned I needed to stop by WalMart to pick up a few things. The person I was speaking to immediately said “I like shopping at WalMart but they’re too expensive.” That comment struck me as odd because I’ve been conditioned by all the commercials to understand that WalMart is “Always the Lowest”. So I thought to myself, “Does WalMart have a lock on their customer base or are other companies starting to cut into their market share?” I decided to look into the fundamentals of three companies and see what’s going on internally. I decided to look at WalMart (WMT) and see how it compares to the fundamentals of Target (TGT) and Family Dollar (FDO).

Wal-Mart Stores

Wal-Mart Stores, Inc. operates retail stores in various formats worldwide. The company operates in three segments: Walmart U.S., Walmart International, and Sam's Club. It operates retail stores, restaurants, discount stores, supermarkets, supercenters, hypermarkets, warehouse clubs, apparel stores, Sams Clubs, neighborhood markets, and other small formats, as well as walmart.com; and samsclub.com. Further, it operates banks that provide consumer financing programs; and offers financial services and related products. As of October 15, 2013, the company operated approximately 11,000 stores under 69 banners in 27 countries and e-commerce Websites in 10 countries.

Target Stores

Target Corporation operates general merchandise stores in the United States. The company distributes its merchandise through a network of distribution centers, as well as third parties and direct shipping from vendors. Further, it provides general merchandise through its Website, Target.com; and branded proprietary Target Debit Card. As of November 21, 2013, it had 1,919 stores, including 1,797 stores in the United States and 122 stores in Canada.

Family Dollar Stores

Family Dollar Stores, Inc. operates a chain of self-service retail discount stores primarily for low- and middle-income consumers in the United States. Its merchandise assortment includes consumables, hardware and automotive supplies, and home products. The company also provides apparel and accessories and seasonal and electronic products. As of October 16, 2013, it operated approximately 8,000 stores in 46 states.

Comparing fundamentals of several companies is always a little tricky because different assumptions are used when calculating sales, earnings, and dividends. I took information from several different sources but I took similar data from similar sources in order to make the data comparisons comparable. I gathered data used in this analysis from Yahoo! Finance, FINVIZ, and the NASDAQ websites for use in analyzing these companies therefore the credibility of this analysis is dependent upon the credibility of those sources.

My Initial Comparison. With a price of $77.43 and earnings of $5.20, WMT has a P/E ratio of 14.89 and a PEG of 1.73. By comparison TGT has a price of $62.49, earnings of $3.74, a P/E ratio of 16.70 and a PEG of 1.55, and FDO has a price of $64.49, earnings of $3.83, a P/E ratio of 16.83 and a PEG of 1.48. Based on this initial comparison all three have a P/E ratio less than 20 (plus) and a PEG greater than one (minus). So far I consider all three of these companies as comparable from an investment point of view.

Comparison of Sales. In terms of the current quarter over quarter (Q/Q) comparison, WMT sales have increased by 1.70%, TGT sales have increased by 1.90% and FDO sales have increased by 5.80%. Annual sales growth over the past 5 years for WMT has been 4.50%, for TGT it has been 3.00%, and for FDO it has been 8.30%. Based on this information FDO far exceeds WMT and TGT for both the Q/Q and the previous 5 year sales.

Comparison of Earnings. For the previous 5 years annual earnings increases at WMT have been 9.70%, at TGT they have been 6.20%, and at FDO they have been 18.20%. For the next 5 years earnings are expected to increase annually at WMT at 8.64%, at TGT 11.2%, and at FDO 10.89%. To put this in perspective, earnings at WMT seem to be pretty steady, at TGT they seem to be increasing, and at FDO they seem to be decreasing. Here the best selection going forward is probably TGT but FDO is a pretty strong second. Historical earnings tell me a lot about the inertia of the company but I’m investing in forward earnings so I consider these more important.

Comparison of Dividends and the Payout Ratio. All three companies can be found on the list of Dividend Aristocrats so dividends have been distributed continuously for at least 25 years and dividends have increased at least once each year during this same time period. So that’s good. In fact that’s terrific. With a dividend of $1.88, WMT has a current yield of 2.42% and a payout ratio of 36.15%. TGT has a dividend of $1.58, a current yield of 2.52% and a payout ratio of 42.24%. FDO has a dividend of $1.04, a current yield of 1.61% and a payout ratio of 27.15%. Based on this information TGT is currently the most desirable since I like companies that pay at least a 2.50% current dividend yield. But I’d also be concerned that their payout ratio is relatively high. The lower payout of FDO leads me to believe that dividend increases may be more generous with an investment in FDO.

Comparison of Dividend Growth Rate. Dividends are important but if they don’t grow over time then their buying power will decay with the rate of inflation. Therefore I look for a dividend growth rate greater than inflation and these days I look fondly at growth rates greater than 3.00%. WMT has a 3 year dividend growth rate of 15.65%, a 5 year growth rate of 14.62%, and a 10 year growth rate of 11.73%. TGT has a 3 year growth rate of 23.18%, a 5 year growth rate of 21.36%, and a 10 year growth rate of 18.07%. FDO has a 3 year growth rate of 18.61%, a 5 year growth rate of 15.77%, and a 10 year growth rate of 11.82%. All three of these companies in all three time periods have excellent dividend growth rates way in excess of inflation projections with TGT having the greatest dividend growth rate. Looking forward into the future the greater growth rate combined with the greatest initial current yield for these three companies bodes well for TGT.

Conclusion. Based on sales, earnings and dividends, it appears that TGT would be the better investment going forward. The one downside to TGT is the higher payout ratio which could impact TGT’s ability to increase its dividend if profits falter in the future. The other downside is the effect the recent credit/debit card security breach may have had or will have on current and future sales and earnings. If there’s any lasting effects to TGT’s customers they may shy away from TGT stores for some time. In addition, TGT will have to offer additional discounts to get customers back into their stores and those discounts may effect current and future profits. At this point I would take a wait and see with TGT and instead I will seriously consider investing in FDO as funds become available. If the picture clears with TGT then that company may be the better investment.

Good Luck and Good Trading.

Note: I never invest in any company without reviewing the technical charts. Fundamental analysis may be able to identify the better investments but investing, like everything else in life, is all about timing. The idea of investing is buying the right companies at the right time. Below I've included the stock charts for Wal-Mart, Target and Family Dollar for your information. Hope this helps.

Wal-Mart Stores, Inc.

Target Corporation

Family Dollar Stores

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Triple Witching Hour

12/20/2013

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The last hour of trading at the NYSE, NASDAQ and AMEX each day is often referred to as “The Witching Hour”. This is the hour that stocks and futures continue to trade after the bond market has closed for the day.

After the bond market has closed, many of the bond traders move over to the exchanges and trade equities, options and futures. This last hour of trading is generally dominated by professional traders, program traders, and institutional traders and can often produce a higher than normal level of volatility. It also gets a lot of volume from day traders that want to be in cash overnight so the pressure is on these traders to complete the trades for that day. It makes for a very hectic final hour on some days.

Today is a somewhat unique trading day because during the last hour of trading stock index options, stock options and stock index futures all expire and roll over into the next series. Luckily this doesn’t happen very often. As a result of all of these expirations occurring on the same day, the market usually experiences increased volatility as positions are either closed out, rolled forward or allowed to expire. It can be really fascinating to watch this activity from the sidelines. But it’s not nearly as much fun to participate in it. I generally just step aside during these events and let the big boys play.

Luckily this occurs only four times each year on the third Friday in March, June, September and December. When it occurs it’s generally referred to as “The Triple Witching Hour” and it’s generally three times more exciting, bewildering and confusing than a normal witching hour.

Of the three items expiring on this day, I only deal in stock options. And I only do this for the sole purpose of getting into or getting out of a particular stock or simply to increase my monthly and/or weekly options income. I always have a plan in place long before this day approaches. For me this triple witching hour is simply a spectator event. I rarely if ever transact on those days. That's because before I even decide to sell puts or calls I’ve already made the decision on what to do at expiration regardless of whether the option expires worthless, I lose the stock, or I am put the stock. Therefore I just step aside during the triple witching hour and I let the crazies dance with each other.

On 8 November 2002 Single Stock Futures (SSF) were approved for trading. They too are scheduled to expire on this third friday of every third month. As a consequence of this additional fourth futures contract expiring on this same day, the triple witching hour is sometimes referred to as either the quadruple witching hour or freaky friday. However those monikers are often ignored or forgotten because of the tradition of using the term triple witching hour.

Regardless of what anyone calls this day, option and futures traders need to seriously be aware of these expiration dates because they can greatly affect your financial health when ignored. As an options trader I track these dates religiously. If you want to know when these scheduled event are expected to occur next year, please see the "2014 Options Expiration Calendar" which can be downloaded below.

Good Luck and Good Trading. And be careful during that Triple Witching Hour today!

2014 Options Expiration Calendar

2014_option_expiration.pdf
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File Type:	pdf

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Getting Paid To Do Nothing

12/18/2013

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“The quickest way to double your money is to fold it in half and put it in your back pocket.”
-- Will Rogers, American Humorist.

I like to own stocks that pay me while I’m doing nothing. It's even nicer if I'm getting paid while I'm taking a nap. I like waking up and logging into my brokerage account each morning and finding money there that I didn’t deposit. I like being surprised that I have more money today than yesterday and that I’ll have even more money tomorrow. All this is due to the miracle of dividends. In fact this is the main reason why I like stocks in the first place.

So I’m always looking for companies that pay dividends. Lots of dividends. Increasing dividends. I'm hoping that the money I spend on stocks is similar to the idea of sunk costs. It’s money that’s been spent and is now converted into stock certificates of companies that will pay me a dividend. In fact I’d love to buy all my stocks like that and never sell them. That would mean that they would be companies that continually increase revenue, earnings and dividends forever. And the more they increase their dividends the better. If a company actually did that I wouldn’t ever need to sell it. And I’d be happy. Forever.

And that’s why I spend my nights and weekends researching publicly traded companies.

BreitBurn Energy Partners (BBEP) is an independent oil and gas master limited partnership focused on the acquisition, exploitation and development of oil and gas properties for the purpose of generating cash flow to making distributions in the form of dividends to its unitholders. Their assets consist primarily of producing and non-producing crude oil and natural gas reserves located in the Los Angeles Basin in California, the Wind River and Big Horn Basins in central Wyoming, the Powder River Basin in eastern Wyoming, the Evanston and Green River Basins in southwestern Wyoming, the Sunniland Trend in Florida, the Permian Basin in Texas, the Antrim Shale in Michigan, and the New Albany Shale in Indiana and Kentucky. (See below for a downloadable pdf containing a Fact Sheet and Key Investment Highlights).

Oil and Gas Exploration and Production Locations

BreitBurn Energy Partners appears to be one of these companies I'm always looking for and they recently changed their dividend policy to a monthly distribution. The company had been paying quarterly dividends and astonishingly their dividends have increased each quarter from the previous quarter for the last few years. On November 6th when they announced their third quarter results they also announced that they were switching to a monthly distribution of dividends. (See below for a downloadable pdf containing Third Quarter Earnings and Dividend Announcement). That switch got my attention. BreitBurn Energy Partners knows their unit holders and those unit holders like monthly dividends a lot. Hopefully this switch will attract a larger audience for their shares which will in turn put upward pressure on their stock. Other upstream oil and gas exploration and production companies are noticing this and I expect this competition to move in this same direction.

I am now starting to accumulate a position in this company’s stock and I am also researching and evaluating the other companies in this industry.

BreitBurn Energy Partners 18 December 2013

BreitBurn Energy Partners Fact Sheet
and Key Investment Highlights

bbep_fact_sheet.pdf
File Size:	1233 kb
File Type:	pdf

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Third Quarter Earnings and
Dividend Announcement

bbep_monthly_div_announcement.pdf
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Prospect Capital Corporation Redux

12/17/2013

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Prospect Capital Corporation (PSEC) is a leading provider of flexible private debt and equity capital to sponsor-owned and non-sponsor-owned middle market companies in the United States and Canada. PSEC is a publicly-traded closed-end investment company that has elected to be regulated as a business development company (BDC) under the Investment Company Act of 1940. PSEC is managed by Prospect Capital Management LLC.

Prospect Capital Corporation is one of those companies that I’ve liked from the first day I ran my eyes across it’s dividend history (see below to download a pdf file containing the dividend history of Prospect Capital Corporation). I can’t remember when I first came across this equity but it’s been quite a few years ago. This is a stock that pays a dividend every month just like clockwork. It goes X-dividend at the end of each month and pays a dividend around the 20th of the next month. It never misses a beat. Its solid and consistent dividends are very appealing to me and this monthly consistency caught my attention immediately.

The next thing I discovered (and immediately got excited about) was the fact that Prospect Capital increases its dividend each and every month. This is something that is so rare that I cannot find any other company that does this so consistently. Now I’ll grant you that the increases are minuscule but the fact that they increase every single month informs me that management is proactive in its responsibility toward sharing their profits with their shareholders.

"I don't like stock buybacks. I think if a company has the money to buy their stock back, then they should take that and increase the dividends. Send it back to the stockholder. Let them invest their money again from the dividends."
-- T. Boone Pickens, Entrepreneur and Investor.

Located at the bottom of this article is a pdf file that can be downloaded of the recent dividend history and, as you can clearly see, Prospect Capital pays approximately $.11 per month in dividends. As you can also see from the chart, Prospect Capital seems to vacillate from just below to just above $11.00 per share (52 week low of $10.05 and a 52 week high of $11.62). If an investor can obtain this stock for $11 per share (which can easily be done with just a little patience) then the dividend yield results in 1% per month, which is phenomenal. It has both the advantage of providing a high yielding income combined with a monthly distribution which increases my ability to compound the dividends in a timely manner.

I have owned this company for quite a few years now and I haven’t been disappointed. PSEC has a projected one year price target of $11.72 but my experience is that it will stay near $11 per share as it similarly has done for a number of years. This company has a market capitalization of $3.1B which makes this no small company by any means and it has an average daily share volume of over 3M shares so the stock is very liquid (both of these are pluses). Analyst's earnings estimates for the current year ending June 2014 are $1.26 and for the year ending Jun 2015 are $2.14, which is consistent with a stock price that doesn’t waiver much.

PSEC is also listed on the options exchange so a strategy of shorting puts with a strike price of $11 will work nicely in order to get into the stock at that price and lock in that 12% yield. In addition, once the stock is owned an investor can sell call options and increase the yield to a level in excess of 12% with relative safety. This way if the stock is taken away it can be bought back once again using puts.

I really haven’t found a reason not to own this stock. Prudence is the only thing that keeps me from throwing my entire wealth into this stock. For an earlier review of this company please see my article entitled “Prospect Capital Corp” dated 09/02/2013.

Prospect Capital Corporation, 17 December 2013

Prospect Capital Corporation Dividend History

psec_dividends.pdf
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File Type:	pdf

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The Gladstone Company

12/16/2013

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The Gladstone Company is actually a group of four publicly traded companies with very similar names. They are Gladstone Capital Corporation (GLAD), Gladstone Commercial Corporation (GOOD), Gladstone Investment Corporation (GAIN), and Gladstone Land Corporation (LAND). Gladstone Capital Corporation and Gladstone Investment Corporation are organized as Business Development Companies (BDC) and Gladstone Commercial Corporation and Gladstone Land Corporation are organized as Real Estate Investment Trusts (REIT). All four of the companies have a company policy of declaring dividends quarterly and distributing the dividends on a monthly basis. They generally go X-dividend during the middle of each month and distribute the dividend at the end of each month.

Gladstone Capital Corporation invests in small and medium sized private businesses, seeking to achieve returns from current income and capital gains through debt and equity investments. Gladstone Capital primarily makes three types of loans to such businesses: senior term loans, senior subordinated loans, and junior subordinated loans. Loans range from $5 million to $30 million with terms of up to seven years. Gladstone Capital’s equity investments typically take the form of preferred or common equity (or warrants or options to acquire the foregoing). Historically, as Gladstone Capital has primarily been a debt fund, it aims to maintain a portfolio consisting of approximately 95% debt investments and 5% equity investments, at cost.

Gladstone Commercial Corporation is a real estate investment trust (“REIT”) that pays monthly dividends to its shareholders and owns net leased industrial, commercial, and retail real property and selectively makes long-term industrial and commercial mortgage loans. Typically, our investments range from $5 million to $20 million. Gladstone Commercial’s portfolio of real estate is leased to a wide cross section of tenants ranging from small businesses to large public companies, many of which are corporations that do not have publicly-rated debt. Gladstone Commercial intends to continue to enter into purchase agreements for real estate with existing triple net leases with terms of approximately 10 to 15 years, with built in rental increases.

Gladstone Investment Corporation is a BDC that pays monthly dividends to its shareholders. Operating primarily as a buyout fund, GAIN invests in small and medium sized private businesses. It seeks to achieve returns from current income and capital gains through its debt and equity investments. When funding a buyout, GAIN generally provides a combination of equity and debt. The loans typically are senior term loans and, senior and junior subordinated loans. Loans range from $5 million to $30 million with terms of up to seven years, and the equity investments take the form of preferred or common equity (or equity equivalents). Gladstone Investment aims to maintain a portfolio consisting of approximately 80% debt investments and 20% equity investments, at cost.

Gladstone Land Corporation is the newest Gladstone company since going public in January 2013. It invests in farmland located in major agricultural markets in the United States that it leases to corporate and independent farmers. The company currently owns farms predominantly concentrated in locations where its tenants are able to grow row crops, such as berries, lettuce and melons, which are planted and harvested annually or more frequently. The company also has the option to acquire property related to farming, such as storage facilities utilized for cooling cops, processing plants, packaging facilities and distribution centers. This is the only public company that I know of that actually invests in farmland.

My personal goal is to increase my portfolio by 8.00% per year through a combination of dividends and capital gains by investing in companies that increase at this rate or higher. Normally when I’m researching companies I’m looking at companies that distribute between 2.50% and 4.00% in dividends and 4.00% to 6.50% in capital gains. In the case of companies organized as MLPs, BDCs, and REITs, I’m generally looking at companies that distribute 8.00% in dividends with only a slight increase in capital gains. In the case of the Gladstone Companies, GLAD has a current yield of 8.50%, GOOD has a current yield of 8.30%, GAIN has a current yield of 8.60%, and LAND has a current yield of 8.90%. All of these companies distribute in excess of 8.00% in dividends at their current prices.

The Gladstone Company is committed to distributing dividends on a monthly basis from each of their four companies. GLAD has been paying dividends continuously since 2001. GOOD has been paying dividends continuously since 2003. GAIN has been paying dividends continuously since 2005. LAND has been paying dividends continuously since 2013.

Another benefit associated with three of these companies is that Gladstone Capital, Gladstone Commercial and Gladstone Investment are each listed on the options exchange. Therefore a short put strategy can be used to enter these trades at reduced prices while a short call strategy can be used to augment the dividends and increase the overall yield associated with ownership. I don’t expect these companies to lose value over time but any increase in yield over 8.00% due to a combination of dividends and options would offset any potential loss in capitalization due to a fall in price. This provides a nice buffer in case things do not go as expected.

The Gladstone Company and all of it’s sub-companies are led by David Gladstone, author of the books “Venture Capital Investing: The Complete Handbook for Investing in Private Businesses for Outstanding Profits” and “Venture Capital Handbook: An Entrepreneur’s Guide to Raising Venture Capital”. He is well known in the investing community and his strategies are detailed in his two books.

All four of these companies exceed my minimum requirements for ownership so I expect to accumulate positions in each of these companies in the near future. As usual I will begin by buying odd lots and adding to those positions over time as I become more comfortable with owning them and I begin to understand which of the four is the better company.

As usual, this is not a recommendation for anyone else to accumulate these shares. This is simply a statement of a possible course of action I may take in the future.

Good Luck and Good Trading.

A brochure of the four companies can be downloaded by clicking on the icon to the right.

gladstone_company.pdf
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Culling the Herd

12/14/2013

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This is the time of year that I like to look hard at my investments and think about my commitments to stock that I’m currently holding. In most cases, when I first discovered a great company worthy of investing in, I didn’t have enough money to accumulate a large position. What I would usually do is start buying odd lots and then add to those positions over time as I became convinced that the initial buy was a good idea.

Culling the Herd

I find a lot of companies throughout the year that are worthy of investing in. As a result I tend to accumulate stock in a lot of great companies. If I had an unlimited amount of money I’d probably hold on to all of these companies and over time add to each one of these positions. I don’t, however, have that kind of income so like most of us, I have to make choices. December is the month that I usually make those choices.

I’ll spend a lot of time this month looking at my investments and deciding which ones have done well and evolved as I had expected them to when I first started to accumulate them and which ones haven’t. The easiest targets for elimination are the odd lot positions. If I have a stock position in a company that I haven’t added to since the initial buy, that position is ripe for disposal. It may be a good stock to own but since I haven’t added to that position, I must have found better positions during the year to invest in. This is a sign that my limited funds should be redeployed into the better positions.

As most ranchers will tell you, I’m simply culling the herd. I may like all the positions I own but I can’t own everything. I need to put my limited funds where the best returns are, and that means consolidating my positions. I don’t have an upper limit on the number of individual positions I have, I just want the positions that I own to be productive. So as I look out into the new year I want to be invested in the best companies I can find that will increase in value and distribute an increasing amount of dividends.

Because next year I’m going to find a whole new set of great companies that I want to invest in. Sometimes I feel like a kid in a candy store. You just have to love American Capitalism.

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Santa Claus Rally

12/12/2013

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"I once bought my kids a set of batteries for Christmas with a note on it saying, toys not included."
-- Bernard Manning, English Comedian

Santa Claus

Will there be a Santa Claus Rally this year? That’s the question on everyone’s mind this time of year. The Santa Claus Rally is generally considered to be an upward movement of the stock market during the week following Christmas Day and prior to New Years Day. There’s plenty of speculation on the reasons why this phenomenon occurs, but I don’t think there’s any true correlation to anything specific. Many investors think it’s the result of the end-of-year stock selling that occurs in early December and the resultant absence of selling later in the month. Others think it’s a result of individual investor's end-of-year tax considerations. It could be the result of the fact that many companies distribute annual or Christmas bonuses around this time of the year. Finally, and my favorite explanation, is the idea that the rise is caused by the stock purchases by professionals ahead of the average investor who puts money into their IRAs usually at the beginning of the following year.

Whatever the reason, the market has often shown a small rally following Christmas and just prior to the traditional market rise in January, also known as the January Effect. I believe the January Effect is a more reliable stock market phenomenon than the Santa Claus Rally for many of the same reasons that explain the Santa Claus Rally. In fact, January has traditionally been the month that produces the most upward movement in the market.

Whatever the reason, I’ll be looking for any rallies that may occur in December and January and I'll be trying to figure out how I, as an individual investor, can make a buck off these rallies. Because that’s what investing is all about!

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When Averages Change

12/11/2013

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"An index is a great leveler."
-- George Bernard Shaw, Irish Playwright and
Co-Founder of the London School of Economics

Stock market averages were first developed in the late 1800s in order to measure the activity of the overall stock market as well as individual sectors and industries within the market. Prior to the 1880s information about stock prices as well as information about a company’s fundamentals were extremely difficult to obtain for the average investor. In response a young reporter named Charles Dow created the “Customer’s Afternoon Letter” to report consolidated stock tables and individual company’s quarterly and annual financials. For the first time in history financial information was available to not only professionals but individual investors as well.

Today there are several averages or indices but the two most important and most quoted are the Dow Jones Industrial Average (DJIA) and the Standard and Poor’s 500 Index (S&P500). The reason these averages became so important is because suddenly investors could immediately understand the direction of the markets and invest accordingly. Soon the idea of mutual funds created an investment vehicle specifically to invest in the companies included in these indices so that investors could reduce their overall risk by investing in a “basket” of equities.

For example, a mutual fund like the Vanguard 500 invests specifically in the companies included in the S&P500 Index. It's also required to invest in the companies in the exact same proportion as the S&P500 itself. The purpose of this is so the mutual fund mimics the exact activity of the S&P500 Index.

"Index investing outperforms active management year after year."
-- Jim Rogers, Investor

So what does this knowledge of how market averages and mutual funds work provide me with information for my own investing. Well, here’s the edge. At different times some companies are added to the average and some disappear. During these periods when the average is being updated, the mutual fund companies are required to buy the companies that are being added and sell the companies that are being removed from the index. This buying and selling will put upward and downward pressure on those individual stocks.

Today it was announced that Facebook, a social networking company, would be added to the S&P500 Index at the end of next week (20 Dec) while Teradyne, a testing equipment firm, would be removed from the Index. During this transition period it should be interesting to watch Facebook (FB) for upward pressure and Teradyne (TER) for downward pressure as the mutual funds readjust their compositions.

The S&P500 announcement was made after the close today and in after hours trading Facebook is already up $1.98 (4.01%) to $51.36. These two stocks may be worth watching if only for information and entertainment.

FaceBook (FB)

Teradyne (TER)

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