MONEY stocks

How I Plan for the Stock Market Freakout…I Mean Selloff

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Mike Segar—REUTERS A trader works on the floor of the New York Stock Exchange (NYSE).

Advising people not to dump their stocks in downturn is easy. Actually persuading them not to do so is harder.

I got an email from Nate, a client, linking to a story about the stock market’s climb. “Is it time to sell?” he asked me. “The stock market is way up.”

Hmmmm.

If I just tell Nate, “Don’t sell now,” I think I might be missing something.

At a recent conference, Vanguard senior investment analyst Colleen Jaconetti presented research quantifying the value advisers can bring to their clients. According to Vanguard’s research, advisers can boost clients’ annual returns three percentage points — 300 basis points in financial planner jargon. So instead of earning, say, 10% if you invest by yourself, you’d earn 13% working with an adviser.

That got my attention.

Jaconetti got more granular about these 300 basis points. Turns out, much of what I do for clients — determining optimal asset allocations, maximizing tax efficiency, rebalancing portfolios — accounts for about 1.5%, or 150 basis points.

The other 150 basis points, or 1.5%, comes from what Jaconetti called “behavioral coaching.” When she introduced the topic, I sat back in my seat and mentally strapped myself in for a good ride. One hundred fifty basis points, I told myself — this is going to be advanced. Bring it on!

Then she detailed “behavioral coaching.” I’m going to paraphrase here:

“Don’t sell low.”

Don’t sell low? Really? The biggest cliché in the world of finance? That’s worth 150 basis points?

But it isn’t just saying, “Don’t sell low.”

It’s actually that I have the potential to earn my 150 basis points if I can get Nate to avoid selling low. That means I need to change his behavior. Wow. Didn’t I give up trying to change other people’s behavior January 1?

Inspired by Nate and the fact that the stock market is high (or maybe it’s low; the problem is we don’t know), I decided to think like a client might think and do a deeper dive into the research. Why not sell now? Why do people sell low? How can I influence, if not change, client behavior? I’ve got nothing to lose and clients have 1.5% to gain.

One interesting thing I learned in my research: Not everybody sells. In another study, Vanguard reported that 27% of IRA account holders made at least one exchange during the 2008-2012 downturn. In other words, 73% of people didn’t sell.

Current research on investing behavior, called neuroeconomics, includes reams of studies on over-confidence, the recency effect, loss aversion, herding instincts, and other biases that cause people to sell low when they know better.

Also available are easy-to-understand primers explaining why it’s such a bad idea to get out of the market.

The question remains, “How do I influence Nate’s behavior?” The financial research ends before that gets answered.

Coincidentally, I recently had a tennis accident that landed me in the emergency room. While outwardly I was calm, cracking lame jokes, inwardly I was freaked out.

Despite my appearance, the medical professionals assumed I was in high anxiety mode, treating me appropriately. The emergency room personnel had specific protocols. Quoting research and approaching panicked people with logic weren’t among them.

They answered my questions with simple sentences and gave me some handouts to look at later.

Selling low is an anxiety issue. And anxiety about the stock market runs on a continuum:

Anxiety Level Low Medium High
Client behavior Don’t notice the market Mindfully monitor it. “Stop the pain. I have to sell.”

That brought me to a plan, which I’m implementing now, to earn the 150 basis points for behavioral coaching.

During normal times, when clients are in the first two boxes, I make sure to reiterate the basics of low-drama investment strategy.

When I get a call from clients in high anxiety mode, however, I follow a protocol I’ve adapted from the World Health Organization’s recommendations for emergency personnel. Seriously. Here’s what to do:

  • Listen, show empathy, and be calm;
  • Take the situation seriously and assess the degree of risk.
  • Ask if the client has done this before. How’d it work out?
  • Explore other possibilities. If clients wants to sell at a bad time because they need cash, help them think through alternatives.
  • Ask clients about the plan. If they sell now, when are they going to get back in? Where are they going to invest the proceeds?
  • Buy time. If appropriate, make non-binding agreements that they won’t sell until a specific date.
  • Identify people in clients’ lives they can enlist for support.

What not to do:

  • Ignore the situation.
  • Say that everything will be all right.
  • Challenge the person to go ahead.
  • Make the problem appear trivial.
  • Give false assurances.

Time for some back-testing. How would this have worked in 2008?

In 2008, Jane, who had recently retired, came to me because her portfolio went down 10%. The broader market was down 30-40%, so I doubt her old adviser was concerned about her. Jane, however, didn’t spend much and had no inspiring plans for her estate. She hated her portfolio going down 10%.

Jane didn’t belong in the market. She didn’t care about models showing CD-only portfolios are riskier. She sold her equity positions. She lost $200,000!

The protocol would have worked great because we could have worked through the questions to get to the root of the problem. Her risk tolerance clearly changed when she retired. She and her adviser hadn’t realized it before the downturn.

Then there was Uncle Larry.

Like a lot of relatives, although he may ask my opinion on financial matters, Larry has miraculously gotten along well without acting on much of it.

Larry is in his 80s and mainly invested in individual stocks. This maximizes his dividends, which he likes. The problem was that his dividends were cut. The foibles of a too-big-to-fail bank were waking him up at 3:00 a.m. Should he sell?

When he called, I suggested that Uncle Larry look at the stock market numbers less and turn off the news that was causing him anxiety. I reassured him that he wouldn’t miss anything important. We discussed taking some losses to help him with his tax situation.

Although he listened, I didn’t get the feeling this advice was for him. Actually, the emergency protocol would predict this; the protocol doesn’t include me giving advice!

Uncle Larry and I discussed his plan. He ended up staying in the market because he couldn’t come up with an alternative. He also thought, “If I had invested in a more traditional way, I’d probably have ended up at the same point that I am at now anyway. So this is okay.”

He’s now thrilled he didn’t sell and, at 87, is still 100% in individual stocks.

MONEY the photo bank

An Artist Mints Her Own Take on Bitcoin

How one photographer is using digital currency to rethink the value of money and art.

Virtual currency like Bitcoin has captured the imagination of a lot of people, from techies to economists to drug dealers. Now, artists are riffing on the idea, and one is trying to use it to fund her work—and to raise some new questions about what makes both money and art precious.

Sarah Meyohas, a Wharton School of Business grad who is currently finishing up her MFA in Photography at Yale University, is launching her own digital currency, which she calls, cheekily, BitchCoin. (“If you’re a woman who is taking a stake in your future and aggressive, you’re a bitch,” says Meyohas.) Unlike Bitcoin, which is computer-generated by its users, BitchCoin represents a claim on a tangible asset, in this case Meyohas’ photographic prints. One virtual coin is supposed to correspond to 25 square inches of print. Each time Meyohas creates a coin, she’ll set aside a print in bank vault.

BitchCoin will be “mined” inside of Where, a gallery/shipping container in Brooklyn. Meyohas will be camped inside producing her work, while being streamed live via a webcam. Coin buyers will receive a certificate with key number encryption allowing access to an account on a free BitchCoin software program in which BitchCoins can be sent and received.

At one level, this is really just a clever take on crowdfunding art, similar to Kickstarter, IndieGogo and the relatively new Fotofund. The initial BitchCoins will sell for $100 each, and that money goes to Meyohas. But she also says the project is about “the role of value in reproducible objects like the photograph.” And about the value of money. Since the end of the gold standard, regular money is just pieces of paper with pictures, backed by nothing. Meyohas describes BitchCoin as a virtual currency backed by a real asset, the art. But that art, of course, is just pieces of paper with a pictures. That paradox is especially relevant to her own medium. As Meyohas puts it:

For a long time, the art world wouldn’t seriously collect photographs because they seemed too reproducible. It was only once printed and editioned, made materially scarce, that they could be valued. There is something about the value of money which you can print endless copies of that parallels the photographic print.

Meyohas is also exploring where the value of an artist’s work should be placed, on individual pieces or on her entire body of work. Unlike crowdfunding or indeed traditional art buying, in which a patron invests in a specific project or publication, BitchCoin is supposed to represent a piece of Meyohas simply “as a ‘value producer’.” Meyohas says a BitchCoin is exchangeable not for a specific photo, but for any of her “editioned, unframed archival chromogenic photographs.” She believes this approach gives her more of a controlling stake in her art and career; if her career is successful and her works grow in value, she can tap into that by creating new, more valuable coins.

By getting buyers to support a career, not merely one work, she’s harkening back to an older type of arts patronage. In the fifteenth and sixteenth centuries, the Florentine House of Medici which controlled Europe’s largest bank and thus exerted unrivaled social and political influence over the region—used their wealth to underwrite art, architecture, literary and scientific projects. They supported the careers of those geniuses lucky enough to be aligned with their inner circle: Michelangelo, Donatello, Leonardo, Raphael, Galileo, Brunelleschi and Vasari—among others.

This Sunday, February 15, at 8 p.m., Meyohas will be launching BitchCoin at the Trinity Place Bar, a bar in a bank (of course) at 115 Broadway, in the Financial District of Manhattan. At its initial offering, BitchCoin will back the edition of one photograph, aptly titled “Speculation.” Afterward, the exchange rate will fluctuate based on demand for BitchCoin, and of course the value of Meyohas’ artwork in the market.

Virtual currencies are wildly speculative, and buying art is all the more so. And the idea of BitchCoin as a store of value is, well… complicated. If you see BitchCoin as really a part of Meyohas’ artwork, what would it even mean to try to trade it for 25 square inches of her pictures? Since she says a BitchCoin would be destroyed whenever it was converted to art, wouldn’t that in turn destroy part of the art, and part of its value? Prompting such knotty, unanswerable questions is of course what Meyohas is up to with this project.

This is part of The Photo Bank, a recurring feature on Money.com dedicated to conceptually-driven photography. From images that document the broader economy to ones that explore more personal concerns like paying for college, travel, retirement, advancing your career, or even buying groceries, The Photo Bank showcases a spectrum of the best work being produced by emerging and established artists. Submissions are encouraged and should be sent to Sarina Finkelstein, Online Photo Editor for Money.com at sarina.finkelstein@timeinc.com.

MONEY Careers

The Stock Market Is No Place for Millennials

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Roberto Westbrook—Getty Images

Investing in yourself, not the S&P 500, often makes more sense for young adults.

When most people think of investing, they think of the stock market. But that is rarely the best place for young professionals to invest their hard-earned money. Instead, they need to be investing in themselves.

You’ve undoubtedly heard that it’s important to start investing early for retirement. Whoever tells you that will most likely mention the concept of compound returns, as well.

Compound returns are great. Heck, it’s widely repeated that compound interest is the eighth wonder of the world. But I’m not sold on the stock market strategy for twentysomethings with limited cash flow.

Most recent graduates come out of school filled with theoretical knowledge about their major. Although this knowledge can be useful at times, it is often a challenge to apply it to real-world situations. It’s kind of like dudes with “beach muscles”: They hit the gym hard every day so they can look great on the beach. If they ever get into an altercation and actually have to use their strength, though, they fail miserably. That’s because they have no practical experience.

The same goes for theoretical knowledge in the real world.

We never learn about life in college. We don’t learn how to make or manage our money. We are not taught how to communicate effectively or be a leader. And we certainly do not get trained on how to create happiness and love in our lives. These are the valuable things we need to learn, yet we get thrown out into the world to fend for ourselves. So we have to take it upon ourselves to learn and grow organically after college.

The good news is there are plenty of programs, courses, and seminars that actually teach this stuff. But they cost money.

It’s this type of education that I am referring to when I say that young professionals need to invest in themselves. The notion that the stock market will set you free (in retirement) is only half right. It does not take into account myriad possibilities, one of which is that investing in yourself early in your career may be a better choice.

Let’s assume that you start out making $50,000 a year and indeed have a choice. Here are two simplified scenarios:

Option 1: You invest in a taxable investment account every year from the age of 25 to 50, starting with $5,000, or 10% of your first-year salary. Both your salary and your yearly retirement contribution grow 3% annually throughout your career. In year five, you’ll be making nearly $58,000 annually, and you’ll be putting $5,800 away toward your retirement. And assuming the investment vehicle has a 7% compound annual growth rate, you’ll have $350,836, after taxes, in 25 years.

Option 2: You take that initial $5,000 and invest in yourself every year for five years. You choose to attend various training programs covering the areas of leadership, communication, and other practical skills that you can put to use immediately. You gain life knowledge, allowing you to perform better and maybe even connect with a career about which you are passionate. As such, your income increases by 50% over five years — to $75,000 — rather than simply inching up by 3% per year to $58,000. Then, in year five, you start contributing about $17,000 per year to your retirement ($5,800 plus all the extra money you’re earning, after taxes). Projecting forward 20 years using the same rates for contribution growth and investment returns as in Option 1, you’d end up with $829,635 after tax.

After playing out both scenarios above, we can see that Option 2 leaves you with $479,000 more than Option 1 does.

Certainly, I have made a few assumptions — one of which is that you invest all your extra earnings in Option 2 rather than raise your standard of living. And there is no guarantee that by investing in ourselves, we will increase our income. However, this same argument can be made for investing in the stock market. The difference is that by investing in ourselves, we maintain control over that investment. It’s up to us to learn necessary life skills to excel at whatever we choose as a career or life mission.

On the other hand, when we hand over our money to the stock market, we give away that control, basing all results on historical averages. I’m a big proponent on focusing on what we can control. And, as young professionals, our biggest asset is our human capital, or our ability to earn income. Why not focus here first, and save the investing for tomorrow, when our cash flow is at a much healthier level?

———-

Eric Roberge, CFP, is the founder of Beyond Your Hammock, where he works virtually with professionals in their 20s and 30s, helping them use money as a tool to live a life they love. Through personalized coaching, Eric helps clients organize their finances, set goals, and invest for the future.

MONEY Taylor Swift

You’ll Never Guess What Taylor Swift Wanted to Be When She Grew Up

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Kevin Mazur/WireImage

Hint: It wasn't an entertainer.

Pop musician and gazillionaire Taylor Swift is no stranger to business strategy.

In recent months the self-professed “nightmare dressed as a daydream” has flexed her guns by spurning streaming music giant Spotify, investing in a $20 million New York apartment, and applying to trademark phrases like “Nice to Meet You. Where You Been?” for use on future commercial endeavors.

So where did the 25 year old get her financial savvy? One clue comes from an interview she taped for YouTube back in 2011, where she discusses her relationship with her stockbroker father, Scott Swift. The singer says her dad has been telling her to save money and invest in utilities since she was a child.

“My dad is so passionate about what he does in the way that I’m passionate about music,” Swift says in the video. “This guy lives for being a stockbroker… And anybody who talks to him, like, he’ll talk about me for the first five minutes, and then it’s, like, ‘Say, what are you investing in?'”

Swift goes on to explain that at the age of eight, while other students at school said they aspired to be astronauts and ballerinas, she wanted to be a financial adviser when she grew up.

“I love my dad so much, because he’s so gung-ho for his job, and I just saw how happy it made him, and I just thought, I can broke stocks,” she said.

If that line makes you roll your eyes, remember, as a wise person once said, “haters gonna hate, hate, hate, hate, hate.”

 

MONEY Religion

Investing Options Grow for Muslims

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Stuart Dee/Getty Images

U.S. Muslims who don't want to profit from interest or invest in certain types of businesses have an increased number of choices.

A growing number of options address the special investing needs of Muslims.

The U.S. Muslim population is expected to reach 6.2 million by 2030, almost three times the nation’s 2.6 million Muslims in 2010, the Pew Research Center estimates.

Muslim-Americans are younger and better educated than the average U.S. citizen, according to Gallup data. Moreover, they want to see a greater number of appropriate financial products, according to market research firm DinarStandard.

Their investing needs are similar to those of people who want socially responsible investments, but it requires additional expertise on the part of their adviser.

Under Islamic, or Shariah law, investors must shun companies involved in, for example, alcohol, tobacco, gambling or weapons — restrictions common to many religious groups. Shariah law also prohibits interest, because loans should be charitable acts. This makes buying fixed-income securities problematic, and purchasing banking company stocks impossible.

Companies must also have little debt: about 30% interest-bearing debt to trailing 12-month average market capitalization, according to organizations that set Islamic investing standards.

More investment products are becoming available. They include sukuk, the Islamic alternative to bonds, where returns are based on profits from an underlying asset. One fund, Azzad Wise Capital Fund, is available to U.S. retail investors. More choices will likely emerge, advisers say.

Morgan Stanley adviser Mark Rogers in Farmington Hills, Mich., helped his first Muslim-American client about 10 years ago and now serves more. He does not view them differently from clients who want socially responsible investments, he said.

“Once you understand how to apply the filter, it’s just business as usual,” Rogers said.

Naushad Virji, chief executive officer of Sharia Portfolio, launched his investment advisory firm in Lake Mary, Fla., 10 years ago and now serves clients in 21 states, he said.

Virji generally sticks to individual large-cap stocks — names with low debt such as Apple and Walgreens Boots Alliance — but said he is excited about developments in Islamic finance.

Amana Mutual Funds Trust, for example, and a new ETF from Falah Capital, Falah Russell-IdealRatings U.S. Large Cap ETF , are helping meet investors’ needs. But there is more to be done, Virji said. “We are in the infancy of Shariah-compliant investing in this country,” he said.

Advisers should go through each holding with clients to make sure they are happy with the choices, said Frank Marcoux, a partner at Wells Fargo’s Nelson Capital Management, a Wells Fargo & Co. unit. Some clients are even more strict than even the standard-setters, Marcoux said.

Clients also should understand they cannot expect to beat a benchmark, when chunks of companies are missing, Marcoux said.

But the main point is that advisers can help Muslims get in the market, Marcoux said. “People are surprised that this type of product and strategy even exists, and very appreciative.”

MONEY Tech

Amazon Just Admitted It’s Making Less Than You Think

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Chris Ratcliffe—Bloomberg via Getty Images

Investors need to wise up to Amazon's accounting games.

Shares of Amazon AMAZON.COM INC. AMZN -0.27% surged after the company reported its fourth-quarter earnings on Jan. 29, with investors focusing mainly on the small profit that Amazon managed during the holiday season. For the full year, Amazon posted a net loss of $241 million despite both double-digit revenue growth and generating nearly $2 billion of free cash flow.

Free cash flow has long been the metric Amazon points to as the best way to measure the company’s performance, and Amazon certainly delivered on that front. But there’s a problem with Amazon’s free cash flow numbers: They ignore billions of dollars in spending that the company is financing through capital leases. Despite the impressive-looking free cash flow, Amazon is actually losing a tremendous amount of money, no matter how you slice it. I pointed this out in a previous article, which includes an explanation of exactly how Amazon accounts for its capital leases.

A funny thing happened during Amazon’s conference call a few days ago. Instead of just touting its free cash flow figures and moving on, as it usually does, the company actually mentioned these massive capital leases, pointing out that it finances some of its spending in addition to the capital expenditures reported on the cash flow statement. The biggest piece of this financing is for Amazon Web Services.

Why does this matter? Here’s a slide from Amazon’s earnings presentation showing the company’s reported free cash flow:

Source: Amazon.

This is essentially the same slide that Amazon shows every quarter, with one important difference: The second footnote points to some additional free cash flow measures in the appendix, including one which adjusts for its massive spending via capital leases. This is the first time that Amazon has actively pointed out its capital lease activity beyond the required disclosures in its financial statements. What does this slide look like?

Source: Amazon.

This changes the story pretty dramatically. Along with the $4.9 billion Amazon spent directly on capital expenditures during the past year, it also committed an additional $4 billion through capital leases. While this $4 billion doesn’t represent a cash expense today, these capital leases will have to be paid for during the next few years.

During the past 12 months, Amazon paid about $1.3 billion in capital lease payments, erasing most of its reported free cash flow. These payments are considered financing cash flows, therefore excluding them from the free cash flow calculation.

These payments are only going to rise as Amazon finances more of its spending. Next year, Amazon expects to spend a little more than $2 billion paying for these capital leases, according to its 10-K, excluding any additional capital leases that the company enters into next year. This will effectively wipe out any reported free cash flow, and these payments will continue to rise unless Amazon curtails its capital lease activity.

The second slide above shows how much Amazon is truly investing in its business. Unlike other companies with big public cloud business, like Microsoft and Google, Amazon doesn’t have billions of dollars in profit coming in from other businesses to finance all of this growth. During the past 12 months, Microsoft spent $5.3 billion in capital expenditures, with much of this going toward growing its cloud business. Google spent a staggering $9.7 billion.

If Amazon wants to remain competitive in cloud computing, it can’t slow down its spending. But it also can’t afford to keep spending as heavily as it has been. Amazon’s reported free cash flow numbers make it seem like the company can invest heavily and still manage to generate cash. Well, it can’t. Not even close.

Amazon’s long-term goal is to optimize free cash flow; but its reported free cash flow is meaningless if it doesn’t adjust for capital leases, or at the very least, payments on those capital leases. I applaud Amazon’s management for finally pointing out these capital leases to investors, as they are extremely important in order to truly understand Amazon’s business. But the company is still touting its nearly $2 billion in free cash flow as if it means something. It doesn’t.

If Amazon keeps doing what it’s doing, the company is going to be taking on a lot more debt during the next few years. It paid $210 million in interest during 2014, completely wiping out its operating income for the year, and this number will only rise if this heavy spending continues.

It turns out that Amazon isn’t some sort of magical cash machine, able to generate $2 billion of free cash flow while reporting far lower, or even negative, earnings, all the while investing heavily in capital-intensive businesses. Instead, it’s a company that’s borrowing billions of dollars in order to finance its growth, using lease accounting to make it appear profitable on a free cash flow basis. There’s nothing wrong with what Amazon is doing, but investors need to wise up to these sorts of accounting games.

Timothy Green has no position in any stocks mentioned, although he does own a Kindle, and he likes that quite a bit. The Motley Fool recommends Amazon.com, Apple, and Google (A shares). The Motley Fool owns shares of Amazon.com, Apple, Google (A shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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This article previously appeared under a different headline, “Amazon Just Admitted That It’s Losing Billions.”

MONEY Investing

Why Big Oil Can Withstand Cheap Oil Prices

BP gas station with rainbow in the background
Toby Melville—Reuters

What investors need to know about the recent struggles of the petro-behemoths

The price of oil dropped dramatically in the second half of last year, resulting in less-than-stellar earnings for some of the world’s biggest energy companies. Exxon Mobil, BP, and Royal Dutch Shell all recently produced underwhelming fourth-quarter results thanks to lower demand for, and excess supply of, oil.

Despite recent struggles, investors have not jumped ship, and the petro-behemoths have outpaced the broader stock market over the past week. What’s going on, and what does this mean for you?

Oil Companies Have Lots of Money

The last three months of 2014 were not pretty for oil producers. The value of a barrel of oil hit around $115 in June, fell to $55 by the end of the year, and recently dropped to $45 before rebounding in the last couple of days. Exxon’s revenue dropped 21%, BP posted a replacement-cost loss (which is akin to net income) of $969 million, and Shell only saw gains thanks to ancillary businesses.

Despite the recent price uptick, oil’s outlook isn’t much better. The U.S. Energy Information Administration expects the price of oil to average $58 a barrel in 2015, compared to $109 just a few years ago. Lower oil prices simply makes it harder for major energy conglomerates to make money.

Fortunately for executives in Irving, Texas, London, and The Hague, however, large integrated oil and gas companies tend to have a lot of capital to soften these blows. Even after enduring a rough quarter, Exxon has nearly $5 billion in cash on hand, BP earned more than $12 billion for all of 2014, and Shell took in about $45 billion in cash flow last year.

Oil Companies Have Other Businesses

While cheaper oil makes the act of getting the black stuff out of the ground less profitable, other businesses in these large oil companies actually stand to benefit from lower oil prices. Exxon’s chemical operations, for example, actually saw a 35% increase in earnings over the same period in 2013.

“Our chemical business is very well positioned to take advantage of the lower commodity prices,” says Exxon’s head of investor relations Jeff Woodbury in the most recent earnings call. “Particularly in the U.S. our manufacturing sites are highly flexible and can run across a wide range of feedstocks, from ethane all the way to gas oil.”

It’s About Expectations

Falling energy prices was one of the biggest stories at the end of last year. Americans are feeling better about their own financial situation; cheaper prices at the pump feel to them like a pay raise or a tax cut. Which is to say, the market was not shocked that large oil companies had muted earnings during the last three months of 2014. In fact over the past six months shares of Exxon, BP, and Shell have fallen 6.7%, 16.2% and 17.6%, respectively. (The S&P 500, over the same period of time, has actually jumped 6.5%.)

OIL

And oil executives are doing all they can to lower costs and expectations for the near future. BP announced that it will be spending $4 to $6 billion less in capital expenditures in 2015 than it originally thought, and about $3 billion less than the company spent last year.“We have now entered a new and challenging phase of low oil prices through the near and medium term,” BP chief executive Bob Dudley said in a press release. Shell has also announced that it will reduce costs next year, and expects to spend $15 billion less through 2017.

What Does This Mean for You

Investors still pay a premium to own big oil stocks. Forward-looking price-to-earnings ratio for Exxon, BP, and Shell all exceed that of the S&P 500.

But they still look relatively attractive to USAA fund manager Bob Landry. Oil prices may not rebound this year, he says, but they’ve probably hit a floor at around $40 a barrel. “If you’re a long-term investor you can hold some of these companies that pay a solid dividend, and pick up shares for cheaper than what they were four-to-six months ago,” Landry says. “These companies can survive this turmoil thanks to a fortress balance sheet and the ability to generate significant cash flow.”

MONEY financial crisis

S&P to Pay Billions for Being the Watchdog That Didn’t Bark

Standard & Poor's building
Justin Lane—EPA

Standard & Poor's settlement is a reminder that the industry's safeguards failed in the lead-up to the financial crisis.

On Tuesday, Standard & Poor’s (S&P), agreed to pay $1.375 billion to settle claims by the Department of Justice and multiple state governments that the ratings agency defrauded investors in the lead up to the financial crisis.

As a bond-rating agency, S&P was responsible for keeping banks and other major financial institutions honest. Its apparently intentional failure to do so shows how one of the guard dogs of the financial system was co-opted by the very people it was meant to police.

Perverse incentives

Standard & Poors is one of three companies designated by the Securities and Exchange Commission as Nationally Recognized Statistical and Ratings Organizations (NRSROs). Their job is to rate the safety of bonds and thereby provide a kind of warning label for investors. The safest bonds—those issued by companies deemed most credit-worthy and best able to meet their financial commitments—are designated AAA; debt rated BB or lower is considered below investment grade, or “junk” in common parlance.

While companies like S&P theoretically exist to protect investors, much of their revenue comes from the lenders whose securities they were rating. As Kathleen Engel and Patricia McCoy describe in their book The Subprime Virus, ratings agencies generally bring in 1% of any debt deal they rate. Between 2000 and 2007, the three agencies underwrote $2.1 trillion in subprime mortgage-backed securities.

With that kind of money at stake, there was an obvious incentive for these firms to issue ratings that are favorable to the interests of their paying clients.

S&P and the financial crisis

According to a statement of facts released by the Justice Department and “agreed” to by S&P, that seems to be exactly what the company did. Contrary to the company’s Code of Practices and Procedures—which promises that its ratings “shall not be affected by an existing or a potential business relationship”—S&P “toned down and slowed down” the roll out of a new rating model for so-called Collateralized Debt Obligations (CDOs) after an unnamed investment bank suggested the system could jeopardize “potential business opportunities.”

The statement also shows S&P delayed for months ratings revisions on securities it knew to be failing. As far back as November 2006 the head of S&P’s residential mortgage-backed securities group sent two senior executives a spreadsheet—revealingly entitled “Subprime_Trouble.XLS”—warning that many S&P-rated loans were in serious trouble and should be downgraded.

Multiple sources told the Justice Department investigators that the group’s head frequently complained that her concerns were ignored because downgrades would hurt S&P’s rating business. A public warning that major downgrades were imminent was delayed until July, 2007.

Aftermath

The rest, as they say, is history. The housing crash brought to light the incestuous relationship between rating agencies and bond issuers, and eventually resulted in lawsuits like this one. Though S&P was not forced to admit wrong-doing, the case and subsequent settlement revealed a trove of information about the inner workings of the agency and wiped away a full year of the company’s profits.

Dodd-Frank imposed a number of additional regulations on ratings agencies, including new rules regarding conflicts of interest. But S&P’s payout is a reminder that it wasn’t just crooked banks and lenders that tanked the financial sector. The supposed watchdogs were involved as well.

MONEY Food & Drink

Why Shake Shack’s IPO Is Too Rich for My Blood

Shake Shack founder Danny Meyer (3rd R) and Shake Shack CEO Randy Garutti (2nd R) ring the opening bell at the New York Stock Exchange to celebrate their company's IPO January 30, 2015. Shares of gourmet hamburger chain Shake Shack Inc soared 150 percent in their first few minutes of trading on Friday, valuing the company that grew out of a hotdog cart in New York's Madison Square Park at nearly $2 billion.
Brendan McDermid—Reuters Shake Shack founder Danny Meyer CEO Randy Garutti ring the opening bell at the New York Stock Exchange.

I used to think Shake Shack might be undervalued. Not anymore.

Last week, I wrote a positive article on burger chain Shake Shack’s SHAKE SHACK INC SHAK -1.76% IPO on the basis that, “in [the indicative $14 to $16] price range, the shares could significantly undervalue Shake Shack’s growth potential.” The shares began trading today, and I’m much less excited about the offering. In fact, I think investors ought to avoid the stock entirely. What’s changed?

Is no price too high?

It’s not unreasonable to think a stock that is attractive at $15 may well be repulsive at more than three times that price — which is where Shake Shack shares are now trading. (The stock was at $48.62 at 12:30 p.m. EST.) Indeed, the underwriters raised the price range to $17 to $19 — and the number of shares being sold — before finally pricing the shares at $21.

Apparently, that did nothing to deter investors once shares began trading in the second market this morning – they opened at $47, for a 124% pop! Despite solid or even outstanding fundamentals, a business will not support any valuation. Price matters.

Last week, I compared Shake Shack to Chipotle Mexican Grill CHIPOTLE MEXICAN GRILL INC. CMG -0.36% . Let’s see how the share valuations of the two companies on their first day of trading now compare:

Number of restaurants operated by the company at the time of the public offering Price / TTM Sales
(based on closing price on first day of trading)*
Chipotle 453 4.4
Shake Shack 26 16.1

*Shake Shack’s price-to-sales multiple is based on the $48.62 price at 12:30 p.m. EST. Source: Company documents.

That’s a huge gap between the two price-to-sales multiples! Given the massive appreciation in Chipotle’s stock price since the close of its first day of trading — a more than fifteenfold increase in just more than nine years! — there’s a good argument to be made that the shares were undervalued at that time.

However, had Chipotle closed at $160 instead of $44 on its first day of trading — which would equalize the price-to-sales multiples — subsequent gains would have been significantly less impressive.

Buy potential performance at a discount, not a premium

Furthermore, with Chipotle, we are looking back at performance that has already been achieved, both in terms of the stock and the company’s operations. The Mexican chain has executed superbly well during that period.

With regard to Shake Shack — however likely you think a similar business performance is — it remains in the realm of possibility instead of certainty. I don’t know about you, but when I buy possibility, I like to buy it at a discount to the price of certainty.

Although I think Shake Shack’s brand positioning is comparable, and possibly even superior, to that of Chipotle, I’m not convinced the business fundamentals are as attractive.

For one thing, Shake Shack faces stiffer competition in its segment than Chipotle did (or does) in the likes of Five Guys and In-N-Out Burger. For another, Shake Shack’s same-store sales growth is significantly lower than Chipotle’s was, at just 3% for the 39 weeks ended Sep. 24 versus 10.2% for Chipotle in 2005, which was followed by 13.7% in 2006.

Don’t swallow these shares

Shake Shack may produce a premium burger — founder Danny Meyer refers to this segment as “fine casual dining” — but the stock is currently selling at a super-premium price. Paying that price is the equivalent of eating “empty calories” — it could end up being detrimental to your financial health.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

 

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MONEY Tech

Why Apple Needs Its New Watch to Be a Huge Success

Apple Watch
Stephen Lam—Reuters

The pressure is on.

The market may have loved Apple’s APPLE INC. AAPL 0.21% blowout quarterly report on Tuesday afternoon, but this doesn’t take any of the pressure off of April’s highly anticipated Apple Watch. If anything, the report actually places even more weight on the tech giant’s initial foray into wearable computing.

Let’s go over some of the reasons why Apple needs its new watch to be a smashing success.

1. There is too much riding on the iPhone

Apple’s revenue during the holiday quarter may have soared 30%, but back out the iPhone and sales actually slipped 7%. The iPhone is hot — and that’s awesome — but it’s also 68.6% of the revenue mix at Apple.

Apple needs to earn its innovator wings again. With iPad sales plummeting and the iPod no longer even worthy of being its own line item in Apple’s quarterly summary data table it’s time for something new to take the weight off of the iPhone.

2. The iOS newbies are ripe for the picking

The only thing better than Apple selling a record 74.5 million iPhones is that a record number of them are also new to the tech giant’s mobile platform.

“We had the highest number of customers new to iPhone last quarter than in any prior launch,” CEO Tim Cook boasted on Tuesday night. “The current iPhone lineup experienced the highest Android switcher rate in any of the last three launches.”

In other words, there are a lot of people making their initial investments in Apple products. The long overdue move to introduce larger screens to keep up with the competition is predictably paying off by eliminating their objections to going Apple. This leaves them ripe to to absorb other Apple products, and it’s not iPads or iPods. Mac sales should benefit, but the no-brainer is an accessory that works in cahoots with the phone itself. Yes, we’re talking about the smart watch.

3. Let’s bring back the halo effect

It’s not a coincidence that the Mac experienced a resurgence shortly after the 2001 introduction of the iPod. The media player worked with Macs and PCs, but it made Apple desktops and laptops cool again. Don’t be surprised if we see this happen with the Apple Watch.

Ultimately the purchase of an Apple Watch is a commitment to iOS. It’s unlikely to work with Android or other devices, cementing an iPhone user in place. Wireless carriers make it brutally easy to switch sides every two years, but someone buying an Apple Watch is that much more invested to sticking to the iPhone at the next upgrade cycle.

4. Show Google how wearable computing is done

It’s not a surprise to see Google GOOGLE INC. GOOG 0.4% backpedalling from Google Glass. The search giant suspended sales of its high-tech specs to developers. They cost too much. They were too creepy. They weren’t fashionable enough.

However, this also opens the door for Apple to make a splash by showing how wearable computing can be fashionable and useful. Skeptics will argue that rival smart watches have failed, but that hasn’t deterred Apple in the past. There’s always time to get it right.

5. Apple can use a new winner

The only two product lines posting improving sales this holiday season were iPhones and Macs. We’re talking about the smartphone that it introduced nearly eight years ago and its legacy computer business that’s obviously even older.

The iPad has been shrinking for a year, joining the iPod that’s been diminishing in popularity for years. Apple TV seems to be holding its own, but it’s not substantial enough to merit being singled out as a category. It’s lumped together with the iPod in the “other products” catchall that posted an overall decline.

Apple can use another winner. The Apple Watch won’t lend itself to the same upgrade cycle as the iPhone. There won’t be too many people buying a new one every two years. However, if it succeeds it will give Apple a more recent product introduction to brag about.

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