MONEY Ask the Expert

Rental Properties vs. Stocks and Bonds

Investing illustration
Robert A. Di Ieso, Jr.

Q: I bought a rental property that has increased in value considerably. The cash is great, but I’m wondering if I should sell high and invest in a different asset.
– Russell in Portland, Ore.

A: “This is a situation where there really is no one-size-fits-all answer,” says David Walters, a certified public accountant and certified financial planner with Palisades Hudson Financial Group.

To tackle this question, you’ll want to first get a handle on just how well this investment is performing relative to other assets.

For a simple apples-to-apples comparison, take the property’s annual net cash flow (income minus expenses) and divide it by the equity in the home, he says. You can use this yield to see how the income generated by this property stacks up against that of other investments, such as dividend-paying stocks.

To calculate your total return, take that yield and add it to your expected annual long-term price gains. If your yield is 5%, for example, and you expect the value of the property to appreciate 2% a year on average, your annual total return would be 7%.

Next, you’ll want to figure out just how much you would have left to reinvest after you pay the real estate broker (typical commissions are 6% of the sale price) and the taxes. “In this case, taxes could be a big factor,” says Walters.

Remember, because this is an investment property, you are not eligible for the capital gains exclusions ($250,000 for individuals and $500,000 for couples) available when you sell a primary residence.

Assuming you’ve owned the house for more than a year, you’ll owe the long-term capital gains rate, which is 0% to 20% depending on your tax bracket; for most people that rate is 15% for federal taxes. Your state will also want its share, and in Oregon it’s a pretty big one – 9.9%.

There’s more to it. If you depreciated the property – odds are you did – you’ll need to “recapture” some of that write off when you sell, and at your marginal income tax rate. Here too you’ll owe both federal and state taxes.

One way to avoid paying a big tax bill now is to do a 1031 exchange, in which you effectively swap this property for another investment property in another neighborhood or a different market — though there are plenty of caveats.

Assuming you don’t want to re-invest in actual real estate, the big question is where you should invest the proceeds of the sale – and is it better than what you already have?

You could look at alternative assets that have a similar risk and reward profile — dividend-paying stocks, real estate investment trusts or master limited partnerships.

A better approach, however, may be a more holistic one. “You want to know where this fits in the big picture,” says Walters. Rather than try to pick and choose an alternative investment, you may just roll the proceeds into your overall portfolio – assuming it’s appropriately diversified. If you can max out on tax-deferred options such as an IRA or, if you’re self-employed, a SEP IRA, even better.

Depending on how much other real estate you own, you could allocate up to 10% of your overall portfolio to a real estate mutual fund, such as the T. Rowe Price Real Estate Fund (TRREX) or Cohen & Steers Realty Shares (CSRSX).

The tradeoff: “Most of these funds own commercial real estate,” says Walters. “There aren’t a lot of options to get passive exposure to residential real estate.”

Then again, investing in actual real estate takes time, lacks liquidity, and comes with some big strings attached. On paper, your investment property might seem like a better deal than any of the alternatives, says Walters, “but there are 50 other things you have to think about.”

With real property there’s always the risk that you’ll have to pay in money for, say, a new roof or heating and cooling system. That’s one thing you don’t have to worry about with a mutual fund.

MONEY stocks

Why Netflix Is Splitting Its Stock

Headquarters of Netflix, Inc., in Los Gatos, California
Tripplaar Kristoffer—Sipa USA Headquarters of Netflix, Inc., in Los Gatos, California

Netflix is asking shareholders to pave the way toward a drastic stock split. But it really doesn't matter -- with a few notable exceptions.

Netflix NETFLIX INC. NFLX 1.69% shares are about to split, probably in a drastic manner. The company is asking shareholders for permission to go as far as a 30-for-1 share exchange. It sounds very dramatic, but most investors really shouldn’t care at all.

Here’s why.

What’s new?

Netflix just filed a preliminary version of its 2015 proxy statement, asking shareholders to vote on seven proposed actions before the June 9 annual meeting. Among the typical issues, including approving Netflix’s chosen auditing firm and reelecting a tranche of directors for the next three years, is a more unusual request straight from the board of directors.

In Proposal Four, Netflix asks for a simple majority vote to approve a vastly expanded reserve of capital stock. This is an important first step toward splitting Netflix shares, which have looked rather pricey in recent years.

The board is currently authorized to issue as many as 160 million common shares. If the fourth proposal is approved, that limit will soar to 5 billion potential certificates.

This move could lead in many directions:

  • Some companies raise their share counts before selling a heap of additional certificates back to shareholders. That’s one way to raise capital — and dilute the stock’s value for current shareholders.
  • It could also go toward a generous stock-based compensation program, which would artificially boost bottom-line earnings, but with another helping of share dilution.
  • Netflix even said the extra shares could be used for share-based buyouts, paying off the target company’s current owners with fresh Netflix stock instead of cash. Again, dilution follows.

Netflix made no bones about the intended purpose, though. The company said it “does not have any current intention” to explore any of the activities I just listed, other than supporting the share-based compensation strategy that is already in place.

Sure, the board reserved the right to issue additional shares for these purposes at a later date, without asking stockholders for another share count expansion. But there’s no reason to expect any of these things to happen anytime soon.

No, this is all about powering “a stock split in the form of a dividend.”

Simmer down now

Now, just because Netflix is likely to get its wish doesn’t mean you should expect the entire 5 billion shares to hit the market right away.

For example, Netflix doesn’t use its entire 160 million share allotment today. The company only has 60 million shares on the market at this time, and could do a simple 2-for-1 split without even asking for shareholder permission.

In fact, it’s absolutely normal to have a large reserve of approved but unprinted shares. Netflix said it set the 5 billion share count to be “consistent with the number of shares authorized by other major technology companies.”

Following that trail of cookie crumbs, you’ll find IBM INTERNATIONAL BUSINESS MACHINES CORP. IBM -1.51% has 988 million shares on the open market but a shareholder-approved maximum allotment at 4.7 billion stubs. Microsoft MICROSOFT CORP. MSFT -1.38% is allowed 24 billion shares but has only issued 8.2 billion. Apple APPLE INC. AAPL -1.09% lifted its approved share count from 1.8 billion shares to 12.6 billion just before running through a 7-for-1 split last year, but has only issued 5.8 billion tickets so far.

All of these major tech stocks sit on approved share counts somewhere in the same ZIP code as the proposed Netflix target. They also have the power to execute a modest stock split anytime they like, or to put their share reserves to work in any of the other actions I mentioned earlier.

It’s just a nice buffer to have, and I expect the Netflix split to stop far short of the maximal 30-for-1 ratio. Something like a 10-for-1 split would leave plenty of future wiggle room while lowering Netflix’s share prices well below the psychological $100 barrier.

What’s the big deal?

In most cases, stock splits are nothing but a massive play on investor psychology. Buying 10 Netflix shares at $470 each serves exactly the same purpose as picking up 100 stubs for $47 each. In both cases, you built a $4,700 position with a single commission-spawning transaction.

But a $47 stock certainly looks more affordable than a $470 version, even if all the usual valuation ratios stay unchanged. And the move actually does make a difference every once in a while.

For example, Apple would not be a member of the Dow Jones Industrial Average today if it hadn’t performed a radical stock split first. On the price-weighted Dow, the pre-split Apple ticker would have overshadowed the daily moves of the other 29 members, and the Dow was never meant as a proxy for Apple investments.

Netflix isn’t exactly in position to snag a Dow spot anytime soon, but you never know. Extreme share prices can make for some strange and interesting situations. Keeping share prices low (but not too low!) can save Netflix some sweat if the company ever gets close to a Dow Jones seat — or any other price-based honor that could boost the company’s market status.

Finally, the single-share price might matter to very modest investors who could afford a couple of $47 Netflix shares but would have to save their pennies to get a single $470 stub. Options contracts also become more affordable at lower prices, since they often represent 10 or 100 shares each.

So when capital is tight, lower share prices actually matter. From that perspective, stock splits are shareholder-friendly moves.

NFLX Shares Outstanding Chart

Final words

I expect this proposal to pass, because such plans rarely meet much resistance. Investors tend to like stock splits, and it doesn’t hurt to give the company’s board and management some extra financial flexibility.

Then, we’ll see Netflix pay out a special dividend. For each current share, Netflix owners will receive another four to nine additional shares for a final split ratio between 5-for-1 and 10-for-1.

The move won’t change Netflix’s total market value. Nor will it affect the direct value of your current Netflix holdings. We’ll all get more granular access to the stock. So we can make smaller trades and have more control over the size of our Netflix investments.

This is a fairly nice move with no real downside. But it’s also no reason to break out the champagne bottles and order up fireworks.

It’s ultimately just another housekeeping item that won’t move Netflix stock at all. Or if it does, the change will be based on nothing but day-trader psychology and will fade quickly.

Feel free to buy or sell Netflix shares based on whatever happens in Wednesday afternoon’s first-quarter earnings report. But for all intents and purposes, you can ignore the upcoming stock split.

MONEY stocks

How to Tame the (Inevitable) Bear Market

baby bear in front of scary bear shadow
Claire Benoist

Stocks will eventually suffer a downturn, but don't assume it has to be a grisly one. Here's what you need to do now to get your portfolio ready.

The current bull market is looking almost old enough to qualify for Social Security. Now in its seventh year, this rally is nearly twice the length of the typical bull and is the fourth-oldest since 1900. Meanwhile stocks are getting expensive, profits are slowing, and equities will soon face another headwind in the form of Federal Reserve interest-rate hikes, possibly starting as soon as summer.

Yet this is not a call to hightail it out of the market. Few suggest a bear attack is around the very next corner. And even if a selloff is coming soon, two-thirds of bull markets over the past 60 years have added gains of at least 20% in their final stage, according to InvesTech Research. So there’s a risk to overreacting.

Money

That said, “how you invest in the seventh year of a bull market is not the same as at the start of a bull market,” says InvesTech president James Stack. And the next bear market is probably going to look a lot different from the ones you’ve grown used to.

So here’s a playbook for getting your portfolio ready:

Expect a less grisly bear

The last two downturns you recall happen to be among the worst in history, so it’s understandable if you’re concerned about getting mauled. But this time “we don’t see any bubbles or concerns that would suggest we’re heading for a repeat of 2000 or 2007,” says Doug Ramsey, chief investment officer at the Leuthold Group.

Ramsey expects a “garden variety” downdraft of around 27.5% (see chart). After a six-year rally in which the market has soared more than 200%, that’s not catastrophic. Also, it’s psychologically difficult to buy on the dips in a megabear that might drag on for years. But a run-of-the-mill bear market can be viewed as “an opportunity,” says Kate Warne, investment strategist at Edward Jones.

Warne’s advice: Plan to rebalance your portfolio to your target stock allocation in the next bear. Get ready to do so once your mix changes by around five percentage points. A 70% stock/30% bond portfolio will hit that point as equity losses approach 20%. Selling bonds to replenish your equities will set you up for the next bull.

Stay committed abroad

In the last bear, global economies tumbled in sync. Not so this time. In the U.S., the Fed is on the verge of lifting rates on the strength of our economy. Yet the eurozone and Japan are stuck in neutral, and their central banks are trying to stimulate growth. “Their stocks reflect that weakness, making them more attractive right now compared to the U.S.,” says Warne.

The broad U.S. market trades at a price/earnings ratio of 17.7 based on profit forecasts. Yet stocks held by Fidelity Spartan International IndexFIDELITY SPARTAN INTL INDEX INV FSIIX -1.23% and Dodge & Cox International DODGE & COX INTERNATIONAL STOCK DODFX -1.44% —both in the MONEY 50—trade at about 15 times earnings. Warne suggests keeping up to a third of your stocks in developed foreign markets.

Don’t overlook late-stage bull leaders

While the S&P 500 is trading modestly above its long-term average, the median P/E of all U.S. stocks is at an all-time high. “That tells you that small- and midcap stocks have higher P/Es, and they will be the ones to fall the furthest in a bear market,” says Stack.

That makes blue chips more compelling. InvesTech also studied the final stage of bull markets and found that the energy, technology, health care, and industrial sectors tend to outperform. Energy is obviously a tricky case given the recent volatility in oil prices, but Stack says it should not be shunned. MONEY 50 pick Primecap Odyssey Growth PRIMECAP ODYSSEY GROWTH FUND POGRX -1.31% has nearly 80% of its assets in those sectors.

Dial back on alternatives

If you’ve been using high-yielding utility stocks as bond stand-ins, now is the time to take some profits. Along with financial and consumer discretionary stocks, utilities are late-stage laggards.

And if you’ve reduced your fixed-income allocation in favor of higher-yielding alternatives such as REITs or master limited partnerships, it’s time to shift back to core bonds. Such income alternatives are more highly correlated with stocks than are basic bonds. Fixed-income returns may be muted once rates start rising. But that doesn’t change the role of high-quality bonds: shock absorbers when stocks are falling.

TIME Economy

Low Wage Workers Are Storming the Barricades

Activists Hold Protest In Favor Of Raising Minimum Wage
Alex Wong—Getty Images Activists hold protest In favor of raising minimum wage on April 29, 2014 in Washington, DC.

A few weeks back, when Walmart announced plans to raise its starting pay to $9 per hour, I wrote a column saying this was just the beginning of what would be a growing movement around raising wages in America. Today marks a new high point in this struggle, with tens of thousands of workers set to join walkouts and protests in dozens of cities including New York, Chicago, LA, Oakland, Raleigh, Atlanta, Tampa and Boston, as part of the “Fight for $15” movement to raise the federal minimum wage.

This is big shakes in a country where people don’t take to the streets easily, even when they are toiling full-time for pay so low it forces them to take government subsidies to make ends meet, as is the case with many of the employees from fast food retail outlets like McDonalds and Walmart, as well as the home care aids, child caregivers, launderers, car washers and others who’ll be joining the protests.

It’s always been amazing to me that in a country where 42% of the population makes roughly $15 per hour, that more people weren’t already holding bullhorns, and I don’t mean just low-income workers. There’s something fundamentally off about the fact that corporate profits are at record highs in large part because labor’s share is so low, yet when low-income workers have to then apply for federal benefits, the true cost of those profits gets pushed back not to companies, but onto taxpayers, at a time when state debt levels are at record highs. Talk about an imbalanced economic model.

A higher federal minimum wage is inevitable, given that numerous states have already raised theirs and most economists and even many Right Wing politicos are increasingly in agreement that potential job destruction from a moderate increase in minimum wages is negligible. (See a good New York Times summary of that here.) Indeed, the pressure is now on presidential hopeful Hillary Clinton to come out in favor of a higher wage, given her pronouncement that she wants to be a “champion” for the average Joe.

But how will all this influence the inequality debate that will be front and center in the 2016 elections? And what will any of it really do for overall economic growth?

As much as wage hikes are needed to help people avoid working in poverty, the truth is that they won’t do much to move the needle on inequality, since most of the wealth divide has happened at the top end of the labor spectrum. There’s been a $9 trillion increase in household stock market wealth since 2008, most of which has accrued to the top quarter or so of the population that owns the majority of stocks. C-suite America in particular has benefitted, since executives take home the majority of their pay in stock (and thus have reason to do whatever it takes to manipulate stock price.)

Higher federal minimum wages are a good start, but it’s only one piece of the inequality puzzle. Boosting wages in a bigger way will also requiring changing the corporate model to reflect the fact that companies don’t exist only to enrich shareholders, but also workers and society at large, which is the way capitalism works in many other countries. German style worker councils would help balance things, as would a sliding capital gains tax for long versus short-term stock holdings, limits on corporate share buybacks and fiscal stimulus that boosted demand, and hopefully, wages. (For a fascinating back and forth on that topic between Larry Summers and Ben Bernanke, see Brookings’ website.)

Politicians are going to have to grapple with this in the election cycle, because as the latest round of wage protests makes clear, the issue isn’t going away anytime soon.

Read next: Target, Gap and Other Major Retailers Face Staffing Probe

Listen to the most important stories of the day.

MONEY stocks

The Hidden Danger in Apple Stock

150409_INV_AppleDanger
China Stringer Network—Reuters

Apple's mountain of cash—which is generally considered a safety net—actually comes with risks.

Investing in Apple APPLE INC. AAPL -1.09% today seems like a smart bet by many measures.

The company broke records for the most profits for any business in a single quarter—ever—earlier this year. With nearly $180 billion in cash, management has plenty of cushion against setbacks—like, say, if the new Apple Watch doesn’t sell as well as projected. And while Apple has been criticized for not sharing that cash with shareholders as much as peers like Microsoft do, recent signals from company leaders suggest they may announce a hefty dividend hike as early as this month.

Certainly, there’s plenty of cause for investors to favor cash-rich companies like Apple, says Thomas McConville, co-portfolio manager of the Becker Value Equity fund, which holds Apple stock.

“A company having lots of cash is like a person having lots of savings,” McConville says. “If a person loses a job, savings help to weather the storm. Cash helps a company protect itself from shocks and keep investing in value-creating activities.”

But, he says, the devil is in the details of how exactly a company invests in activities—and whether those enterprises actually add value.

New projects and products can make or break a company, and it can be especially risky for a business to step out of its wheelhouse. Apple’s wheelhouse is making the best-looking and best-functioning advanced consumer tech products, says McConville.

That’s at least partly why some critics are skeptical about whether the rumored Apple car is the right new venture for the company.

“As an investor, I want to see that any product extension they announce fits under their umbrella,” McConville says. “If they get into vehicles, creating onboard technology and displays is a good fit, since visual appeal and functionality are top concerns. But if they were going to try to design seat brackets? Well, that’s probably not the perfect fit.”

That makes sense. Then again, traditional automakers already seem enthusiastic to team up with Apple—and with all that cash, the tech giant could easily just buy a company with more experience creating car parts like seat brackets. So what could go wrong?

Well, cash-rich companies have lots of buying power, says Don Wordell, portfolio manager of the RidgeWorth Mid Cap Value fund. And, as the saying goes, with power comes responsibility.

“Companies that are simply too big to grow organically can grow inorganically by buying others,” he says. “But that creates risk. Cash can be as much of a liability as an asset.”

So, for example, it worked out well when Disney bought Pixar for $7.4 billion nine years ago. That acquisition led to a spate of successful movies, a stronger brand, and happy investors who have seen total returns of more than 300% since 2006.

But when Quaker bought Snapple for $1.7 billion in 1994, it bungled the brand’s marketing campaigns and relationships with distributors; after just 27 months, Quaker sold Snapple to a holding company for about $300 million—less than a fifth of its purchase price. The whole affair left Quaker with a damaged credit rating and dragged its stock price flat during a period when the rest of the market was on fire.

Hindsight is, of course, 20/20. But a key quality investors should watch for is how patient and thoughtful a company’s leaders seem to be before deploying resources.

“Too much cash can burn a hole in management’s pocket and cause them to make a bad acquisition,” says McConville.

Apple’s record of acquisitions and product launches is not without flops. Among other failed products, there was Apple’s 2007 Bluetooth headset, which was discontinued after two years because it couldn’t compete with third-party devices. And although the company has invested millions over the years in acquiring mapping companies, like Placebase and Poly 9, Apple has still not succeeded in creating a mapping application that competes with the likes of Google Maps.

Of course, Apple’s top executives have made plenty of successful moves on behalf of the company in recent years, and sales of core products like the iPhone are still breaking records. But strong is not invincible, and if its new wristwatch doesn’t take off, Apple will soon be looking to throw cash at developing its next big product.

Investors would be wise to keep an eye on how, exactly, that cash is spent.

 

MONEY Ask the Expert

When Going All In Is Not A Risky Bet

hands pushing poker chip stacks on table
iStock

Q: I’m 33 and recently received a $200,000 windfall. But I’m lost on how I should put it to work. Should I invest in phases or all at once? I’m nervous about investing at all-time market highs. – Rod in Los Angeles

A: Assuming you’re investing this money for the long term — and you have sufficient cash set aside to meet short-term needs and emergencies — go ahead and invest it all at once, says Jerry Miccolis, founding principal of Giralda Advisors, a Madison, N.J. firm that specializes in risk management. “Don’t let headlines about the market hitting new highs make your nervous because, if the market does what it’s supposed to do, that should be the norm,” says Miccolis.

Now, you may have heard the term “dollar-cost averaging.” This notion of automatically investing small amounts at regular intervals, as you do in a 401(k) retirement plan, does tend to smooth out the natural ups and downs of the market. It’s one of many perks of investing consistently, come what may.

Still, if you have cash at the ready to put to long-term use, says Miccolis, it’s just as well to invest all at once – and given your age primarily in equities.

This isn’t to say that short-term market corrections – even sizable ones – won’t happen again. “You’ll probably see many in your lifetime,” says Miccolis. “But you risk losing a lot more waiting around for something to change before you invest.”

In fact, investors who’ve had the bad luck of getting in at the very top of a market have ultimately come out ahead – provided they stayed the course. Consider this analysis from wealth management tech company CircleBlack: An investor who put $1,000 in the Standard & Poor’s 500 index of U.S. stocks at the beginning of 2008 (when stocks fell 37%) and again in early 2009 would have been back in positive territory by the end of 2009.

A critical caveat: This advice assumes that you actually keep your savings invested, and not panic sell when things look ugly. Hence, before you make your decision, try to gauge your tolerance for risk – here’s a quick survey to understand your comfort level – as well as your capacity for risk.

While tolerance generally refers to how risk affects you emotionally, capacity refers to how much risk you can actually afford. (You may have a high tolerance for risk but low capacity, or vice versa.)

If you have a steady income, little debt, and several months of emergency savings, the odds that you’d be forced to tap your long-term savings should be low, meaning that your capacity for risk is adequate. If the rest of your financial advice is a bit of a mess, however, you’ll want to use some of this windfall to tighten your ship before you commit to investing it.

Another exception to the advice to invest in one-fell swoop: If you can’t afford to max out on your 401(k) plan, earmark some of this money for living expenses so you can divert a bigger chunk of your salary to these tax-deferred contributions.

MONEY Tech

3 Companies Hoping the Apple Watch Fails

150408_INV_HopingWatchFails
Stephen Lam—Reuters

Apple's new gadget will shrink a few stocks if it's a hit.

Investors are gearing up for this month’s rollout of Apple’s APPLE INC. AAPL -1.09% new smartwatch. There will be plenty of winners outside of the Cupertino-based tastemaker of consumer tech when the Apple Watch hits the market. The companies making the components will naturally benefit from the incremental sales, and one analyst even showed traditional retailers some love on the thesis that springtime mall sales will get a boost from folks buying the high-tech wristwatches at local Apple Store locations.

However, you don’t introduce a pricey gadget without disrupting the business models of others. Let’s take a look at three publicly traded companies that aren’t going to be too happy about the Apple Watch arrival.

1. Garmin GARMIN LTD. GRMN -1.97%

Citi downgraded shares of Garmin to sell on Monday, slapping a bleak $42 price target on the shares that suggests the stock will be moving lower in the year ahead.

The Apple Watch debut was cited as a primary reason for the downgrade, eating into Garmin’s fitness trackers. Garmin is a company that most of us still associate with GPS devices that helped drivers get around a decade ago, but obviously that market’s been drying up over the years. The connected car has made it easier to get around using Bluetooth-enabled smartphones to make it happen.

Garmin’s been able to hold itself up by pushing into the great outdoors, arming hikers and runners with devices to help them know where they are and track their activities. Automotive devices now make up less than half of its revenue.

Apple Watch will naturally make it harder for Garmin to stand out in the fitness market. Yes, the Apple Watch surprisingly doesn’t offer GPS. It relies on the iPhone to provide that feature, and that’s going to be a deal breaker for marathon enthusiasts that don’t want to be weighed down by smartphones as they train and compete. However, future Apple Watch generations will likely embrace built-in GPS to compete in this niche of active consumers. Merely waiting for this to happen could be enough to freeze near-term Garmin gadgetry sales to iPhone owners.

2. Google GOOGLE INC. GOOG -1.83%

There are some arguments to be made that Apple Watch will actually benefit Google’s globally dominant Android operating system. If the Apple Watch does for smartwatches what the iPhone did for smartphones and the iPad did for tablets, then it will help educate the market that will eventually flock to cheaper Android-fueled wrist huggers. This hasn’t happened so far with most of the Android smartwatches failing to generate material buzz.

Making smartwatches popular would also benefit Google’s market leadership in online advertising. The smartwatch may be small, but it still represents a new screen for Google to serve up sponsored missives as some app makers try to monetize their programs.

However, things can also go the other way for Google. The Apple Watch, after all, is a way to keep iPhone owners loyal. Folks investing at least $349 for an Apple Watch later this month aren’t likely to migrate to Android when it’s time to upgrade their iPhones. The Apple Watch — for now, and possibly forever — works exclusively with the iPhone. Every person spending $349 or more is making a commitment to the Apple ecosystem. The same can be argued the moment that the first hot Android-exclusive smartwatch becomes available, but that may take time.

3. Fossil FOSSIL INC. FOSL -1.61%

Apple has put out plenty of gadgetry over the years, but this is its first push into wearable computing.

“The Apple Watch is the most personal device we’ve ever created,” CEO Tim Cook said during last month’s media event. “It’s not just on you, it’s with you.”

This is high-tech jewelry, and that’s going to take a bite out of the premium wristwatch makers. Fossil could be easy pickings. We’re not wearing traditional wristwatches the way that we used to. It doesn’t make sense to own a watch when the smartphone in your pocket does that and so much more. Fossil has held up considerably better than its peers, largely on the fashionable merits of its timepieces. Apple Watch’s success could change that, especially given the many,many, many reports that paint iPhone owners as more affluent and likely to spend money than Android users.

Fossil is already feeling the pinch. It’s probably not a coincidence that earnings fell short of expectations during the holiday quarter — just after Apple officially announced that it would be entering the smartwatch market — after several quarters of beating the market. Analysts see sales and earnings declining at Fossil in 2015.

It could get uglier than that if Apple Watch becomes the new trendy wristwatch. A wrist occupied by an Apple Watch isn’t going to have room for a Fossil or a Rolex. These will be challenging times for an industry that may have peaked.

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MONEY investing strategy

The Dark Secret Behind Most Popular Investing Strategies

money splitting into different directions
C.J. Burton—Corbis

Investing gurus scrap their advice all the time.

Like countless others, I read Benjamin Graham’s book The Intelligent Investor when I was young. It totally changed how I looked at investing.

Graham’s book was more than theory. He gave directions — actual formulas — investors could use to find cheap stocks. The formulas were simple and they made sense. This appealed to me, as I had no idea what I was doing.

But something became clear once I started putting his formulas to use. None of them worked.

Graham advocated purchasing stocks trading for less than their net working assets — basically cash in the bank minus all debts. This sounded great, but no stocks actually trade that cheaply anymore — other than, say, a Chinese pharmaceutical company accused of accounting fraud, or a shell company run out of a garage in Toledo. No thanks.

One of Graham’s criteria suggested that defensive investors should avoid stocks trading for more than 1.5 times book value. Following this rule in recent years would have led an investor to own almost nothing but banks and insurance stocks. In no world is this possibly OK.

The Intelligent Investor is one of the greatest investing books of all time. But I don’t know a single person who has invested successfully implementing Graham’s formulas exactly as they’re printed. The book is chock-full of wisdom — more than any other investment book ever published. But as a how-to guide, success is elusive.

This bothered me for years. Then, a year ago, I had lunch with Wall Street journalist Jason Zweig, who explained what was happening.

Graham was as practical as he was brilliant. This is probably because in addition to being an academic he was an actual money manager, running what we’d now call a hedge fund. He had no desire to stick with antiquated strategies that other investors had caught on to and become too competitive, rendering them less effective.

“In each revised edition of The Intelligent Investor,” Zweig once wrote, “Graham discarded the formulas he presented in the previous edition and replaced them with new ones, declaring, in a sense, ‘that those do not work any more, or they do not work as well as they used to; these are the formulas that seem to work better now.”

The most recent edition of The Intelligent Investor was published 42 years ago. Who knows what Graham’s strategies would look like today if he were alive to update them?

The cornerstones of successful investing are timeless. Patience, contrarian thinking, and tax efficiency will be as important 50 years from now as they were 50 years ago.

But among specific investing strategies, things change.

Every strategy to outperform the market must be based on the logic of, “The market disagrees with me today, but it will agree with me in the future, and when it does share prices will rise and I’ll profit.” But what investors believe today, and what they’re likely to believe tomorrow, changes. Since the prevalence of data, social norms, and company disclosures change over time, what worked in one era might not work in another. As an investor, you have to adapt.

Just before his death in 1976, Graham was asked whether detailed analysis of individual stocks — the kind of stuff he became famous for — was still a strategy he believed in. He answered:

In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then.

What he believed, he continued, was buying a portfolio of stocks based on a few criteria — maybe low P/E ratios, or high dividend yields. But what matters — and what so many overlook when studying Graham — was that he changed his mind. He adapted.

In his great book Investing, Robert Hagstrom compares financial markets to biological evolution. There’s a tendency to think of markets as something that are established and rigid — a set of numbers that get jumbled around. But they’re not. Markets evolve over time. Successful strategies are selected, while those that are no longer effective — usually because investors gain access to better information than they had before — get pushed out.

Hagstrom looked at the last 100 years, and found that four popular investing strategies have come and gone.

“In the 1930s and 1940s, the discount-to-hard-book-value strategy … was dominant. After World War II and into the 1950s, the second major strategy that dominated finance was the dividend model … By the 1960s … investors exchanged stocks paying high dividends for companies expected to grow earnings. By the 1980s a fourth strategy took over. Investors began to favor cash-flow models over earnings models. Today … it appears that a fifth strategy is emerging: cash return on invested capital.”

If you don’t know that markets have evolved and some strategies are no longer valid, you’ll end up making terrible decisions.

“If you are still picking stocks using a discount-to-hard-book-value model or relying on dividend models to tell you when the stock market is over or under-valued, it is unlikely you have enjoyed even average investment returns,” Hagstrom writes. There is no reason to expect this strategy will lead to outperformance because so few investors pay attention to it anymore. Even if you find stocks trading at a discount to book value, there’s no reason to believe that anyone else will agree with you … later.

So many investors today put tremendous faith in investing metrics showing, say, that this stock is overvalued, or that the overall market is undervalued. They back it up with a century worth of historic data, showing how well the metric has worked in the past.

I often wonder: Have things changed? Have so many people caught onto a popular metric that they’re less effective than they were in the past? Should we, like Graham, be constantly tinkering with our metrics, discarding what’s unlikely to work anymore?

The S&P 500 did not include financial stocks until 1976; today, financials make up 16% of the index. Technology stocks were virtually nonexistent 50 years ago. Today, they’re almost one-fifth of the index. Accounting rules have changed over time. So have disclosures, auditing, and market liquidity. 401(k)s and IRAs — which hold trillions of dollars — didn’t exist until 40 years ago. Comparing today’s market to the past isn’t apples to apples.

There’s a mocking statement that “it’s different this time” are the four most costly words in investing. And sure, investors fall for some of the same traps again and again. But for many things, it’s always different this time. Things change. So should you.

MONEY Warren Buffett

The One Thing Warren Buffett is Wrong About

Warren Buffett, CEO of Berkshire Hathaway
CNBC—NBCU Photo Bank via Getty Images Warren Buffett, CEO of Berkshire Hathaway

Buffett's personal bias seems to be interfering with his judgment in food stocks.

Warren Buffett cannonballed through the food industry once again this past week, orchestrating a merger of Heinz and Kraft Foods KRAFT FOODS GROUP INC. KRFT -0.37% to create the world’s third-largest food company.

Buffett’s Berkshire Hathaway conglomerate and partner 3G Capital, a Brazilian investment firm, will pay a special dividend to Kraft shareholders worth $10 billion, and Kraft shareholders will own 49% of the new company while Heinz, which was acquired by Buffett and 3G Capital in 2013, will hold 51%.

This is far from Buffett’s first foray into the food business, but the deal seems questionable at a time when more Americans are shunning the packaged processed foods that Kraft is known for such as Velveeta and Lunchables, and its sales have been flat in recent years. Still, Kraft is a typical Buffett target with its portfolio of well-known brands and easy-to-understand business model. Berkshire is also a major holder of Coca-Cola COCA-COLA COMPANY KO -0.74% , and owns Dairy Queen, after acquiring it in 1997.

Buffett is a big personal fan of these brands, and readily admits that he eats “like a six-year old.” He has said he’s a regular consumer of Heinz ketchup, and Dairy Queen. He drinks at least five Cokes a day, regularly munches on Potato Stix, and told Fortune he had a bowl of chocolate chip ice cream for breakfast the day of the interview. Perhaps the octogenarian’s tastes may be clouding his judgement when it comes to his investments in the food world.

Coca-Cola COCA-COLA COMPANY KO -0.74% , for example, was one of the best performing stocks of the 20th century, but as soda consumption has fallen in the last decade, the stock has languished in recent years. Over the last five years, it’s returned 44%, against the S&P 500’s 74%, while in the last two years Coke is down 1%, compared to a 32% gain for the broad-market index. As long as people are turning away from soda, Coke’s prospects look poor.

In 1997, Buffett bought Dairy Queen for $585 million. At the time, it had 6,200 restaurants under its banner. Nearly 20 years later in 2014, it has only grown to about 6,500. As a minor subsidiary, Berkshire doesn’t break down Dairy Queen’s financial performance, but its average sales per store was just $659,000 in 2013, below most major fast-food competitors. Growth in individual stores has also significantly trailed the industry. In that time, McDonald’s, for example, has grown from about 23,000 restaurants worldwide to over 35,000. Fast casual chains have boomed as Chipotle Mexican Grill went from a handful of stores in 1997 to a valuation north of $20 billion today. Buffett may have gotten a good price for Dairy Queen, but the business is past its prime.

Heinz has only been under Buffett’s auspices for less than two years, but sales have been falling recently.

Like the recent Duracell deal, Kraft is yet another low-growth company with a strong brand. 3G has shown a knack with such businesses before, applying its playbook of cost-cutting and international expansion to ramp up profits. It worked with Anheuser Busch-InBev, and Heinz managed to grow profits last year. The group is now trying to pull the same trick with Restaurant Brands International, the result of the merger of Burger King and Tim Horton’s.

That may be the saving grace in the deal for Kraft, but the $10 billion dividend still seems like a generous gift for a company with flat sales that was valued at $35 billion before the deal was announced. If 3G can wring more profits out of Kraft, then perhaps the deal will pay off, but the business itself — with its products losing shelf space to organic competitors — looks weak. For a master of the deal like Buffett, the merger may pay off, but a Heinz-Kraft stock looks unappetizing for the average investor.

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