Gibybo’s Money

Most people understand what the stock market is and that a bunch of suits driving fancy sports cars use it to make lots of money. At least I think they do, I know I do. Unfortunately, the complexities of the system often intimidate the rest of us without suits or fancy sports cars (damnit) into avoiding it altogether. Hopefully I can help by providing a simple overview of how it all works without all the stupid nuances that I am convinced exist solely to make it complicated.

It helps to look at it from a company’s point of view so imagine you’re just starting a business and you need to buy supplies, equipment, advertisements, and if you’re lucky maybe an employee or two to help you out. The first place people typically turn is their credit card which sort of works but it has its limits. Ideally though, they persuade an investor to give them a ton of money in exchange for partial ownership of the business so that if it ever takes off they will all make even more money. Usually they fail and lose the money but occasionally the business gets lucky and starts making truckloads of cash and the lucky investor who decided to take a chance with them wants to collect his reward.

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I finally got the cash from the Landec sale transferred into one account and used it to buy enough shares of NVDIA to bring that position back up to it’s fair share of market value in my portfolio. I still have a larger than necessary amount of cash sitting around so I’ll be looking to bring other positions back to balance and perhaps another company as well. Actually, I bought the NVDIA shares on March 31st but didn’t want to post about it until I had the rest of the site back to working order.

It took longer than I had planned but the shiny new backend is running well and tracking a few different portfolios now so perhaps I will show them off in the near future. In the meantime, the performance graph and holdings are back to being updated daily.

I’ve been keeping a close eye on Google stock as it has fallen from $700/share to just over $400/share in the past few months due to concerns of stagnating growth. Its high valuation came tumbling down in the midst of recent credit issues when they missed earnings expectations and investors grew weary of less than solid profits in recessionary times. What really happened was they made a long term business decision that dropped their short term earnings with AdWords, their primary source of revenue. While investors were already afraid of market collapse their earnings report seemed to invoke a sense of panic that the cash machine may be fizzling out. A month later they reported that ad clicks had decreased for the first time ever and investors became even more concerned and pushed shares even lower when really the decrease in ad clicks is a direct result of the same long term business decision and was really already accounted for in the previous quarter’s earnings drop.

I mentioned awhile ago I thought Google was a great buy but I would wait for shares under $400 before I felt it was great enough for my own portfolio and I stick by that. It’s a fantastic buy now at $430/share but so are a lot of companies due to credit fears and I want the best, not just great. However, it seems to be getting closer and closer to my $400 mark and I’m ready to jump on it if it does. I think people are being unreasonably pessimistic, but I’m certainly not complaining as long as they are willing to sell their shares to me :]

I’ve been pretty busy recently with various thing and haven’t had a chance to update much. I have been redoing the back end of the portfolio tracking system though to handle a lot of portfolios rather than just my real money account, that way I can track multiple test portfolios and perhaps put up a simple interface for others to create their own as well. It’s not quite done though which is why it hasn’t updated my graph or holdings in the last few days.

Along with that I am going to move the CAPS testing portfolios to this site and automate the task of updating it weekly. As you may have noticed, I have fallen a little behind updating the portfolio on the CAPS website. Still though it appears to be handily beating the market with a relatively diversified set of holdings. With my last update I also added a few bear recommendations using the same ratings differential logic (but using a negative differential) to test a short selling application of the idea. It appears to have exceptionally high accuracy (70-75% depending on how you measure it) in determining short term movements which is a bit unexpected since I am looking for long term valuation mistakes rather than any sort of momentum. It could be a sign that I’m just getting lucky or perhaps the differential is more an indication of momentum than I thought originally.

I hope to have the enhanced portfolio system up and running soon, until then you’ll have to use your imagination!

I have finally setup a system to find the stocks that have the highest ratio of All-Star recommendations to total recommendations as defined in my first post here. It takes periodic samples of the ~3000 stocks with more than 50 ratings from the CAPS website and allows me to run the necessary calculations.

For the first week I changed the math slightly to use the difference between the ratios instead of the ratio of the ratios between All-Stars and the total population. I think this way it is a bit more reflective of what I was trying to accomplish in finding the stocks where the smart money disagrees with the average money most drastically. I ran the numbers and found the top ranked stocks then setup a separate account on CAPS to record my predictions. You can see a list of the current stocks I am predicting to be undervalued in a table lower on that page, as well as their price movement since I predicted them. Every week I will adjust the account to reflect the new top ranked stocks if there are any differences. As time progresses and I add more predictions these tests should provide pretty accurate results of my ranking mechanism; the error margin is still really high, but so far it has climbed ahead of the S&P 500 by 2% in a week!

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I have been keeping a close eye on Landec (LNDC) for awhile now and it just doesn’t impress me anymore. Analysts have high expectations and CAPS loves it but I’m not seeing it. I ended up selling it at the end of the day on Friday (caught it a few cents short of its daily high, only for it to pop 5% on Monday - oh well!) because I think everyone else must be seeing something I don’t which means I no longer have an edge.

The real issue is just that I don’t understand their business very well, which was probably a mistake from the beginning. I know what they do and what they make and what their market is, but their revenue is a mystery to me. It seems they go in phases - either they are increasing top line sales and earnings are staying still, or earnings are increasing but total revenue isn’t budging. Recently their revenue has stayed pretty consistent and I’m not sure they can really go anywhere until that’s increased; I don’t understand how they plan to do that. Their 2007 numbers are skewed since they sold a portion of their business for $22 million which has more than tripled their earnings for the year, dropped their P/E ratio to the floor, and sent their profit margins to the sky. Maybe that helps explain the high expectations, I don’t know. However, if that sale is not counted, their earnings have actually decreased from the previous year and their ratios seem more expensive than they should be.

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I still rent movies at the store rather than online, but when I get there I end up staring at a large shelf of movies with no idea which ones are any good! I do have a fancy smart phone with internet access, so occasionally I try to lookup the movie on Rotten Tomatoes to check its rating but they don’t have a mobile version so it requires loading 3 pages and waiting 10 minutes just to lookup one title! Eventually I just end up picking one with a decent looking cover and title which often results in wasting $5 on a crap movie because I didn’t know any better. Never again!

I wrote a little script at www.gibybo.com/m that works on my phone providing a really quick way to check ratings. It just sends the search to this site which navigates Rotten Tomatoes to get the rating for you then sends it back without all the extra loading time. It still requires a phone with internet access (text message support would be a cool addition), but it turns a formerly impractical 10 minute search into a convenient 5 second check which means you no longer have to rent shitty movies!

Ok ok it doesn’t have much to do with finance unless you count the saved rental costs, but it’s still pretty cool!

Update: Fixed again!

I hear it everywhere, ‘experts’ telling investors to buy into and out of stocks in increments; after all, you could buy a stock and it might go down and you’d lose a lot of money so you should only buy a little at first! The way it works is when buying a stock and you have say $900 to put into it, you put $300 at first, then $300 a week later, and the last $300 a week after that. As the stock price fluctuates over those few weeks, each purchase will be worth a different amount and at the end they will combine to provide an average purchase price that is less susceptible to wild fluctuations on any one purchase. It’s a risk mitigation strategy and it definitely mitigates short term risk.

Reduced average earnings

There’s nothing wrong with reducing risk, of course, but this strategy reduces longterm return in favor of smaller short term fluctuations. Sure stocks appear to behave quite randomly in short periods of time, so why not buy them over time to get a less random investment? The short version is that share price is not as random as it may seem. All stocks have a subtle random bias towards increasing in value in the future. This bias is incredibly important as it has allowed the stock market as a whole to roughly double in value every 7 years on average. It makes sense then that the sooner you put money into the market, the more that money will probabilistically be worth in the future. Just about everyone involved with financial advice understands this and preaches early investing.

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I gamble like I invest, I take the easy money. The bookies and the established betting firms always have the advantage, there’s no money to made there (unless you have inside information of course). However, we had a small Super Bowl gathering and everyone had money to gamble with! I was able to take advantage of this with a small ($10) bet on the favorite with 1:1 odds giving an expected value of $16 (based on the 80% consensus for Patriots to win). That wasn’t the important betting though.

The real money was in the last digit betting pool we had going. They typically call these ‘Super Bowl Squares’ because the way it works is that you create a 10×10 grid listing the numbers 0-9 on the top along with a team and do the same thing for the side with the other team. Each square then represents a unique combination of the last digits of each team’s score. Each square can then be sold for a set amount and the square representing the last digits of each team’s score at the end of each quarter gets 1/4th the total amount (since four quarters). However, some squares are more likely to win than others since the chance of a score ending in certain numbers is much higher than a score ending in others.

The accepted way to deal with this is to sell the squares before randomly assigning the digits to them, that way each square is probabilistically worth the same as any other square. Fortunately, that’s not the way we did it; we were allowed to pick our squares after knowing the digits, allowing an enormous advantage to the more mathematically inclined. Of course I wasn’t going to let easy money get away, so I found this handy chart that listed the frequency of each digit appearing in football teams’ scores at the end of each quarter since 1994 and quickly bought up the 15 best squares (the ones that had a probability of at least 2%). The combined expected value of just these 15 squares (based on an even split between four quarters as opposed to the 10/10/10/70 weighting in the last column of the linked chart) was roughly 40 times a single square.

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Okay I missed the news when everyone else was talking about it, but better late than never right?!

Google reported earnings after hours on Thursday missing estimates and raising concerns of slowing growth. Their stock responded with a swift drop despite 52% growth since last year. This appears to be a really short-sighted reaction since they recently changed the way AdSense accepts clicks. AdSense revenues make up a majority of the company’s income and by reducing the click area of the ads they have temporarily reduced earnings since they receive less clicks. However, it looks like everyone is failing to realize that they made a strong long-term business decision that will increase the value of their advertising (since clicks will now be of higher quality and less accidental) in the coming years (quarters?). I find their current $120 billion valuation really attractive, I definitely anticipate them trouncing the market in the near future as they continue to surprise everyone with future earnings.

If that news wasn’t enough to shake up the tech sector, Microsoft announced their plan to buy Yahoo! for $44 billion less than a day later. This deal is a clear response to Google’s growing threat to their online presence and Microsoft sounds really hungry for Yahoo!. Not only is their bid 60% higher than Yahoo!’s previous valuation, but they sound comfortable increasing that bid if they have to! Still, Google investors seem to be unaffected by the news as GOOG shares were about the same as they were right after the earnings report.

In related news, I have an interview for a software engineering internship with Google in a couple weeks; I think that will add an easy $10 to their share price if I get it :)