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200th Post: Who’s the Next Wolf of Wall Street?

Yacht parties. Huge mansions. Flashy cars. Drugs. Girls. Debauchery.

This is the lifestyle depicted by the movie The Wolf of Wall Street. In the film, Leonardo DiCaprio plays Jordan Belfort, the true story about a guy who peddled penny stocks and made a fortune off it.

next wolf of wall street

The question that everyone wants to know… is it possible to be like the Wolf of Wall Street? If some average guy was able to make all that money on Wall Street, well then can I? Are penny stocks the answer?

Well if you want to know my take about penny stocks, you can read my piece about it here. I want to be clear with you first and foremost.

Jordan Belfort did NOT make his fortune off Wall Street in the traditional way that you think about the stock market. He never owned any stocks, and the business he was involved in was not holding investments.

No, the Wolf of Wall Street was an investment broker. He was the middleman between the individual investor and Wall Street.

As a consequence, there was no incentive for Belfort to help his clients succeed. As a broker, think of the online brokers we see today like eTrade and Tradeking, he only got paid when a transaction was made. Interestingly, this reflects on most of Wall Street today. Many of them don’t get paid based on your success, they only get paid on your action (buys and sells).

So Belfort did what every greedy man without morals would do in his situation. He grabbed the horse by the throat and would say whatever he could to get his client to buy. **SPOILER ALERT** You see, Belfort quickly recognized that the commission on penny stocks was much higher than regular stocks.

All he had to do was to convince his prospect of a hot story, and get them to buy a stock. It didn’t matter what stock it was really, and it didn’t matter to him what the stock did tomorrow. As long as he got the prospect to buy some penny stocks, he would make a fortune. [click to continue…]

Investing in Commodities: What, Where, Why

If you really want to know what drives the global market of commerce, you must obtain an innate understanding of commodities and the facts behind investing in commodities. Commodities and their prices have long dictated the laws of supply and demand, determining imports and exports and attracting innovators who dare to make things more efficient or valuable.

In simplified terms, commodity prices move and the stock market reacts to those movements. Yet it’s interesting, most books about investing don’t broach the topic of commodities. So how are these investors able to be successful?

Well in the same sense that you don’t have to be a mechanic to be a great car dealer, those who are good at picking stocks don’t necessarily have to know how commodities prices are affecting long term prospects.

But it couldn’t hurt to learn. In fact, it can very well give you an advantage in a world where quarterly earnings are dissected excessively.

Here’s the definitive guide to investing in commodities: its various methods, the background and applications in the real world, and how to help it benefit you.

investing in commodities

The commodity market was created out of a basic need for stability. You see, a long time ago farmers and other merchants were extremely dependent on the price of their goods and services. This dependence was not a good thing for everyone involved.

Just one bad year could completely wipe a farmer out. Consider a year where crops weren’t very plentiful. A lower supply of corn, let’s say, would drive the price of corn higher. This would make the farmer very rich, assuming he had plenty of corn to sell.

But consider the reverse situation. Say that there was a year where harvests were bountiful all across the world, so much so that there was too much corn to sell. This oversupply would’ve driven the price of corn lower, making it harder for the farmer to turn a profit on his labors.

A farmer can’t survive in an environment such as this. He has annual expenses that don’t care if he had a great harvest or not. The farmer needs to constantly buy or repair equipment, buy inventories and seeds, and pay for his own rent as well as feed his family.

And what if he was the only game in town? Now he’d have a whole city of people who are depending on him to stay in business, or else the whole economy could collapse.

It was these unfavorable conditions that led to the creation of the commodity market. What the market did was allow anyone to buy or sell contracts on commodities like corn. This was fantastic news for the farmer. He could now “hedge” his bets, by buying or selling contracts that would bring him profit if the price of corn fluctuated.

The way to buy hedges was through an instrument called futures. Futures trade on the current price of a commodity, and fluctuate daily like the stock market. The flashing quote screens and charts you see in the movies represent commodities and the futures market.

Now the farmer could bring in enough profit no matter what happens to the price of corn. By buying the right number of contracts, his bottom line would be covered and allow him to stay in business no matter what happens in the market.

Author’s note: You can also use options for similar hedging purposes but that is for a different topic and blog post

Companies today do the same thing with derivatives. Business owners are able to use the commodity market to hedge themselves just like the farmer used to. Commodity investing, trading, speculating, and hedging draws more attention now than ever before.

Investing in Commodities: Application

Now that we know the basics of commodities, we need to learn how to apply them. After all, this information is of no use if it doesn’t make you money.

There are several major commodities that drive the world economy. You can find their charts by their ticker symbol. Here’s what they are, with their tickers: [click to continue…]

Penny Stock Investing for Beginners: 5 Rules

It’s time to finally write about the infamous topic of penny stock investing. Chances are, you’ve heard or seen them peddled before. Scammers and fraudsters seem to be attracted to the topic like white on rice. Penny stocks have a somewhat bad rep. But here’s what I think.

penny stock investing

Penny stock investing draws a wide lure because they prey on the common human emotion of greed. Mini-celebrities such as Timothy Sykes have made their fortunes from penny stock investing. The chance of “making it big” seems so much greater in penny stocks because you are starting so small.

The definition of penny stocks is any stock that is trading at less than $5, and often even less than $1. You typically see these stocks trading on an OTC, or over the counter, market. This is in contrast to the big Wall Street stocks, who trade on national exchanges such as the New York Stock Exchange (NYSE) or the NASDAQ.

At first glance the exchange might seem like a minor detail. But in fact, the exchange a stock trades on can play a massive role in just how risky a stock is.

Stocks that trade on the NYSE and NASDAQ are federally regulated by the SEC. This requires companies to submit audited financial results to the general public, which allows us to make smart and profitable investing decisions.

Stocks that trade on OTC exchanges such as the OTCBB have much lower SEC regulation requirements. Stocks trading on “Pink Sheets” aren’t regulated by the SEC at all. It’s important that you know that a lot of stocks that have gone bankrupt have gone through a stage of being listed in a major exchange, to having its share price crash, to being traded exclusively on Pink Sheets, to finally becoming worthless. Pink Sheets are like a stock market graveyard, you must avoid it at all costs or else you’ll be buried too.

That’s not to say that penny stock investing is a lost cause. On the contrary, you can find a lot of great deals with penny stocks. You just have to know what you are doing, and reading this article is the first step.

Beware of Pump and Dump Schemes

Before we continue with this penny stock investing guide, you must understand the additional risks. Because these stocks are so small, they are more easily manipulated. Though it is against the law, many penny stocks have been promoted in pump and dump schemes.

What happens in a pump and dump is that a promoter buys a bunch of shares of a certain penny stock, then convinces his audience to buy those shares. While investors think they are getting a good deal or a good investment, the promoter waits for the stock price to shoot up and then sells his shares to make a handsome profit. The promoter will often say whatever he can to get those shares higher.

In even more elaborate schemes, the promoter will sell early access to his stock pick. He releases his recommendation to the high paying clients first, then release a recommendation to his free audience.

The high paying clients will see a nice bump in the share price, but the last victims will be stuck with bad shares as the promotion ends and the stock price returns to normal levels. This type of pump and dump is very convincing because investors often see early success initially. Of course, it never lasts long and it tails off as the scheme plays out.

Penny Stock Investing: Risks/Rewards

These are the major risks behind penny stock investing. To review, let’s look at the pros and cons in a nice consolidated table.  [click to continue…]

Average Investment Fees and Hidden Fees Concerns

This is one of those fundamental posts that every beginner should read. I send out a short anonymous survey for all of my subscribers, and have gotten some insightful feedback. Here’s a question about investment fees, with my answer to follow.

“I have not started investing and find it rather difficult to get started, I read about all these transaction fees and other costs involved in starting with trading and I am concerned that there could be hidden fees that eat into my earnings.”

The topic of fees is an important one. As a beginner, it’s hard to know what to expect and it seems like hidden fees will pop up wherever you turn. Don’t fear. This post will show you exactly what investment fees you do and don’t have to worry about.

investment fees

There’s several types of fees you have to think about.

1. Yearly account maintenance fees
2. Transaction fees
3. Expense ratios (mutual and index funds)
4. Loads (mutual and index funds)

You can see that right away if you are only buying individual stocks, you only have to deal with 2 types of fees. A lot of the hidden fees that you hear about in the media are referring to mutual fund expense ratios, front end loads, back end loads, etc. Only funds have these hidden fees, and yet they aren’t so mysterious once you understand them.

The first fee is waived by most brokers. The broker I use, TradeKing, will only charge me a yearly maintenance fee if I don’t make at least 1 trade a year. So really it’s not something we need to worry about.

That leaves only transaction fees for the individual stock investor. How transaction fees work is that they will charge you a fee every time you buy or sell a stock. It doesn’t matter how many shares you buy or sell, you will be charged one time for each transaction.

What’s nice is that with the advent of the internet, transaction fees have greatly reduced over the years. In previous decades, orders had to be filled physically on a trading floor. Nowadays, everything is electronic. The dot com bubble did help the investment community in one way, by popularizing brokerage websites such as eTrade and making it easier than ever to enter the stock market. [click to continue…]

How to Calculate a Stock’s Upside Potential

Got the following question from a reader: “I was wondering, how does one go about calculating upside potential?”

upside potential

The answer to this question is really a two-part one. Firstly, you should realize that there is no real way to calculate upside. That is the beauty of investing, and wealth.

Wealth is not a zero sum game. The potential is literally limitless. It is because of this reason why the stock market can be so beautiful. People can dream for the stars and reach them.

A stock could double, but it could also gain 1,000%. Depending on the size of the stock and the growth of the company’s profits, you could see a company make fascinating gains over many years.

This is another reason why short selling is so dangerous (and counterproductive in most cases). Not only is time fighting against you, you’ll have to pay out dividends instead of receive them, but the risk/reward advantage that you should’ve had as a long term investor is reversed.

A short seller has infinite loss potential and only a 100% gain potential. Because of the infinite upside of stocks, a short seller is forced to use leverage in case of a stock run-up. Therefore, he could lose much more than he initially invested.

Contrast that to the average long term investment. The most you can lose on a stock is 100%, but the most you can gain is much more than 100%. Again this is why stocks are so attractive and useful as a tool for building wealth.

You can’t calculate future upside any more than you can calculate what the exact temperature will be in 3 months, or who the Super Bowl winner will be next year, or what fashion trend is going to explode in 2020, or even which video will go viral next.

Sure there are calculations to be made that will help our probabilities, it isn’t all helpless. But to say that one stock has more upside than other… in most cases, that’s a foolish thing to say.

Depending on the Context…

I’ll add though that it also depends on the context of the conversation. For instance, I’ll say with complete confidence that Stock A with a P/E of 15 and Debt to Equity below 0.5 has far better upside than Stock B with negative earnings and a Debt to Equity of 10.

Also, I’ll add that a stock with a market capitalization of $2 billion has more likely upside than a stock with a market capitalization of $700 billion. It’s not that I don’t think the bigger company isn’t fantastic, but it just doesn’t have as good a chance of doubling as the smaller $2 billion stock.

All that being considered, it’s hard if not impossible to calculate which of my stocks in a portfolio has the most upside. Knowing that I test rigorously and have taken the precautions to find a conservatively run company with high profitability, the rest is out of my hands. I don’t know which stock will be my big winner, but I know that over time and with enough stocks I’ll do real well.

Upside Potential pt. 2

The second part of this answer is that many investors do calculate upside potential. In fact, I see value investors do it all the time. [click to continue…]

2012 Stock Market History: THQ Bankruptcy

Not all games are fun. Just ask the shareholders who held stock through the THQ bankruptcy.

thq bankruptcy

THQ built a reputation for making big bets in the gaming industry. Unfortunately, many of those big bets never paid off.

Take the example of their big game console accessory, the uDraw GameTablet. Originally released for new Nintendo Wii in 2010, this accessory allowed gamers to draw on a screen which would output into their TV screen. The only problem was, nobody wanted it.

A released version for the new Xbox 360 and Playstation 3 didn’t help matters. There just wasn’t demand for a $70 accessory that let you draw. THQ learned this the hard way, and spent a ton of money trying to make it work.

This wasn’t the only big bet that failed for the company. Most of their big-budget games were critically acclaimed but performed poorly in the marketplace.

The Importance of Marketing

Let this be a lesson to entrepreneurs and investors out there. Just because a product is engineered optimally doesn’t mean it will sell well.

You can’t discount the importance of marketing in a business. Products go around and profits are made because of consumer demand. As a business owner (which is what stockholders essentially are), you must have an intuitive feel for what the market demands. The products you produce must be highly desired.

It doesn’t matter how much money you pour into a project, if people don’t want or need it you won’t see success and thus won’t see profits. The stock market is all about profits. This is what drives the economy, and drives stock prices higher. Simple supply and demand. Forget about the demand side of the equation and you get a failing business.

Take a look at the other grand deals THQ had. With a basic monopoly on games based on the popular Nickelodeon and Pixar franchises, it seemed like THQ was destined for success. On paper, relations with Nickelodeon and Pixar sound like a sure fire money tree.

But in the end, the market doesn’t care about who you know or how prestigious you sound. Kids just didn’t care to pay for these games, especially with the rise of online games that were free to play.

Yet another well intentioned and expensive project that ended in disaster for THQ. With a rise towards the top of the gaming world in the early 2000’s, THQ could never catch its rivals and finally filed for bankruptcy in December of 2012.

How to Avoid the Bad Bets

At first, it sounds like you can’t blame investors. How were they supposed to know that the company’s products would fail in the market? Nobody can read the future, and it’s impossible to know whose products will rise to the cream of the crop.

But there is a way that investors could’ve avoided this THQ bankruptcy disaster. There always is. A company with a bad track record for wasting shareholder money is not going to be able to hide their faults. The truth will surface in the financials. [click to continue…]

2011 Stock Market History: Borders Bankruptcy

Ironically enough, as I write this there sits 5 packages from Amazon next to me. Amazon might’ve killed the bookstore, but Borders didn’t do much to help themselves. In the end, the Borders bankruptcy shows what happens when a company is slow to change.

I mention slow to change because Borders epitomized this characteristic. To say that they were slow to adapt to the internet would be an understatement.

borders bankruptcy

When internet sales first started to get off the ground, Borders shot themselves in the foot by outsourcing all of their internet purchases to Amazon. This was a grave mistake that eventually crippled their bottom line, seen especially evident in 2006 and later.

In business, getting the customer is the name of the game. A business’s most likely customer is a previous customer. Borders failed to understand this miserably, giving away all of its online sales to Amazon from 2001-2008. What a way for Amazon to jump start their business!

That’s not the only way that Borders yielded to Amazon. Jeff Bezos, the founder of Amazon, figured out very quickly that the ebook was soon to take over the publishing space.

As a result, he made sure that his Kindle was the first e-reader to be released, in late 2007. Barnes and Noble wisely followed suit with their Nook release in 2009. Borders finally released the Kobo in 2010, but it was too little, too late.

The Borders bankruptcy could also thank the company’s inefficiency for contributing. In a time period where big box retailing was losing its allure, Borders continued to expand and insert their big box strategy into ill-suited locations. This predictably resulted in crushing liabilities in the form of binding lease agreements coupled with decreasing store traffic.

The miscues and lack of sound direction from management could very well be attributed to the fluctuating status of top level executives. What I mean is, management was constantly either leaving or being replaced.

Leading to the Borders Bankruptcy…

Borders started losing money in 2007. In 2009, the company cleaned ship. The CEO was replaced and given a severance package, the CFO was replaced, and 5 of the 8 board of directors were replaced as well.

The new CEO Ron Marshall only lasted a year before jumping ship, resigning and moving to be CEO of a different company. He had effectively convinced most if not all of the top executives to resign, including those who had faithfully worked in the company for over 20 years.

Of course, this all leads to speculation of the chicken versus the egg. Did the company collapse because the old management was all cleared out, or did old management destroy the business?

It’s hard to definitively say, and frankly, it doesn’t matter. What matters is that this ship was headed for the icebergs once it started losing money, and shareholders who were smart enough to jump onto lifeboats didn’t lose substantial investment like the rest of them did. [click to continue…]

2011 Stock Market History: AMR Bankruptcy

Some industries in the stock market should just be avoided like the plague. It’s just a sad fact about the fairness of life. Some business plans are just better than others. For stubborn investors who didn’t believe this, the AMR bankruptcy proved them wrong.

amr bankruptcy

The AMR corporation was the parent company for the more famous American Airlines. American Airlines used to be traded with the ticker $AMR, until their restructuring led to the founding of AMR corp. on October 1, 1982 in Fort Worth, Texas.

AMR also presided as parent company over other airline companies such as American Eagle Airlines, Executive Airlines and AmericanConnection. However, even they couldn’t escape the mass execution of airline stocks throughout the 80’s and 90’s.

The company filed for a Chapter 11 bankruptcy on November 29, 2011. To really understand the history behind it, you have to become familiar with the history of the airline industry.

The airline industry was heavily regulated until 1978 with the Airline Deregulation Act. This led to a glut of airline companies being created, which led to price wars and subsequent mass bankruptcies. Extremely high operating costs, in addition to big players squeezing out the little guy through continuous lowering of prices, contributed to an absolute bloodbath for investors.

Over 250 airline companies have been created since the deregulation of 1978, with most of these companies eventually falling into bankruptcy. “Legacy carriers” became a term to describe an airline that had started before 1978, and every single one fell victim to the same fate. Coincidentally, American Airlines was the last legacy carrier to file for bankruptcy.

Airline Stocks Are Terrible

The bottom line is that airline stocks have historically been a terrible investment. Similar to many of the railroad stocks in decades past, airline stocks just haven’t been able to create consistent, steady growth for long term shareholders.

Whether it’s because they are in the mass transportation business, or for other reasons previously discussed, these stocks have not done well and continue to perform this way.

Even the famous Virgin Airlines founder and entrepreneur extraordinaire Richard Branson has been quoted saying, “If you want to be a Millionaire, start with a billion dollars and launch a new airline.”

The investing Oracle of Omaha, Warren Buffett, fell victim to the allure of airline stocks in 1989 with a large investment in U.S. Airways. After the stock performed miserably, he called his decision to surrender to the siren call of airlines as temporary insanity.

About this decision, he said, “There’s no worse business of size that I can think of than the airline business. You’re selling a commodity product with no variable costs. Huge fixed costs. It’s a terrible business.”

The legend really puts it succinctly. Airlines is a terrible business. Period. [click to continue…]

2011 Stock Market History: MF Global Bankruptcy

Some things don’t seem important until they are gone. Concerning the importance of liquidity, the public learned this the hard way with the MF Global bankruptcy.

mf global bankruptcy

MF Global was a global derivatives broker providing many various financial instruments. The key word in there was global. Because the company’s reach spread through international waters, the way this debacle played out became increasingly complex.

After a series of poor decisions, a riskily placed bet of over $6 billion on bad European debt put the nail in the coffin. Scrambling to keep these bets viable, the company unforgivingly transferred customers funds into their account. It only took a few days before the final bell tolled.

Due to recent events, the company had a bad reputation for poor decisions across its ranks already. A commodity trader at the firm tried to take advantage of a temporary shutdown in MF Global’s risk management system. Trying to turn a personal profit, he ended up losing the firm $141 million in ill-placed trades.

The fact that such a mistake took place reflects on the competency of the management there, who really take the lead behind the CEO. Turns out, the U.S. Commodity Futures Trading Commission recognized this and fined MF Global several times for risk supervision failure. [click to continue…]

2010 Stock Market History: Blockbuster Bankruptcy

Steve Jobs once said, “cannibalize your product or your competitors will do it for you.” In the case of videos, Netflix and Redbox were the new competition. This and more contributed to the blockbuster bankruptcy of Blockbuster Video.

blockbuster bankruptcy

Before the Blockbuster bankruptcy that was preceded by Hollywood Video’s bankruptcy, Blockbuster’s origin story sounded like every other good business success. Before the internet and Netflix, Blockbuster had carved out a very profitable business model.

DVDs, and VHS tapes before that, were bought just once. The inventory was then rented out and turned a profit on itself after just a few rentals. The same inventory then brought repeat business for as long as demand would allow. For some popular movies, this “free” profitability could last for years.

The products also saved the customer money. For the fraction of the cost of box office tickets or outright purchases, customers could view the titles they always wanted to see.

For decades, Blockbuster was the king of its industry. As the number of Netflix subscribers 10x-ed from 1 million in 2002 to 10 million, Blockbuster slowly started to die as it saw less and less traffic in its retail locations. The famed billionaire Carl Icahn did his best to try and revive the company, but it was too late. On September 23, 2010, Blockbuster filed bankruptcy.

For the young and trendy people, this bankruptcy came as no surprise. Their consumer habits had already shifted towards the more convenient Netflix. But for the “out of touch” investor, the bankruptcy should still have come as no surprise as well.

Like is the case with each of the bankruptcies we have studied, the writing is on the wall before a company files. Filing for bankruptcy is the last desperate surrender. So as investors, we can avoid getting axed by paying attention and knowing what to look for.

So what warning signs did Blockbuster show investors? Like always, I need to see hard proof. It’s easy to say that Netflix was going to take over Blockbuster, because we have perfect hindsight and the luxury of seeing these events already play out. [click to continue…]