Earnings Per Share – the #1 most talked about metric for a company’s quarterly results (based on my experience that is backed up by 0% statistics and 100% listening to my peers when discussing earnings).  There’s so much emphasis put into a companies EPS and therefore, such a huge importance on EPS estimates.

If you’ve ever listened to Mad Money with Jim Cramer or Fast Money, or really anything about investing at all, you know that EPS is really all the hype.

But why is that?  Does a company’s quarterly earnings really change the value of the business?  In short – no.  Now, there could be something that comes up in the conference call that could fundamentally change the value of the business that also impacts earnings. 

For instance, maybe a company says that while they expected to be able to continually decrease their Cost of Goods Sold (COGS), they have hit a limit to the amount that they can decrease their expenses and it basically is what it is, so now the earnings are lesser than anticipated because the COGS are higher than expected. 

But, are the earnings really what is causing the concern, or is it the lack of potential to decrease the COGS? 

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Have you ever realized that you have unrealized gains?  See what I did there?!

I know, I know – I really need to stop being so cheesy…

So, what actually is an unrealized gain?  Well, you’ve likely heard of the term ‘realized’ which simply means anything that has come to fruition.  For instance, you might’ve invested in a company an expected annual 8% return, but the return was actually 10%. 

So, let’s say that you bought the $1000 worth of stock and sold It for $1100 – your ‘realized’ return was 10% because that actually happened.

Now, an unrealized gain would be the exact same scenario except that you don’t sell the stock.  So, instead of selling the stock for $1100, you’re still holding it but it’s currently worth $1100.  In other words, the difference between realized and unrealized is if it can change or not.

The first example is realized because you sold the stock for $1100.  So, even if the stock crashes, or continues to rise, it doesn’t matter – you sold your holdings and locked in a 10% gain.  So, you realized a 10% gain. 

In the second example, those are unrealized gains because while you’re currently up 10% over your investment, if the stock boomed or crashed, your returns would be lesser or greater, depending on which way the stock went.

I will oftentimes in my 8-5 job talk about realized margins when I am doing a post-audit on a contract.  For instance, we will put out an ‘anticipated margin’ but we don’t know what the ‘realized’ margins are until the product has already been sold and a margin has been locked in.

If I had to boil it down into a simple thought, it’s this:

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Table of Contents [Click to Skip Ahead]

1. Intro to Options
2. The Two Most Basic Options Contracts
3. The Options Killer: Time (Theta)
4. How to Create a Safe Income Stream from Options
5. How to Calculate Potential Profit and Loss on Any Call or Put
6. Other Strategies and Important Risk Management
7. The Martyrs of Options Trading and Their Losses

I like to warn beginners that options trading is like “the stock market on steroids”. One day of watching options prices and you’ll see that it’s true. 

Those small 1-2% moves made in the stock market each day can mean huge returns for options traders. The premium to be made in volatile stocks that are hated by the market can be huge too, dwarfing the income received by your average dividend.

But, the options market is rife with risks. With some of these types of trades, your capital is likely to go to zero, and/or… your account will blow up in a big way (as Warren Buffett says, like picking up pennies in front of a steam roller).

I’m not here to try and convince you about options trading one way or the other.

What I will try here is this.

To present to you an overview of the options market, in the simplest way that I can.

I won’t bore you with second degree algebra, confusing charts, or complex unexplained jargon.

What we’ll boil down to is the basics. You should know what the basics of options are after this post. You should understand many of the risks that come with trading options. You should get a grasp of some ideas to trade profitably– and hopefully– consistently. 

Take this information here, and have at it.

But please…

• BE CAREFUL. 
• Try to ALWAYS keep your emotions in check. 
• Absolutely RESIST the urge to be greedy.

Start small, with some play money, and especially with money you can afford to lose.

Please don’t trade options on margin, and especially don’t write naked calls. And finally, when it comes to investing big bucks into options, know EXACTLY what system you will use. And follow it.

I believe options are incredibly powerful, and dangerous. 

So please, take these warnings to heart. Try to really pay attention to the details of this post. Bookmark it even, and re-read it time and again to keep your approach straight and really understand what you’re doing.

Intro to Options

Alright, so just how great can options be?

Well… imagine putting $50 into an options contract. Say that the stock for that options contract jumps 10% in a day. Your gain on that $50 could be $130, or even $1,453!!

But it’s not all rainbows and flowers. To get a return like that, you’d have to take quite a risk. So much in fact, that if the stock doesn’t jump significantly, your $50 would turn to zero.

This is just one example of an options trade you could make.

I’ll present several more, but know this: options contracts generally give you more flexibility and greater variety on your risk/reward profile than stocks do. 

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Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:36                     All right folks, we’ll welcome to investing podcast. This is episode 133 today. Andrew and I are going to discuss commodities and oil a little bit. We’ve not talked about these before and so we thought we would touch on this subject a little bit. So Andrew, why don’t you go ahead and share your thoughts with me and we’ll have our little conversation.

Andrew:                              00:56                     Okay. so you know, oil has been awful lately. Have, have you invested in any oil stocks as of late?

Dave:                                    01:06                     Uh not as of late, but about three years ago, I did buy a company called national Oilwell. Varco yeah, that sounds right. Yup, yup, yup. Yeah. NOV. Yup. I didn’t invest in them and I lost a lot of money and then I sold out of it. So that was not to the bottom at the time.

Andrew:                              01:31                     So, yeah, yeah, I remember looking back in 2013 and seeing that Chevron looked interesting. And if you look at their price charts since then, it’s been, they’ve done like absolutely nothing. I had bought a company that was oil services and I sold that one at a loss and then it proceeded to double from there. But I think when you look at the majority of oil stocks lately, they’ve been awful. Especially as this bull market has run up through the end of 2019, it seems that every industry is firing on all cylinders except for oil and not even oil. Just when you say, the energy sector that kind of encompasses all of that. And so as an investor, you know we want to try to stay within our circle of competence. And when you start to get into some of the more complex industries, something like natural gas, oil, crude oil things can get complicated. And it’s not always as simple as looking at customer behavior or, you know, as an example, I could be somebody who is a certain type of consumer.

Andrew:                              02:53                     And so when I see a business doing something that I like, I can take that and, and make a general observation that there’s probably a lot of other people who are also liking a certain company for their product. And then, you can look at the financials and that can kind of play out when you start to look at companies that are more complex or are dependent on other factors such as commodities. It can be a little bit more difficult, but I don’t think that it needs to be something where necessarily it becomes a thing where we’re never investing in these types of companies. I think it’s worth taking a look and finding ideas and opportunities. And if we can understand the basics of how commodities work, then we can at least have some competence. And then you can choose to become, you know, anything from an industry specialist down to maybe someone who’s at least aware of what factors are, are contributing to how your commodity business is either profitable or not profitable.

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Andrew and Dave recently talked about investing in Biotechnology Companies on their podcast and it was by far, one of my favorite episodes that they have ever done, and I can say that for multiple reasons:

• Biotechnology Companies are the hot thing right now.  Think that toy in Jingle all the Way that Arnold Schwarzenegger is doing everything he can to find a way to get.  That’s how people are treating these stocks.
• They go through a very thorough discussion of a company, Jounce Therapeutics (JNCE), and talk about the numbers behind the stock and whether it is a good investment.
  • I constantly talk about the importance of running your own analysis and this is by far the best example of this that I could give, and I am not even actually providing the example, so do yourself a favor and listen to the episode.

For starters, biotechnology companies are those that use living organisms to make drugs.  Some of the largest and most well-known biotechnology companies include Pfizer, Johnson & Johnson, Tilray, Gilead, and Amgen.  Chances are you have heard of some of these companies but regardless, let’s check out some of the pros and the cons of investing in biotech:

Before I get into the specific pros and cons of biotech companies, I think it’s very important to explain the nature of these companies.  Biotech companies are super, super risky.  You’re trying to find a company that you think is going to be able to hit it big and one of their drugs are going to pan out for them. 

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Reporting quality and earnings quality are two sides of the same coin used to judge a company as a potential investment. Analysts need to first make an assessment of the reporting quality of the company before they can begin to rely on and interpret the reported financial information to make judgments about the earnings quality of the company.

If reporting quality is low enough on the spectrum and enough red flags are raised in an assessment of earnings quality, prudent investors should not hesitate to say “I wouldn’t touch that company with a 10-foot pole”. Studious investors doing their homework might have got out of the likes of Enron, Nortel Networks, Valeant Pharmaceuticals and GE (to name only a few) early to avoid the impending corporate disasters that were so clear in hindsight. 

Reporting Quality

First up, reporting quality is concerned with the presentation and information provided in the financial statements. The financial statements should provide decision-useful information which can then be used to assess the quality of earnings and make investment decisions. In order for financial information to be useful to investors, it needs to be both reliable and relevant which are primary qualities of financial information. 

Reliability: Financial information needs to be faithfully represented and follow either U.S. generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS). High quality financial reporting should also be free from material errors and bias.

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Have you heard of the January Effect before?  The January Effect is a very common topic this time of year in the investing world where people claim that the best performing month in any single year is January.  In other words, the market is going to have the greatest return in January than it would vs. any other month.  That’s great and all, but is it true?

First, let’s start at why people think that this is occurs.  Far and away, the biggest reason why people think that the January Effect occurs is because people are selling off their stock losses at the end of the year to minimize their taxes.  For instance, if you have a stock that you sold earlier in the year where you made $2000, and that was the only stock you sold all year, you’re going to be taxed on that $2000 at either your normal tax rate, or the capital gains tax rate if you held it for less than a year (which is substantially higher)! 

But, if you sold a stock that has been a major loser for you, and say you’ve lost $1000 on that stock, now you will only owe taxes on $1000 rather than the $2000 noted above.  You can use your losses to cancel out some of your gains to minimize taxes.

So, is this valid reasoning why the market might dip in December as people sell off and then regain in January?  Yes, absolutely.  But – now that so many people are using tax-sheltered accounts like an IRA, 401K, HSA, and many others, this is becoming less and less prevalent.

The next reason that people give is that mutual fund managers, and even individual investors, are rebalancing their portfolios.  The mutual fund managers might be seeking for the biggest winders for the next year while maybe the individual investors are rebalancing their stocks that started at 80/10/10 (stocks/bonds/cash) that now has grown to 90/5/5 so now they’re going to sell 10% of their stocks at year end to get back in cash and bonds and take ac vantage of a tactical asset allocation plan.

I understand this logic as well and I don’t dispute it.  I think it’s important to rebalance at least once a year and now maybe more that you’re likely not paying fees on your rebalancing. 

But the question is – do either of these reasons generate enough of a reason for January to be the best performing month of the year?

In my analysis, I looked at 20-year time periods starting in 1930 except for 2010 – current, and I compared the return of the S&P 500 vs. other months.  Below is a summary of the information:

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At a very high level, a financial instrument is simply a monetary contract between parties.  The International Accounting Standards define a financial instrument as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.”

The key word to focus on here, in my opinion, is ‘contract.’  The contract portion of this really determines whether it is a financial instrument or not.  While the timing and asset classes can classify these financial instruments into different categories, the contract is what makes it fall into the much larger ‘bucket’ of financial instruments.

There are mainly two different types of financial instruments, cash instruments and derivative instruments.

Cash instruments are instruments that are very liquid and can be easily traded.  One very common example of a cash financial instrument is a stock.

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Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners, led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:37                     All right folks, we’ll welcome to investing for beginners podcast. This is episode 132 tonight Andrew and I are going to listen to a few clips from our uncle Warren Warren buffet that is, and we’re going to, I picked out some different interviews and picked out some different clips, and I’m going to play them for us. And then Andrew and I are going to comment on those as well. So hope you guys enjoy, and without any further ado, I’m going to go ahead and turn it over to uncle Warren and let him do his thing.

Warren Buffett:                01:06                     Well, yeah, if you own stocks like it on a farm or apartment house, you don’t get a quote on those every day or every week. And I think you look, you look at the business, and the value of American does. This depends on how much it delivers in cash to its owners over between now and judgment day. And I don’t think it changes by 10%.

Andrew:                              01:23                     Yeah, I liked this one. Was this from a recent Berkshire meeting? It sounds very familiar. It’s an interview that he gave on TV about a year ago. Yeah, I remember that interview. I think it was with Becky Quick on CNBC. That’s correct. I’m everything out now. Okay, cool. Yeah. Yeah. So yeah, I liked that quote by Buffet. When you look at the market, and you see the wild swings, we’ve, you know, one of the things that have been on my mind lately is the big moves and a lot of these different stocks based on just the smallest of news. And so you’ll see these huge swings and it goes against what you know is a business losing, let’s say 10% of its earning power or gaining 10% of its earning power within the period of a few days. I think that’s, that’s somewhat hard to imagine.

Andrew:                              02:32                     And yet we see these huge swings in price with a lot of these stocks. And so it makes me laugh to think that there’s, there are ideas that you can’t find value within these wild swings. And I think especially when you’re looking at a prolonged bull market, or you’re looking at a very pessimistic bear market, there are going to be a lot of wild mispricings. And so that can lead to a lot of opportunity for investors and particularly investors that can be a little more rational level headed and have this old school, Warren buffet business owner type approach to the stock market. And so I think, you know, it’s starting with that quote right there. I like it because it defines how we look at the stock market and kind of where that competitive advantages, right? Because if you’re going to try to buy stocks and you’re going to try to be at least as good as the market of their, tried to beat the market, you have to know where your edge is and what that is.

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