Stay Away From Homebuilders

November 21, 2007

On October 9, I wrote an entry to tell people to stay away from airline stocks. Since then, both China Southern Airlines and China Eastern Airlines (CEA) and China Southern Airlines (ZNH) are down 30%. Other airline stocks mentioned by tao2death like US Airways Group (LCC), UAL Corporation (UAUA), and AMR Corporation (AMR) are down between 20-33% since that time. Of course, a lot of stocks are down because of the declining market, but oil is closer to $100/barrel since then and there have been no legitimate talks of a UAL/Delta merger that would help the entire airline industry.

My next advice would be to stay away from homebuilders. We all have been aware of the subprime fallout, credit crunch, and the slowdown in the housing market. Analyst aren’t entirely sure of when the housing market will stabilize and bottom out and many have been forecasting middle to late 2009. A CNN Money article states that some homebuilders could end up bankrupt and while homebuilding was reaching 2 million homes/year in 2005. That homebuilding rate is poised to be about 1 million homes/year in 2008. That does not bode well for US homebuilders like Hovanian (HOV), Pulte Homes (PHM), D.R. Hortan (DHI), and Beazer Homes (BZH). Beazer Homes also suspended their dividends earlier this month and laid off 25% of its workforce. Even historically stronger housing stocks like KB Homes (KBH) and Lennar (LEN), which sports over 4% dividends, are down 62% and 82% respectfully from their yearly highs.

When the 3th largest home builder by market value, Pulte Homes, hit $15/share (57% drop from their yearly high) all throughout October, I was contemplating that it might be a chance to pick up some shares of this discounted home builders. Since then Pulte has managed to drop down to today’s current price of $9.50.

Pulte CFO Roger Cregg is selling over 150,000 shares of the companies stock at less than $12/share and if you own housing stocks, maybe you should too. If you’re fortunate not to have any holding in this sector, make sure to stay on the sideline for the time being. Houses are losing value all across the country and homebuilders are piling on huge incentives for people to buy houses. Buyers are spooked to buy a house, mortgages will be harder to obtain, and people seem to be more willing to rent in the immediate future. To me, it looks like a bleak time where nobody knows where the bottom is and for some of these homebuilders, there might never be a recovery for them.


Tax Awareness: Kiddie Tax 2007

November 14, 2007

The kiddie tax is a tax stipulation implemented by the government to prevent parents from taking advantage of their children’s lower income tax rate. The government wants to discourage families from using their kids as a safe zone for investment gains. The gift tax allows individuals to give up to $12,000, and married couples to give $24,000, without triggering the gift tax. Therefore, the kiddie tax discourages parents from giving their kids big chunks of investments so they don’t have to pay the higher tax bracket rates.

The kiddie tax has these basic rules:
– in fiscal year 2007, applies to children younger than 18
– applies to unearned income (investment income) more than $1700 (the first $850 of unearned income is tax free and the next $850 is taxed at the child’s lower tax rate)
– earned income like working a job does not apply to the kiddie tax because it is not a form of investment income
– in 2008, the kiddie tax will apply to children under 19 and college students under 24 (with exception of students who provide more than 50% of their support)

What this means?
Before the end of 2007, parents (who fit into the lowest two income brackets) needs to make sure to exploit the kiddie tax rules before changes occur in 2008 by giving the maximum allowable amount, without incurring the gift tax, to their children between 18 and 24 years old. Their children can then sell the unearned income before January 1, 2008 and only incur a 5% long term capital gain tax.

Here’s how the kiddie tax works this year. Let’s say that Robert and Lianna have a son named Nic who is 16. Their combined income puts them in the 28% tax bracket.

Scenario 1:
Robert and Lianna give their son $10,000 worth of appreciated stock. Nic sells the stock for an exact $1,700 profit (unearned income). Nic will pay nothing on the first $850 of profit and then 10% of the next $850 (via the 2007 federal tax rate). In conclusion, Nic pays $85 in taxes on the $1,700 investment gain from his parents which equates to a 5% total tax of the total unearned income.

Scenario 2:
Robert and Lianna give their son $10,000 worth of appreciated stock. Nic sells the stock for a profit of $3,000 and pays $85 tax on the first $1700. On the next $1300, the kiddie tax comes into play and is taxed the normal rate of Robert and Linda at 28% ($364 tax incurred). In conclusion, Nic pays $449 in taxes on the $3,000 gain from his parents which equates to a 15% total tax of the total unearned income.

While this isn’t something that benefits every family, it is always good to be aware of tax loopholes and ways to lessen what you have to give to the government. Why give more than you have to?


Basics: Annual Percentage Yield (APY)

November 11, 2007

To be able to compare different investments, you need some number to measure and quantify. This number is the Annual Percentage Yield or APY.

First off, APY is different from Annual Percentage Rate aka APR. In the past I wrote APR when I meant APY. This has since been corrected. The number you care about is the APY, which is the equivalent interest rate for holding something for a year. APR is the interest rate per period times the number of periods per year. This does not take into account compounding. Why is APR even used at all? They use APR for listing loans to make the interest on them appear smaller. Those banks and car salespeople are sneaky, sneaky.

Let’s take a look at CDs and consider why you need something like an APY to compare them. I will make an assumption that the rates will never change. Let’s say you have a CD that will give you 1% of the principal at the end of 3-months and another that will give you 4% of the principal at the end of a year.

Well, 4% is more than 1%, so I’ll choose the 4% one.

Wait. It takes a year to get the money back from the 4%, but only 3 months to get the 1% back. There are four 3-month periods in a year, so you could get 1% back 4 times, which is 4%. Wouldn’t that make the two the same?

Wait. That 4% interest for the 3-month CD is the APR. You’re not actually getting that much. At the end of the 3 months, you get your money back and 1%, which you can reinvest into another 3-month CD and get 1% back on your principal and interest gained on the 1st CD. Your gains at the end of a year would actually be (1.01)^4 or 1.04060401. That 1 is your principal, so your gains are 4.06%. 4.06% is the APY on the 3 month CD that gives you 1% back at the end of 3 months.

CD #1 #2
Period 3 months 1 year
Period Interest 1% 4%
APR 4% 4%
APY 4.06% 4%

Only when you look at APY do you see a bigger number, which is really how much the investment is worth. APY is also important when you have two options that have the same duration. You can have two 1-year CDs, which compound monthly versus daily. Let’s examine this more carefully and actually calculate APY for a general case.

CD #1 #2
Period 1 year 1 year
Compounding Periods per year 12 365
APR 4% 4%
APY 4.074154% 4.080849%

APY = (1 + APR/(# of compounding periods) )^(# of compounding periods)

CD #2 is a better choice since it has more compounding with the same APR.

Summary

The APY gives you a number that you can compare investments even if they are different in duration. The only reason you would pick something with a lower APY is when you think interest rates are going to change.


Basics: Certificates of Deposit (CDs)

November 3, 2007

The Certificate of Deposit (CD) is the most basic and mundane investment vehicle offered by banking institutions. If you agree to hand over your money to the bank for a specific period of time they will reward you with a higher interest rate than your savings account. In a regular savings account the bank has no guarantee that you won’t just withdraw all the money the next day. As an example, Citibank (C) currently offers 0.7% APY for day-to-day savings account and 5% APY for a 6-month CD.

Term Structure

Term APY
3 month 3.75%
6 month 5.00%
9 month 4.5%
1 year 4.20%
2 year 4.00%
3 year 4.00%
4 year 4.00%
5year 4.25%

The amount of interest on your deposit depends on how long you hand over your money to the bank. The general trend is that the interest is higher the longer you keep your money in the bank. This is because the bank can do more with your money during a longer period of time; like investing it or loaning it out to people. In this example, the rate goes down after 6 months because the bank expects the Federal Reserve to lower interest rates in the future. If the bank can get cheaper money in the future, then it is unlikely to give you a better interest rate for longer-term CDs.

Laddering

People often ladder CDs to lower the commitment of their funds. Laddering eases the commitment by having multiple CDs mature at different times. Each time a CD matures it is like a rung on the ladder. If I had $10k in a one year CD, my money would be locked up for a year. If I put $2.5k in a one year CD in January, April, July, and October I would have $10k in CDs for a 1 year term, but every 3 months I can take $2.5k out and spend it as I wish or reinvest it. This keeps your money from being locked up.

Advantages

  • Higher returns than savings accounts
  • Guaranteed return for a period of time
  • FDIC insured up to $100,000
  • Easy to transfer money from existing savings/checking at the same bank

Disadvantages

  • Returns typically lower than stocks and bonds
  • Penalties for early withdrawal of funds from a CD.
  • Some banks require high minimum balance

Analysis

Online banks offer savings account with interest rates close to CDs, such as 4.5% on HSBCDirect (HBC). While investing in a S&P500 index fund will most likely yield 10% over the long run, CDs still have their place if you plan to use that money in a year but don’t want as much risk. If you’re planning to buy a car in a year, then a CD is a good place to put your money.


Application of Stock Picking Basics (2)

November 2, 2007

It is very easy to get carried away and buy stocks when the market is up to ride the positive upward momentum. But it is much more difficult to invest in declining markets. Declining markets provide opportunities to buy stocks that are oversold or undervalued. Investors need to realize the following points when investing in declining markets:

a) Make sure you have the cash available to invest in new options. This is why it is always a good idea to keep a share of your stock portfolio liquid on the sideline for major drops in stock prices.

b) Selling a stock at a loss may be necessary to get into another investment opportunity with more potential. If you think the stock you currently own can only go back up 20%, but another company has the potential for 30% gain, write down the loss for the year and make a better investment choice.

c) Keep your head up and don’t get discouraged by all the negative news because people will panic and it’s your job to find stocks that don’t deserve to be at their current valuations. Think of down markets as discounts the market is offering you.

d) Don’t just buy whatever has dropped the most, but still concentrate on what businesses have the best future growth prospects. Remember, some sectors are not very attractive markets to buy whether you’re in a bull or bear market. Right now, I feel that way about home builders and mortgage companies. Maybe a company like Home Depot (HD) would be a safer bet if you want a company that has some direct correlation with the housing market.

e) Mentioned in the Application of Stock Picking Basics (1), make sure you only invest in companies that you understand. If you don’t understand how the company makes money and will be able to increase profits domestically and globally, it doesn’t matter how much they are down.

The NYSE was down 2.6% (more than 360 points) and will probably feel some negative effects tomorrow with much uncertainty in the market. Stocks from all sectors got pummeled, and some stocks of note to take a look at that were down at least 4% are:

  1. Las Vegas Sands (LVS): -5.6% in regular session and -15.1% after hours to 106.402
  2. Peabody Energy (BTU): -11.3% to 49.47
  3. Wynn Resorts (WYNN): -4.0% in regular session and -8.3% after hours to 142.084
  4. Aluminum Corp of China (ACH): -7.1% to 68.02
  5. KB Homes (KBH): -6.4% to 25.88
  6. Merrill Lynch (MER): -5.8% to 62.19
  7. Flotek Industries (FTK): -28.3% to 36.45
  8. Aéropostale (ARO): -7.2% to 21.26
  9. Nucor Corporation (NUE): -6.6% to 57.91

There are so many stocks down over 4% today that it’s hard to pick and choose the “best” ones, but there are a lot of opportunities for investors who have the right mind set while others start to panic. Invest wisely!!