Monday, November 18, 2013

Why do Townhouses never have decks? (Upgrades)

A lot of new home construction is sold with no deck on the house, but rather a french door with a piece of fence across it, so the owner can "add" a deck as an upgrade.   In many developments, these decks never get built for years.   What's up with that?

As I noted in my Upgrades posting, home builders love to sell buyers on the concept of "upgrades".   When Mark sold townhouses in Northern Virginia, he was encouraged to sell these lucrative add-ons, as they added a lot to the bottom line for the builder.   A $400,000 townhome could be "upgraded" to a $500,00 townhome, in short order, simply by selling the deluxe kitchen, upgraded carpeting, and marble bath accents - as well as a finished in-law room in the basement.

The builder makes money on these upgrades, as they don't cost him much more than the basic level of materials.   Labor is the big cost, and whether you use a crappy "contractor grade" carpet or an upscale plush makes little difference to the overall cost.   And since the builder owned a marble business, adding marble accents was a real money-maker for him.

But one upgrade that is rarely sold in most home developments is the deck.    When traveling across America, we see a lot of these "new homes in a cornfield" with sliding glass doors blocked off with little fences, as shown in the photo above.  The homeowner did not opt for the "deck upgrade" and likely won't add one, for many years.

Why is this?

Well, from the builder's point of view, a deck is an additional structure, and something that requires both additional labor and materials.    And the labor involved is not labor you have on-site.   Your framers are not going to be good deck builders, nor are your sheetrock workers, plumbers, or electricians.   You basically have to "farm out" this business to a deck-builder.

So the home builder gets a quote for a deck, doubles the amount, and presents that as an "upgrade" to the buyer.   Not surprisingly, most buyers balk at the high cost of the added deck, and say to themselves, "We'll add the deck later!"

And since they are new home owners - and have financially stressed themselves out over the optional sun nook and upgraded carpet - they can't afford to put the deck on the house, at least for five or ten years.

As a result, you see a lot of these new homes, sans deck, for many years after they are built.

And maybe another reason builders don't want to mess with decks is the liability involved.   When we lived in Northern Virginia, not a year would go by without some tragic deck story hitting the paper.  Harry and Harriet Homeowner contract out to Bubba & Co. to build a deck.   And when it is finished, they have a party, invite all their friends, and crank up the music and have 20 of their friends dancing on the new deck.

Since Bubba & Co. lag-screwed the deck into the siding (and not into anything solid) the deck collapses, injuring, maiming, and perhaps killing some of the guests.   That's about when you wished you had that umbrella liability coverage!

Bolting a deck into the side of a house as the main means of support is not a very good idea, particularly if the bolts are just going into siding.

For this reason, many responsible deck builders put posts near the house, to carry the load of the deck.   The deck may still be bolted to the house (to help keep it from moving) but the load is carried by beams and posts that are independent of the house structure.

So what's the point of this post?  Perhaps none.  It just got me to thinking, after reading my "Upgrades" posting, how many vinyl-clad townhomes-in-a-cornfield we see across America, with no decks on them.

Are builder upgrades worthwhile?   I suppose that would depend on the upgrade involved.   Bear in mind that a lot of things like carpeting and even kitchens, end up being replaced, over time.   It may be cheaper to go with the base carpeting and then wear it out over ten years, rather than "upgrade" to fancier carpeting from the get-go.   This is particularly true if you are financially stressed in buying the home in the first place.

And bear in mind that once the townhomes (or houses) are built, the value of each home is going to be roughly the same, as neighborhood (location) and home size determine price more than fixture and amenities.  If you live in the home for 10-15 years, chances are, the new owner is going to rip out the kitchens and baths, anyway.

I guess it also illustrates how buying a home that already has the things you want can be a far better deal.   While a deck adds some value to a home, the value added is generally less than the cost of construction of the deck.   So it may make more sense to buy a home that some homeowner already plowed money into, rather than buy new.  In some cases, it is better to move than remodel, as remodeling returns only pennies on the dollar, in terms of increased home value for money spent.

Sunday, November 17, 2013

Google Goes Evil (Ad Block Plus)

Google has gone Dr. Evil on us. 
By the way, I believe Dr. Evil was based on the real-world character of Fritz Haber.

The other day I was using Firefox, and I got a notice that I should update to a newer version of Firefox.   I believe this was a legit notice, but nevertheless I was busy, so I squelched it.

Later on, I decided to update Firefox manually, so I put in "Firefox Update" into Google and saw several hits for what appeared to be Mozilla Firefox.

Appeared to be being the operative words.

The first hit was an advertisement on Google for something called "Firefox_Mozilla_todownload" or some such nonsense.  Not thinking clearly, I hit the link and a page that looked a lot like the real Firefox download page came up.

I thought, "This looks legit, they even have the Firefox logo, albeit very large" and I hit "download now" and my computer froze.

Thankfully, Malwarebytes, Spybot, and Windows Defender were all smarter than I was.   They blocked the download on the spot and would not let me open it.

I did some more research and realized that "" is a virus site that loads the nearly-impossible-to-get-rid-of Babylon search redirector.   I dodged a bullet there.

But the question remains - why is Google accepting ad money from sites that download viruses, adware, and other sorts of malware to your computer?

What ever happened to Google's motto of  "Don't be Evil"?

Today, it is "Don't be evil - be DOCTOR EVIL!"

Google has gone over to the dark side.

Fortunately for every evil Corporation like Google, there are others not-so-evil, like Mozilla, or Spybot, or Ad Blocker Plus.

Ad Blocker Plus, which can be downloaded for free from (for both Firefox and Explorer) will block ads on Google, on News sites, and even on The Daily Show (no more ads for Axe Body spray - hooray!).

It works as a plug-in and works seamlessly.   There is one setting you have to tweak, however.   In Firefox, go to "tools" and then "ad block plus" and then "filter preferences" and then UNCHECK the box labeled "allow some non-intrusive advertising" (an oxymoron if there ever was one).   This will kill all the ads on Google searches, including the ones from odious malware peddlers.

I would feel bad for Google, blocking their ad revenue and all.   But Google has it coming.  Actually, Google has a whole lot of bad shit coming their way, if they continue to allow things like malware sites to "advertise" on Google.

And perhaps this is a turning point for Google.   Google right now seems omnipresent and successful and profitable.   But they are just one Windows-8 away from oblivion (where Microsoft is headed, if recent events are any indication).

You can only annoy your client base so much, until they start seeking out alternatives.   Already, I am finding that I have to go to Bing or Yahoo or some other search engine to find articles and resources, as Google tries to pre-filter my results based on what it thinks I want to see (e.g., stuff I have already seen).  And the harvesting of data from my e-mails and other sources is starting to get, well, creepy.

For example, if I mention here, in this blog, that I want to buy a new Toyota, you can bet that the next time I log into a Google site, the sidebar ads will be for the local Toyota dealer.   Let's try this and see if it works.

Of course, ad-blocker plus may just thwart those plans!

Saturday, November 16, 2013

Crocs goes private? (an IPO story)

A company that makes one kind of trendy shoe might not be a good company to invest in.

When I was in Law School, we studied Economics and Corporate law, and I learned a little bit how Corporations work - or at least how they are supposed to.   One thing that puzzled me - and puzzles me to this day - is how a company that pays no dividends, ever, could be worth anything at all, to the small investor.

Our professor explained about "retained earnings" and how a company, instead of paying out dividends (which are taxable as income) could keep these earnings on the books, and thus the value of the company stock would be worth more.   If shareholders sold stock, they would make a profit, and thus pay taxes at the capital gains rate (which is usually lower).

This sounded all nice in theory, but the problem is, most stocks are horrifically overvalued to begin with.   The vaunted "market cap" of a stock (multiplying the stock price times the number of shares) is well above what the actual liquidation value of the company would be - even with these "retained earnings".

Even after the professor's explanation, it all seemed, well, sort of a scam.    And to some extent, we were both right.   Companies that go public and never pay any dividends, really are sort of a scheme, in that to keep the scheme going, it relies on people continually viewing the value of the company as increasing - even if the company will never "pay out" in cash, its actual value, either in dividends or in liquidation.

Crocs, the company (CROX) is poised to go private - again.  The company was founded by three individuals who bought out a Canadian company which made the closed-cell foam shoes.   They brought the shoes to the boat show in Ft. Lauderdale, and the rest was history - at least for a while.

Crocs became a sensation overnight.   People raved that they were good on your feet and that the soft foam design was great for people who worked standing up all day.  Suddenly, it seemed, everyone had a pair.

But the fad lasted only about two years.   And just as suddenly as people started to love Crocs, just as suddenly many people decided to hate them.   They are ugly and weird looking, to be sure.   And they seem to cater to the child within all of us - the one too fat and lazy to tie his own shoes, or even be able to reach down that far.

Crocs and America's Obesity Epidemic were made for each other.

Unfortunately, despite a number of acquisitions of smaller shoe companies, the company never really expanded beyond its original product line - in any significant way.   And so, about six years after its IPO, the rumor is the company will again go private.

Was buying CROX stock a good investment?   Not really, unless you could time the market (that pesky broken time machine, again) and buy it at its nadir and sell at the peak.   The company never really paid a dividend, except in connection with a one-time 2:1 stock split.

The chart below illustrates the problems with CROX:

CROX, unlike a lot of other IPO stocks, did not "pop" out the gate, but took a couple of years to peak in price.   It was hammered in the recession of 2009 and then slightly recovered.   Sales have slacked off, though, and the company wasn't able to expand beyond its single-product offerings.

From Wikipedia:

Crocs completed the initial public offering of its common stock in February 2006. It began trading on the NASDAQ Stock Market under the symbol CROX. On October 31, 2007 the stock CROX dropped from $75 per share to slightly under $40 (its value six months  previously) when the company announced decreased revenue projections. On April 14, 2008, during the midst of the Credit crunch of 2008, the stock dropped 30% in after-hours trading after the company issued a press release in which they significantly guided down earnings estimates for the first quarter. In the same statement they also said they would lay off its 600 Quebec City factory employees as retailers have been reducing orders, though about 100 sales and marketing positions would remain. "The retail environment in the U.S. has become increasingly challenging as consumer spending and traffic levels have slowed," Chief Executive Officer Ron Snyder said. During the financial crisis, CROX dropped to as low as $0.79 before rebounding ($15.50 by November 2010). On October 18, 2011, Crocs stock suffered a single day drop of about 39.4% on lowered earnings and revenues forecast. In June 2013, Crocs reported a 42.5% decrease in net profits from a year before. As a result the stock fell 20.2% in one day.

When the stock went public at the IPO, the IPO Price was $21.  As you can see, the market yawned, at least initially.  However, as the shoes became more popular, people started bidding up the stock - to a high of $75 a share.   The shoes suddenly seemed everywhere, and once again, people confused popularity with profitability.   When something is mentioned in the media a lot, people bid up the stock.

But then the stock crashed, as high profits were not realized.   The crash of 2009 hammered the stock further.  It recovered later on, briefly hitting $30 a share, until it dropped to about $10 a share today.  Quite a roller coaster ride!

Was this a good investment?   If you bought at the IPO price of $21 a share, you are now looking to be bought out at $13 - losing about half your initial investment.  Unless you sold out at $75 a share, or bought at the nadir in 2009, you are poised to lose a lot of money on this stock, or at best, break-even (which is akin to losing money, if you held the stock for eight years).

In other words, the only way you could have "made money" on CROX was to time the market - know in advance when the stock price would peak and valley - and the profit from the losses of other buyers and sellers in the marketplace.   Timing the market is akin to gambling.   Unless you cheated (knew insider information about the profit forecasts) you are just playing with numbers.   And in most cases, gamblers lose.

And the shoe business is murder.   Back in 1968, my Dad looked into buying a shoe company in Paris, Illinois.   The amount of debt he would have had to take on would have been staggering.  And the business was one of margins, even back then.   If you had the right fashions and styles, you might be able to charge premium prices.   Otherwise, you had to compete on price -which means keeping a very tight ship and finding your profits in marginal cost savings.

Since those days, the shoe business has gotten worse.    The Chinese and Koreans control most of the market, manufacturing shoes even for American shoe makers.   Very few American companies make shoes in the USA anymore, other than a few artisan shoe makers and New Balance.  There are no easy profits in shoes, unless, like Nike, you can create a "must-have" shoe and sell it for $200, when the costs are less than $20.

Crocs does have a few Patents on their shoes (Design and Utility) which issued around 2006 (and thus will not expire until about 2020 or so).  And they have used ITC actions to go after knock-off artists who are importing cheap look-alike shoes.   In theory, they should be able to maintain a monopoly on these types of shoes.  But the problem with that business model is this:  The knock-off artists made and sold look-alike shoes when they were trendy and hip.   Once the hip factor wore off, well, they were all to happy to fold their tent and move on to the next hula-hoop.  Patents are of little use for trendy products.

Yes hula-hoop.  I said it.   Have you seen anyone wearing Crocs lately?   If you have, you remember it because they just are not as omnipresent as they once were.  The fad has faded, and it is hard to believe that Crocs will again be as ubiquitous as they once were - except perhaps as a retro fad in 20 years.

So who makes out in this deal?   Well, the founders of the company undoubtedly sold some stock along the way.  Given what they paid for the initial company and what they sold their shares for, they probably made out.   And even at the price of $13 a share, the founders still make out like a bandit.  Out of about 40 million shares of stock, only about 10 million were sold in the IPO, which means the founders and insiders kept about 75% of the company (how foolish, Martha Stewart kept 96% of hers, Facebook kept 95%!).

Why would they go private now?  Sales are down, the fad is over, and the founders want to sell out:

Crocs posted a 2 percent decline in sales for the third quarter, hurt by weakness in the Americas and Japan. The company said it saw less discretionary spending for footwear, apparel and other consumer goods in the U.S.
 "I wish I could tell you we were expecting a big improvement in consumer confidence in the U.S. throughout the year, but we are not," Crocs Chief Executive John McCarvel told analysts on the company's earnings call last month.
The last comment is telling.   Consumer confidence and spending IS WAY UP since 2009, and people are buying more junk again.   However, consumers want the next big thing, not some shoe they already have in their closet, or already had, and found it made their feet sweaty.

           This satirical Kelly cartoon from The Onion came out about the time CROX stock peaked.

For every Groupon, ZipCar, Crocs, or other hyped IPO, there is always Google - the IPO that keeps the true believers believing.  The difference between Google and, say, Twitter, is that Google is a hugely profitable company and has a very rational P/E ratio of 29.69 even though the stock is over $1,000 per share.

To put that in perspective, if Google had Linked-In's P/E ratio, Google stock would be trading at $25,000 a share.

CROX, on the other hand, has a very rational P/E ratio of about 12.   A low P/E ratio, of course, it not always as good as it sounds.   If the company is profitable, people will bid up the stock to a P/E ratio of about 20 or so - as the rate of return mirrors that of the market in general.   However, if people are pessimistic about the future of the company, this may bid the stock price down, and the P/E ratio as well.

But that really isn't of much help to the small investor.   People who "invested" in this stock because they liked the shoes, likely got their ass handed to them on a platter.   The only folks who made out in this stock are the founders, who used the stock to cash out at least part of their investment, and perhaps the Venture Capitalists, who may turn around the company and make money from it.   The big people win, the small people lose.  Maybe a few lucky gamblers win - but a hoard of others lose.   It balances out.

And this is why, as I get older, I am buying more conservative, dividend-paying stocks in traditional ventures - companies that actually make things, earn profits, and pay back their shareholders.   I don't have to sit and wonder why the company's share price spikes and falls - it is tied to the profitability of the venture, not speculation by the marketplace.  And even if the share price fluctuates, I have the consolation of cashing all those nice dividend checks every quarter.

These may not be "sexy" investments, and the shouting guy on the TeeVee never mentions them.  And yes, sometimes "old line" companies like GM can go bankrupt and wipe out shareholders.   But if you held that stock for a number of years, you likely made back your investment in dividends, over time.

I guess the smoke-and-mirrors of non-income stocks is one reason I always sell such stocks when they go up in value.   When AVIS spiked from 74 cents to $20, you can bet I sold half of it.   When my Access National stock, doubled in value, I sold half of it.   Better to get your money back, while you can, than to double-down your bet by seeing how high it will go.

But "bet" is the operative word here.   Buying non-income stocks is really just gambling - gambling that some other chump down the road will think the stock is worth even more than you did - even though neither of you have any rational reason to value the stock as you did.

POSTSCRIPT:   Winn-Dixie and Dell

As I noted in an earlier post, I made some money buying Winn-Dixie stock for about $8 a share and then selling it, when it went private, at $12 a share.   What made me do this?   Well, in the classic sense, I was investing based on familiarity with the brand.  I shopped in their stores and just prior to the buyout, Winn-Dixie shed a lot of its manufacturing facilities and poured money into the stores, updating them considerably.

So, foolishly, I thought, "Gee, this seems like a good stock" and I got lucky when the buyout came a few months later.   Never confuse getting lucky with being brilliant.   This was a classic "struck by lighting" investment, like my spectacular AVIS buy.   But for every Winn-Dixie and AVIS, there is a General Motors, Fleetwood,  CREE, or Syntroleum.   Buying stocks based on the news media is a really bad idea - as I have learned firsthand.

When I say buying Pop Stocks is a bad idea, I say this with the authority of having been there and done that - and learning a few painful lessons in the process.  Compare the Winn-Dixie stock price chart below with the CROX chart above - they are almost exact matches.

Winn-Dixie's Post-Bankruptcy IPO followed a very familiar pattern!

When the buyout came, a lot of people who bought at $20 a share and up were upset, as the buyout was for about $12 a share.  A few people like me made out well, because we bought at the nadir.   We timed the market, but it was more by luck than by design.   Never confuse getting lucky with being brilliant.   The buyout could have been at $6 - or the company could have gone bankrupt again.

I still have a trading account with Fidelity (moved over from e*trade) but I do not do a lot of buying and selling of stocks.   Why is this?  Well, I have a collection of about 50 stocks in that account, and it is sort of like a mutual fund at this point (and often out-performs my actual mutual funds).

Another "Getting Lucky" stock pick was DELL.  Why did I buy Dell?  Well, people were hammering the stock and claiming that since the company didn't have a presence in the tablet business, it was going to go belly-up in no time.   But I thought about it and came to a few conclusions:
1.  Despite the popularity of tablets, there will always be a demand for real computers.  You may be reading this on a tablet, but there is no way I could have TYPED it on one.

2.   Just because Dell isn't big in the tablet business doesn't mean it never will be.  In fact, their new Christmas catalog is chock full of tablets.

3.  The media hypes Apple as the end-all to creation, even though they have a minority share of the marketplace for PCs, Laptops, Smart Phones, and Tablets.   What's more, Apple's market share will again shrink as cheap counterparts to these products become popular.

So I took a flyer on Dell and it paid off.  I invested the whopping sum or $2800 and sold out to management for $4125, making about $1325 in the process..  As you can see, I am a big-time "playa".  (UPDATE:  I bought some of their bonds which have done well - so far.)

Which also illustrates the other half of my philosophy - never place too big a bet on any one stock.  And yes, I said "bet" - because when you are buying stocks, as an individual, you are gambling to a large extent.   Why?  Because no matter how much research you do on a given stock (which is easier today, thanks to the Internet) there are armies of people out there who have done far more research and know a lot more than you or I.

But that is why my stock trading portfolio is less than 1/10th of my overall portfolio - about the same amount I have invested in whole Life Insurance.   The rest is in mutual funds and a huge chunk is still in un-mortgaged Real Estate.

In fact, this trading account originally was invested in mutual funds, and I decided many years ago to roll it over into a self-directed e*trade account, thinking that I could do better than those fund managers - and at least know what I was invested in.   The net result was predictable - I invested in a lot of dumb things early on (stuff hyped on the television) and lost my shirt.  I also invested in some blue-chip and dividend-paying stocks, which seemed to hold their value more.    When my annual dividends came in, it was often enough to buy more stock (which is how I ended up with the Winn-Dixie and Dell stocks, and how I ended up with 50 different stocks in the account).

If I had it to do all over again, I am not sure I would do it all over again - or if I did, I would do it differently.   However, backward-looking investing is never useful, unless you have a time machine - and mine's broken.   So, in reality, you can't go back, and if you did, you'd end up doing the same dumb things.

So if you are going to "play the market" I wish you luck.   Diversify your bets and don't put any significant chunk of your portfolio into stock-picking.   And if you'd rather just invest in mutual funds, don't feel you are being "left out" of the exciting world of stock-picking and IPOs.   Chances are, your mutual funds will do a lot better than your own half-assed picks.

Thursday, November 14, 2013

Whole Life Insurance - After 20 years


This plot of cash value versus premiums paid for this Northwestern policy illustrates that life-insurance is a long-term investment, with a payback measured in decades, not years.  Click to enlarge


            1.  Chart is from June 1993 (inception date) to June 2014.  Standard Premium was $111.71
            2.  Dividends used to increase cash value and coverage from 1993-1998.
            3.  Dividends used to reduce premiums for 1999 - 2003.
            4.  Dividends used to increase cash value and coverage from 2004-2006.
            5.  Dividends were used to reduce premiums starting in 2007.
            6.  Overall Rate of Return over  20 years, approximately 58.07% (average 2.9% per year)
            7.  $1300 per year, invested over 20 years at 2% interest would produce $33,222.53
            8.  Incremental rate of return, at his point, is over 200%.
            9.  Premiums last year were about $756, while the increase in cash value was $1715.60
            10.  Dividends exceeded premiums in 2014, no premiums due for 2015 and beyond?

Conclusion:  As an investment, life insurance is no real bargain.  However, bear in mind that in addition to its use as an investment vehicle, the policy also has a death benefit of $108,432.00.  And, in the next 10 years, the cash value will continue to grow, while the premiums (currently $63 a month) will remain relatively flat.  The dividends from our other "paid up" policies more than pay for the premiums on this policy at the present time.  For every dollar invested as this point, the policy increases by more than two dollars.

Life Insurance - it is a good deal?  I have written about it before, and it is an interesting animal.   For a young family starting out, a term policy can be bought cheaply enough - and provide coverage in case a spouse dies young.   However, as you get older, the premiums become larger and larger.   By then, you should have enough set aside in case of early death - and a term policy is no  longer necessary.

Whole Life, on the other hand, acts as both an insurance policy and an investment vehicle.   The original idea was that you would pay in more than the amount needed for a term policy, and the company would invest the surplus, and eventually a nest egg would build up and the dividends from this would cover the premiums.   Your policy would then be "paid up" and you would have to pay no more premiums on the policy.

It is possible to convert a policy to "Paid up" status at any time (provided the policy has a cash value).  The policy is basically cashed in, and the cash value used to buy a "paid up" policy, which increases in cash value, over time.   The death benefit may be less than the original policy and remains fixed.   This is a good option if, later down the road, you don't want to (or cannot afford to) pay premiums - but don't want to lose all of your policy, either.  I did this for two of my Northwestern Mutual Life policies, as I could not afford the hefty premiums on four life insurance polices.   Yes, I bought too much.

Speaking of  "paid up" - most Insurance Agents will encourage you to use the annual dividend to buy additional "paid up" additions to the policy.  These add a little to the death benefit, and generate dividends of their own, which are added to the pile.   In one respect, this is like re-investing more money into the policy.   In another respect, it is like buying little tiny life insurance policies at a very, very high cost per dollar of coverage.  A better idea is to use dividends to pay down premiums.  The policy may not grow as quickly, but then again, it won't cost you as much, either!

It is also possible, of course, to lay out a huge wad of cash and buy a "paid up" policy from the get-go.   But most of us can't afford that.  Most of us just pay the monthly or annual premiums, one bit at a time, because as salary slaves, we get paid that way.

Is Whole Life Insurance a good deal?   Should you apply dividends to reduce premiums, or to buy additional "paid up" additions?  How long does it take to pay back what you have invested?    Should you buy additions to a policy if they are offered?

After 20 years, I finally have some answers to these questions - and I am finally understanding what these policies are all about.

I harp here all the time about never investing in things you don't understand fully, and to some extent, my Life Insurance investments are an example of this.   I did not understand these investments very well at the beginning, and that was a costly mistake, to some extent.  However, it was better that I bought these policies that spend the money on a Jet-Ski, I guess.

To answer the first question, the general answer is NO - Whole Life Insurance is not really a good deal.  You would likely do better investing that money in the Stock Market, or even in Bonds.   When you buy a Whole Life Policy, some of that money goes to the death benefit insurance itself (a term policy, basically) and another part goes to the investment portion.   Right off the bat, you can see this is not an efficient way to invest.   Another portion goes to company overhead and profit (profit, if it is a Stock company and not a Mutual company) so there is an inefficiency there as well (but the same could be said of your Mutual fund company as well, right?).

It does act as a forced investment scheme, as you have a regular amount deducted from your bank account every month.  I chose to keep this amount less than $100 - about what people pay for a Cable TV bill or Cell Phone plan these days.    And in that regard, I am glad I spent that money on the Life Insurance, rather than Cable TV.   One has paid off, the other would not.

As a way of diversifying a portfolio, it is not a bad adjunct to other investments.  But I would not put all my money into this one basket - or even a significant chunk of it (Life Insurance, in terms of cash value, represents less than 1/10th of my net worth).

Should you apply Dividends to Reduce Premiums?  YES - always.  If you look at the chart above, for my Northwestern Mutual policy, you can see that the "crossover" point, where the cumulative premiums become less than the cash value, took about 12 years.   Note how the slope of the premium curve decreases after about 2006 - that is when I decided to ignore the advice of my Northwestern Mutual Agent (a real piece of work, let me tell you) and apply dividends to reduce premiums.    As you can see, this accelerated the time when the policy would pay back - that is, increase in cash value by more than the cumulative premiums.

The chart below tells a different story.  This chart illustrates the same data for Mark's State Farm Whole Life policy.  

This State Farm policy has taken longer to pay back its premiums, largely because we didn't apply dividends to premiums early on.   Underlying performance of the company is also an issue, although as illustrated here, State Farm has exceeded its guaranteed values.  Click to enlarge


            1.  Chart is from November 1994 (inception date) to November 2014.  Standard Premium was $91.25
            2.  Dividends used to increase cash value and coverage from 1994-2013
            3.  Overall Rate of Return over 20 years, approximately 4.3% (average 0.21% per year)
            4.  $1095 per year, invested over 20 years at 2% interest would produce $27,137.73
            5.  Incremental rate of return, at his point, is nearly 200%.
            6.  Premiums this year were about $800, while the increase in cash value was $1558.32

Conclusion:  As an investment, life insurance is no real bargain.  However, bear in mind that in addition to its use as an investment vehicle, the policy also has a death benefit of $106,390.11.  And, in the next 10 years, the cash value will continue to grow, while the premiums (currently $800 annually) will remain relatively flat.

For every dollar invested as this point, the policy increases by about two dollars.  Might as well keep it, now.

Here, I did not use dividends to reduce premiums until about 2009, and as you can see, once I did, the slope of the dividend curve decreased and crossed the cash value line that much sooner.   This chart differs from the one above in that it illustrates the guaranteed values from the State Farm Policy, whereas in the Northwestern chart, I projected cash value over time.

These charts illustrate graphically how using dividends to decrease premiums really is the way to go.   Your payback, in terms of cash value exceeding total premiums paid, will accelerate.   Buying additional "paid up" insurance with your dividends may increase the overall size of the policy over time (in terms of both cash value and death benefit) but it also means that this crossover point (where cash value exceeds the amount paid in) will take longer - or may never occur.   Note how the slope of the two lines in the graph above is nearly identical - until I opted to apply dividends to premiums.

At this point, both policies are worth more than I paid for them.  The Northwestern policy clearly is the winner - returning an average pf about 2.9% a year over 20 years.   That doesn't sound very good right now, but at this point, every dollar I pay into the policy increases the cash value by two dollars - a return of 200%.   So at this stage in the game, it pays to hang onto the policy.   The overall rate of return will increase from here on out.

The State Farm policy is not doing as well - returning a pathetic 0.21% on the premiums paid since inception.  But like the Northwestern Policy, at this point, every dollar put into it increases the cash value by two dollars.   From here on out, it is worth keeping, and the overall rate of return will go up over time.

Bear in mind there are two other aspects of Whole Life I have not addressed here.  First, there are some tax advantages to Life Insurance.   You can structure the policy such that you can borrow against it when you retire, and thus have no tax consequences at all (when you die, the policy pays off the loan). 

Second, there is the death benefit.    Both policies have death benefits over $100,000.    So in addition to getting an investment vehicle, you are getting a term policy thrown in - but a term policy that will never expire, as long as you live.

How long does it take to pay back what you have invested?    As you can see from the charts above, this depends on whether you apply dividends to reduce premiums or not.  If you do, the payback will be more rapid - perhaps as little as ten years.  If you do not, you might wait forever.
Should you buy additions to a policy if they are offered?  No.   Our State Farm policy had a provision allowing us to buy $25,000 additional policies at five year intervals  - up to four such policies.  These policies were worth less than the original policy, but cost far more in terms of premium for insured amount, as the rates for the insurance part were higher (we were older, so the risk of death is higher) and since you are re-starting the clock on these new policies, they remain "upside down" for several years.   

You need less and less insurance as you get older, so buying more makes no sense - except in one circumstance.  These add-on polices required no medical exam.   So, if I was diagnosed with terminal cancer, then yes, I would have bought these polices - they would be a sure bet.   Other than that?  Walk away.

And that illustrates why Life Insurance for Older People is such a costly mistake.   Many folks wait until they are 50 and then think "Gee, can I buy Life Insurance?" 

And the answer is "Yes..." but the complete answer is, "....but it is a rip-off".   Insurance companies aren't dumb, and you can't get $100,000 of coverage, at age 50, for any trivial amount.   Even a term policy will be costly, as you are closer to the age of death and the odds of you dying are huge.

When you see an ad for "Life Insurance for Seniors!  No medical exam necessary!" just walk away.   Why?  The Life Insurance companies are not giving out free ponies this week - or next.   You can't get something-for-nothing, so stop looking for it.

Life Insurance is a Young Man's Game.   If you are in your late 20's or early 30's and have a steady job and are thinking about long-term investments, a modest policy with an affordable premium is not a bad option.   We bought our policies in our early 30's, and that is about as late as you want to buy.   It is a long-term investment that takes decades to pay off.   You can't buy whole life at age 50 and hope to make out at all.

Do I regret buying these policies?  Yes and No.   Yes, I regret not applying dividends to reduce premiums.  I regret buying the "add on" policies from State Farm (which I have since cancelled or cashed in).   And I regret buying the additional Adjustable and Variable Life policies sold to me by my Northwestern Agent (which I have since converted to paid up policies)

But, in terms of a $99-a-month expense, I am glad I bought these polices instead of having 500 channels of Cable or a new leased car.   Some folks say saving money may be for chumps, but in the end, the person with money saved - no matter what the rate of return (provided it is not negative) - ends up ahead.

As the projections on these polices show, by the time I am retired, each will be worth about $50,000 or more, in terms of cash value.   That's over $100,000, not counting the two other paid up policies I have, which will add another $100,000 to the pile.   This is more than the average American retires with, these days.

I also think that one advantage of these policies is that they got me to think about my net worth, my overall estate, and where my financial life was heading.   Life Insurance is a long-term investment, where you pay a little in at a time for a long period of time, with a payoff decades in the future.   Having these policies forced me to think about my investment strategies and to invest more in my IRAs and 401(k) plans.

Looking back 20 years, I am glad I saved money over time - and wished I had saved more.   There are a lot of people in this country, older than I am, who have saved nothing and are headed for retirement, whether they want to or not.  And that is both scary and sad.

Friday, November 8, 2013

Another Day, Another Self-Serving IPO

The Twitter IPO had the desired "pop" they wanted.  Who does this profit?  Not you.

Another day, and another self-serving dot-com IPO hits Wall Street.  As I wrote before in The Nature of IPOs, particularly the dot-com kind, the whole purpose of a moden IPO is to make the founders wealthy.

How does this work?  Simple.  But first let's review what IPOs were and what they have become.

In the good-old-days of Corporate America, you did an IPO to sell stock to fund your company.  The IPO provided capital for investment in machinery and materials, so you could build cars or make steel, or whatever - ventures that required a lot of capital to start.   So you sold off a good chunk of your company to make money. 

Alexander Graham Bell (no relation) had to sell off more and more of his stock, over time, to investors, in order to raise capital to make phones (which were leased, not sold).   In the end, he owned less than 5% of the company - and his wife sold half of that in a panic when the stock price spiked.  He still ended up rich, but not as rich as he could have been.

Today's IPOs are a different beast.   Yes, they sell you the story that they are doing the IPO to raise capital for investment.  But it is a bullshit story.   Instead of selling off 95% of the company to raise money, usually they sell off only 4-5% of the company (read that again - four to five percent!).   And they don't "need" the money to "expand their business" as the amount raised in the IPO is often trivial compared to the amount of cash on hand.

In fact, with today's IPO's they leave most of the money on the table by allowing the stock to "pop" in price on the first day.   What does this "pop" mean?  It means that institutional investors and others who "subscribed" to the shares at the opening price can immediately sell their shares for nearly double the money.  They make as much money, in one day, as the company "raises" in Capital.

If this were an old-fashioned IPO, people would scratch their heads and say, "That makes no sense!  How are you going to raise the most amount of money to build your steel mill if you let some banker take half of it?"

And in the days of steel mills, that argument made sense.   But we aren't building a steel mill, we are building a bullshit mill.  And we really don't care whether the company "raises capital" because a bullshit mill doesn't NEED capital.  

What it needs, or more precisely, the FOUNDERS need, is a way to "cash out" of their investment in the company.   They are paid in stock (or invested and got stock in return) and they want to sell it as a regulated security on the open market, where chump investors in the general public will pay top dollar to "invest" in "the next big thing!"

So they hope the stock price spikes - which is bad for the company, as it means the company left money on the table - because it is good for the INDIVIDUALS who started the company.  In other words, what is a direct detriment to the company, profits the people running it.   And these are the people running the company that you are "investing" in - right?

OK, so the Twitter IPO is a day old now.  What happened?
1.  The people who got subscriptions to the stock at $26 a share sold out at $45 to $50 a share and made a ton of money.  This was not you and me, but institutional investors and big money players.
2.  The insiders in the company, who are paid in stock, now are worth Billions, at least on paper.  To cash out, they will have to sell their shares, over time.   Most are locked out from selling for 180 days.   Wait until that day comes....
3.  The small investor bought at $45 a share and up on the first day.  Some paid as high as $50 a share!
 4.  We are ONLY ON DAY TWO and the stock has tanked by 7.24% from its close yesterday.  That's a heck of a drop from the pop!  A few more days of this, and it ain't gonna be pretty.
5.  If you were unfortunate enough to pay nearly $50 a share (as some did), your shares are now worth about $41.  You just lost 18% of your investment, overnight.
Gee, wish I invested in that IPO.
Will Twitter tank as well?   Let's look at a brief history of some famous hyped IPOs of the last few years:

1. Groupon: Groupon went public with the same amount of hoopla and the same vaunted "Market Cap" as Twitter. The stock then tanked about a year later and the founder and CEO was forced out. He was so upset by this, he wrote a sardonic resignation e-mail. You see, he has more money that God, now, and being fired means only that he can now spend it at his leisure.

Groupon's model was copied by others and the product turned out to be a fad. The share price is rising in recent months, but the company is still losing money (-14 cents a share). Where is this going?

2. ZipCar: ZipCar at least sold a physical product - car rentals - and was more than a mere website. Problem was, car rentals are a capital-intensive business, and a costly one as well. ZipCar never made any money to speak of, and the stock price tanked, after the IPO. Again, look at the chart below and the cart above - do you see a pattern here?

AVIS finally bought ZipCar for a fraction of its IPO price. And they probably did this just in time to prevent ZipCar from going bankrupt (why else would ZipCar management sell?). Unless you bought the stock just before the AVIS purchase, you lost out.

Bottom line on ZipCar: The small investors who bought at the IPO price lost their shirts - again in a market where the DJIA was skyrocketing. Are IPOs a great investment? No.

3. Zynga: Zynga was another dot-com stock that went ballistic at the IPO, largely because of the anticipation of the Facebook IPO. But like Facebook, it did a face-plant as well:

Zynga made games like "Farmville" (remember THAT?) and people lost interest in the games. Unlike ZipCar and Groupon, there has not been a "bounce-back" as of yet. If you bought at the IPO price, you got creamed on this one.

Again - and this is important - it is very hard to make money by buying a stock and then having it lose more than half its value. And with no profits (and no dividends) there isn't even income to fall back on.

4. Facebook: Facebook is one success story of the lot (sort of), even with the "botched" IPO. But whether this makes any sense as a long-term investment remains to be seen. Facebook is showing profits, finally, of 41 cents per share. This gives it, at the present share price, a P/E ratio of 116.

Is that a good P/E ratio? Some analysts like to say things like "Well in the tech sector" (as if a website was 'tech') "a P/E ratio of 100 to 200 is acceptable."

But P/E ratio represents the number of years you'd have to wait to make your money back on this stock. In other words, 116 years. Facebook is profitable, yes, just not that profitable. In order to show a more reasonable P/E ratio, Facebook either has to increase profits by a factor of five, or the share price has to decrease by a factor of five. You pick.

Since it has little in the way of profits, and little in the way of assets, there is no "there" there in the company. You have to hope that someone dumber than yourself will pay even more for the stock, over time. It is possible that someone could "buy the company" but at these prices, no one could afford to.

The Facebook experience shows that profits do matter. Facebook's IPO face-planted largely because the profitability of the company was in question. Once the profits went up, so did the stock price. Twitter, losing 30 cents a share, better figure out how to make money - and fast.

5. Linked In: LinkedIn is the darling of the dot-com investors. Why? Because the share price has soared and the company actually makes a profit, albeit not a large one. Yea, Linked-In is making 30 cents a share. But at the current share price, that yields a P/E ratio of over 700. That's scandalous.

People who pay that much for a stock are "buying ahead" just as home buyers in the late 1980's and 2000's did - banking on rising prices to make their overbidding a good investment later on.   But eventually, LinkedIn is going to have to make a profit that justifies its share price - or the share price will have to tumble to provide a more realistic P/E ratio.   At a P/E ratio of over 700, LinkedIn is nearly seven times higher than Facebook.   Where is this going?   Do you think that LinkedIn can grow profits by a factor of 10-20?

Buying Facebook or LinkedIn is an act of faith - and faith-based investing is a bad idea.   You are gambling that someone else will pay even more money for the stock down the road, based on the idea that it is "worth" more, even though the profitability of the company is tiny compared to the share price. 

In other words, you are waiting for a greater fool than yourself to buy the stock.

Is it possible to make money from these IPOs?  Yes and No.  Yes, it is theoretically possible if you can time the market, but timing the market, without a working time machine is nearly impossible to do.   It is also possible if you get lucky and a stock, like Linked-In takes off despite its dismal metrics.

But for the small investor, this sort of gambling is never a good idea.   Why?  Because for every Linked-In or Facebook, there is a Zynga or Groupon or Zipcar.   In fact, the stinkers outnumber the winners, every time.  And even the winners here, as suspect.

And picking winners is never an easy task.   First to market is often last in the marketplace.   And in the Internet world, a year or two is a lifetime.   A decade is a Century.   Few remember today, the fate of AOL - which was once American's premiere online portal.   At one time, it seemed like half the country was on AOL.   They even bought Time-Warner, they had so much money - at least on paper.

And then it went bad.  Not overnight, and not suddenly.   But eventually, other means of accessing the Internet came about.   No one wanted to use AOL KEYWORDS anymore, but would rather search using something called "Google".  AOL faded from view and Time-Warner extricated itself from the wreckage.

Gambling your retirement on trendy, hyped stocks is just not a good idea.  Diversify your portfolio, invest in a number of different things.   And as you get older, invest in more conservative investments, as you can't afford to gamble on IPO stocks.

Tech stocks and dot-com stocks are very volatile - and usually over-valued.   Investing in the tech sector is not for the faint of heart - or the small investor.

Will Twitter be the next Facebook?  Or Linked-In?  Or Groupon?   It is hard to say.  And it is hard to predict how long even the successful dot-com stocks will keep being successful.   If you look at the metrics on Facebook and Linked-In, they make no sense at all.

And as a simple rule of thumb, it never pays to invest in something you don't understand.

Saturday, November 2, 2013

Satellite Radio

You can tell a lot about a company by how easy it is to contact them.

A friend of mine recently signed up for Sirius Satellite Radio.  Why is this?  Well, his favorite radio station switched from "oldies" to "country" and that means that the only radio stations we can get now are (1) Jesus - the hateful kind, (2) Country - the new bad kind, (3) Hispanic, and (4) two NPR stations that barely come in (blasted off the air by the hateful Jesus stations, which over-modulate).

If I was the kind of person who believed in Conspiracy Theories (but I don't) I would think that Sirius had bought up all the radio stations in the country and intentionally switched them to odious formats so you would have to pay extra for satellite radio service.

Anyway, my friend, fed up with this, decided to go satellite, and he claims he called the XM people and they signed him up for $4.89 a month for six months.   If this is true, then he got a steep discount off their advertised price of $17 a month or so.

But never confuse "savings" with "savings".   Reducing the price of an unnecessary expenditure is not creating wealth, just dissipating it more slowly.

And yea, $17 a month is a lot of money.   $17 a month, invested at 7% over a 45 year working life, comes to $62,373.36 at retirement time.   A little here, and a little there, and pretty soon you are bleeding to death from 1,000 cuts.   And that is the nature of subscription services and subscription fatigue.   You sign up for more and more of these types of services, and pretty soon - very soon - you are spending hundreds and hundreds of dollars a month, on "services" which are not essential to your daily life.

It pays to limit the number of recurring charges in your life to the bare minimum.   Small fees like $17.95 (which is seventeen dollars and not eighteen, right?  And certainly not close to twenty!) add up, cumulatively and over time.   People look for large chunks of "waste" to cut in budgets - whether personal, business, or even governmental.  The real solution to cutting waste from a budget is to cut a little here and a little there - because the big things can't be cut, only whittled down.

I met a young man the other day who confessed he spend the whopping sum of $200 a month on his smart phone.  He was 25 and fresh back from Afghanistan.  I tried to explain to him that $200 a month, invested over a working life could be a quarter-million dollars in retirement funds, and he gave me a blank stare.   I didn't have the heart to tell him about the money he was squandering trying to "hop up" a 2005 Dodge Charger.   Kids that age, just want to spend it all.   And it all seems so important back then.

But I digress.

Anyway, I was intrigued that Sirius would cut their rates so much.   I went on the website to check this out, but all I found were sign-ups online, and no discounts offered.   In fact, most of the gags were 'negative option' offers, where you get "30 days free" service (and we all know that FREE isn't, right?) so long as you provide a credit card number - so they can bill you perpetually.

Tellingly, there was no telephone contact number listed, other than on a help page.   I tried calling that number, but got only a DTMF telephone tree.   

When a company makes it hard to contact them, you know where this is going to go.

I did find a page where you can submit a request for them to contact you.   Obviously, their time is more important than yours!   You see how they are power-shifting here.

The entire website was so chock full of flashy animation and distracting graphics, as well as large come-on prices and fine print details that it was impossible to really figure out what the real "deal" or bargain was.   What are you paying and what are you getting?   You have to sign up to find out.   And that means giving them your credit card number.

Negative option sign-up techniques are never a good idea.   You sign up for a "Free 30 day trial" and if you don't cancel in time, your credit card is charged.   If you call to cancel, they claim never to have received your call.   And so on and so on.

AOL tried this technique in the past (google it).   People complain about Angie's List for the same reason.   Companies claim to have not gotten the message that you wanted to cancel, so they keep charging your account.   And many Americans never bother to check their credit card statements or accounts, so they don't notice - until months have past!   So after three months, they realize their subscription wasn't cancelled, and they call, yet again, to start the process over.  Guess what happens then?

As I noted in another article (citing a New Yorker article), AOL is kept afloat in large part because a number of people still pay the dial-up subscription fee, month after month, even though they use a cable modem or DSL or whatever.   People think that they still "need" AOL to get online.

As you can see, the "subscription model" is very lucrative for businesses!

(By the way, it strikes me that the phrase "Like us on Facebook!" which seems so prevalent today, will someday seem as quaint as "AOL Keyword:" was in 1995.    What seems ubiquitous and permanent in the online world, evaporates like ether in a matter of months).

The point is, every time you sign up for a subscription, you put a little hole in your rowboat.   Not a big hole, but one nevertheless.   And if you can't plug this hole - or keep track of it - then your rowboat is going to require more and more bailing, over time.

My friends are very excited about XM radio, and how cheaply they were able to get it.   They claim that they paid for a six-month subscription, and when it ends, they can negotiate another six months, at the same price of less than $5 a month.

I will wait and see how this works out for them.   But frankly, I am skeptical.   I suspect what will happen is that after the six month period (or even before) they will find a nasty little charge of $17.95 on their credit card, and they will spend hours and hours on the phone trying to straighten it all out.

And if you can get satellite radio for $5 a month, why don't they advertise it for everyone at that price?

I tend to go with my gut instincts.  And the Sirius website has all the charm of a carnival barker.   Simply put, I don't trust them - and why should I?   After all, by now, we are all aware of how these marketing gags work.   The splashy ads and fine print say it all - pay no attention to the man behind the curtain!

So, no Sirius satellite radio for me.  Why?
1.  I am punching an unnecessary hole in my rowboat - for a trivial reason.

2.  I will have to dick around with these negative-option cancellation deals.   Not worth the stress!

3.  The carnival barker atmosphere of their website is like police tape roping off a bad deal.

4.  I tried this service once in a rental van, and frankly, I thought it sucked.   100 sports channels, 100 talk channels, and then 50 music stations playing things you probably don't want to hear, anyway.  In other words, I didn't think the service was worth much.  Even when FREE, we listened more to our iPod or CDs or over-the-air radio.  That is telling.
With the advent of Music over the Internet (Pandora, etc.) which you can stream through your smart phone or whatever, the XM model may become obsolete in a few short years.   Their huge cost structure (satellites, programing, etc.) is an inherent disadvantage (Pandora does not have to pay for cell phone towers).
"In the fourth quarter of 2009, Sirius XM posted a profit for the first time, with a net income of $14.2 million. This came after net losses of $245.8 million in the year following the merger. The company’s resurgence was owed in part to the loan from Liberty Media. Increased automobile sales in the US was also a factor. Sirius XM ended 2009 with 18.8 million subscribers.
By the end of 2012, Sirius XM’s subscriber base had grown to 23.9 million, mostly due to an increase in partnerships with automakers and car dealers; a strong push in the used-car market; and continued improved car sales in the US in general. The renewal of radio show host Howard Stern’s contract through 2015 ($400 million for five years, $100 million less than Stern’s previous five-year deal) was also a factor in the company’s steady growth; Stern’s show attracts over 12 million listeners per week"

In other words, Sirius hemorrhaged cash for many years (particularly since it competed with XM radio, until the two merged).  They are now starting to make money, only because a large installed base of radios is out there.   Problem is, of course, if you have two cars with Sirius radios, you need two subscriptions.  And if you want to use Sirius in the house, you need another radio there, another subscription, and an outdoor antenna with a sky view.  It is not like listening to "radio" off the air.  And not like Internet Radio (or streaming) which will play on any device you own, with one user account.

This CNBC report shows that revenues are up, but overall profits have dropped, slightly.   I think in the short term, as more and more Sirius/XM equipped cars enter our national fleet, they have the potential to increase their subscriber base.   But the real threat to their business is the smart phone, which with bluetooth, (or even a hardwire connection) can stream content to a car radio, house radio, or just ear buds - at a cost far below that of Sirius.

So, not only will I not be getting the service, I won't be buying the stock, either.  Long-term, their business model looks to be flawed, unless they can get the price down and greatly boost the number of subscribers.  As Mark put it, even at $5 a month, it wasn't worth it, if all we could do is listen in one car.  (I sarcastically offered to leave the car door open in the garage so he could hear it in the house.   But of course, that wouldn't work without a clear sky view).

And as Americans drive less and less (fewer of us will commute in the future) fewer people will think paying nearly $20 a month to listen to the radio is a worthwhile bargain.  It will be interesting to see how this plays out, over time.   Remember Iridium?