Investing Insights from China

I'm back from the trip of a lifetime in China. While it was an interesting experience for many reasons (primarily because I'm African-American and was quite the spectacle, apparently), I learned ton more about how business is done in China and I know understand much more why investors get so jazzed about sending money to the East.

Upon arrival in Shanghai, I was greeted by this huge Coach ad, right outside my hotel window:

 

It is a country of both extreme wealth and extreme poverty, but investors have jumped on the former as a money-making opportunity. The Chinese middle class is burgeoning and, like Western countries, this means that the population is consuming more luxury goods. I saw an impressive number of Coach, Tiffany, and Louis Vuitton stores in Shanghai alone.

 

But, before you march off to buy shares, note one thing. Many purchases of luxury goods in China were the result of a business and government culture of gifting. Some might call it "bribing," but I think that's too strong a term. Business partners exchange gifts after a deal is closed as a way to thank each other for doing the transaction. Following my team's presentation, we gave our company representatives small tokens of our appreciation, and the they did the same for us. Of course this can lead to many abuses, especially bribing. To that end, the Chinese government is cracking down on this type of corruption. Unfortunately, this may take an unforseen toll on luxury brands in China. A new government was inaugurated only in the last few weeks, so only time will tell what will actually happen. But investors in luxury goods companies who are relying on growth in China should beware.

 

Another thing to note is the major housing boom in the big cities, especially Shanghai, Beijing, and Xi'an. China is the world's most populous country with 1.36 billion people, and all of those people need to live somewhere. However, I was taken aback at the rapid real estate development. It seemed to me that houses (well, apartments, mostly, as result of high population density) were being built long before demand could fill them. This could also play a role in the future on the incomes of the Chinese middle class. If housing values fall, so will their net worths and ability to spend on luxury items. The Communist government can likely keep some damage from occuring if there is a bubble burst like that of the US in 2007. But I would caution investors to be careful of a situation that appears to be growing more precarious.

 

 

 

It's not all bad news, of course! I saw a lot of growth potential in China, particularly in terms of infrastructure. As they continue to build homes, they will need roads, electricity, and public transportation. There is also a bit of a pollution problem that will have to be tackled. Investors can take advantage of these things by putting money toward building out these roads and investing in companies that will put electrical wires underground. Some of my classmates also joked that, once it becomes required to wear a bike helmet, helmet makers will clean up!

 

 

 

Some people say that China is "out," as if it were culottes or harem pants. The world's largest nation definitely has opporunities, but I would shake things up a bit by looking at Brazil or India, or in even riskier frontier markets, such as Mexico. Next week, I'll explore how one would invest in emerging markets.

 

My Conversation with the CEO of Michael Kors / Breaking Up is Hard to Do

Those who follow me on Twitter know how excited I was about John Idol, CEO of Michael Kors, speaking at my university last week. It was a great talk and I fell more in love with the brand by the end of it. But I still couldn't shake the question that's been gnawing at me for the past several months.

So I asked John during the Q&A (after thanking him, on behalf of my stock portfolio, for going public): "How do you respond to equity analysts who say you're growing too fast? Your PE is at 45, and Coach's is 12. What do you say when they ask if this growth rate is sustainable?"

"Great question," he said. Then he squinted and asked, "Is that a Michael Kors watch?"

Yes, it was. :)

His answer to my question was that Michael Kors is filling the "white space" of accessible luxury wherever it can. They will cap the number of stores at certain number, but the company does not want to keep itself from going to places where it could succeed. They don't think about price-earnings ratios, he said; they think about where they can fill a void.

I was somewhat satisfied with his response. In particular, I was comforted that they will set some limits on the growth, but not impede it. However, given yesterday's earnings report of 70% revenue growth, I still wonder if MK is just a really hot trend that can fall out of fashion at any moment.

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This leads me to an important, but painful topic: when do you sell a stock?

I have many stories about selling stocks at the wrong time. Hopefully, I've learned my lesson and can share with you my mistakes, so you don't make them.

There are 3 main reasons to sell a stock: a change in price, a change in the company, or a change in your situation.

A change in price: 
When a stock has hit your target price, it may be time to say good-bye. The target price is the share price at which you say, "There is no way this stock is going to go higher." While you can rarely ever be certain of this, it is always a good idea to have a certain target in mind. This tempers your expectations: you'll patiently wait for the price to go up and/or you'll sell at a high price instead of a low one.

You may have heard the phrase, "Buy low, sell high." It's an investing commandment that every investor sins against. TRY TO FOLLOW IT. Don't get emotionally attached to a stock and believe that if it falls and keeps falling, it will go back up. It might, but there's no way of guaranteeing, so get out while you can while it's hot.

The downside to selling high is that you may miss any additional upside, or share price increases. Well, better safe than sorry, I say. It's better to collect something than to collect losses.

A change in the company:
You'll likely want to sell a stock when the company's finances have deteriorated. If revenues and profits are falling, and expenses and debt are increasing, it does not paint a nice picture for investors.

Take Avon, for example. Although it is a classic, iconic brand, the company has not been able to perpetuate its business model (door-to-door salesladies) in the age of the Internet. This has taken a toll on Avon's revenues and profits. It has mounted up quite a bit of debt as it tries to survive. The company's stock price has reflected its troubles in recent years: even well before the 2008/09 market crash, Avon's stock traded on average between $35 and $40 per share. Now it bearly reaches $20.

In addition to slacking financial fundamentals, other reasons to consider selling a stock could be:

• The company is going in a different direction, perhaps one that doesn't make sense given what the company is good at.
• It could have gotten new leadership that doesn't inspire quite like the old leadership (I'm afraid Apple might become the next example of this).
• It has cut its dividend, which is a sign it could be going through financial trouble.

A change in your situation:
Your decision to sell a stock could come from your own situation. For example, let's say you think another company's stock is worth buying, but you can't afford to own them both. If you believe the new stock will perform better, it might be worth tossing the old one.

Also, stocks are extremely liquid, which means that they can be sold easily. So, if you need cash in pinch, you can always sell your stock without penalties. However...

The tax implications may not be worth it.

When you sell a stock at a higher price than what you paid for it, you have to pay what's called a capital gains tax, which is generally 15% of the gain. This automatically decreases the return you actually recieve. And don't forget that you have to pay commission on the sale to your broker!

Basically, selling a stock can be very expensive, so make sure you are SURE that you want to do it before you go through with it.

I bought 10 shares of Michael Kors for about $33/share on February 2, 2012, just a couple of months after it had gone public. On Valentine's Day, the price jumped to $42/share, after a great earnings report. The price lingered between $39 and $42 for a couple of weeks, and in early March, I sold all 10 shares for $43. I'd made about $100, so I was happy.

Sadly, the price kept going up, and I got antsy. So I dove back in. For $48. I could only afford 5 shares this time. So not only did I buy the shares at a much higher price, I couldn't even own anywhere near as many. :(

The upside to this story is that I still own the 5 shares, and as of yesterday, they bounced to $63/share. While I do believe Michael Kors is growing too quickly now (the PE jumped to 50 after yesterday's 70% revenue growth announcement), I believe in the long-term potential of the brand, so I plan to hold on for years to come, unless something tells me otherwise.

Ultimately, you should strive to be an "investor," or someone who holds stocks for a least a year, not a "trader," someone who holds them for less than a year. It is important to remember that value comes with time, so be patient and leave your emotions at the door.

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Next week, we'll talk diversity. A diverse world is a safe world. At least for your stock portfolio.

Put it all together and what does it spell? $$$

So, now that you know all about how to read financial statements (see here and here, if you missed them), let's see how they all fit together.

Let's use Coach, Inc. (COH) for our example. Although the company recently saw a decline in profits, it's still financially solid. Let's have a look:

Balance Sheet:
For simplicity's sake, we'll look at annual data. Financial information comes out quarterly (and the date of "quarter end" depends on the company), but it's better to get the big picture view and not freak out if there is a small earnings drop in one quarter.

You'll see that total assets, especially cash, has steadily increased (Great sign!), and although total liabilities have also increased, they are proportional to assets. Coach hasn't taken out an exorbitant amount of debt that it will never be able to pay back. Actually, Coach's long term debt has DECREASED, which is great.















Income Statement:
I've cut the screen shot off here at net income. There's a whole mess of lines that come after that, but we're going to focus on revenues, expenses, and the Bottom Line.

Notice that Coach's annual revenues have, again, steadily increased. That's why it's important to look at the big picture -- there may be dips some quarters, but annual revenues should grow consistently, as should gross profit. Expect expenses to increase; it's totally okay AS LONG AS THEY ARE PROPORTIONAL TO REVENUES. Fractions should stay intact!

Coach is a great example of a company that has been around forever, but still manages to grow wildly, evidenced in the large leaps in net income. While competitors such as Michael Kors and Tori Burch are starting to eat into the market, Coach is still a strong player, taking advantage of growth opportunities around in the world, not just in the US.



Cash Flow Statement:
Cash flow statements are generally the shortest of the financial statements, so, no, your eyes are not playing tricks on you.

You'll see that, in recent years, Coach has pulled in more cash than it has paid out (negative numbers are payouts, positive numbers are inflows), which has pluses and minuses for investors. Plus: The company has cash to pay its bills, so it's not going under any time soon. Minus: The company has cash that it has not given to you, and it is just sitting there.

Notice that the amount paid out as dividends is getting increasingly negative -- that's a good thing: the dividend to investors has increased. Buuuuut, by the end of fiscal year 2012, Coach pulled in an extra $217 million in cash. An investor has to ask herself what the company plans to do with all that, if the dividend is not going to increase. Luckily, Coach has some changes in its retail offerings in store, so we'll soon witness them put that cash to work.















And that's that! Not so bad, huh? Surprisingly simple? Of course this can get infinitely more complicated, and it does, but I won't take you through all that. (If you'd like to know all there is to know, I recommend your local top-25 ranked MBA program.)

Now, you're armed. You know the basics of individual stock selection, you can spot a good stock investment when you see one, when to buy it, when to...sell it?

We'll touch on the delicate topic of ending a stock relationship when we return after these brief messages from our sponsor!

Hello, Good Buy (Part 3)

To put skin on the numbers, let's look at a company like Coach (COH). (I would use Michael Kors [KORS], which I've mentioned in previous posts, but an older company like Coach will tend to have more solid numbers.)

Coach is a strong brand, growing around the world. When a woman works her way up the work world, her first luxury handbag well maybe COH. Well-respected by consumers and consistently well-received by the fashion community, Coach is poised to excel as it expands into Asia, particularly China.

Let's look at the numbers, as of market close today.

Range: $61.15 - $62.72 -- Nothing out of the ordinary here. The short range says that there was probably no major news about the company out today, as big news, like earnings hits or misses, can cause a price to flux more during the day.
52-week range: $45.70 - $79.70 -- If you've read news about the financial crisis raging in Europe, you probably already know that it's taken a toll on American markets recently, so some of this variation is likely due to that and not the fault of the company. The current price of $61.82 is about in the middle of the range, which can be a sign that the stock is now not so expensive.

Market cap: $17.77B -- Coach is big -- and growing! Its market cap is about $10 billion more than KORS, due to its higher price and that more of its shares are available in the market.
P/E ratio: 18.47 -- Personally, I think this is the best signal about COH. The S&P 500, one of the most common market indexes referred to, has a P/E of about 14 right now. In a way, this means that the market itself is worth about 14 times what it earns; anything close to that number sets a company up on the road to fair valuation, rather than overvaluation. Basically, you're paying the right price, rather than too much. COH's 18.5 is completely and totally manageable, and actually quite low for a company growing as quickly as COH is. A low PE is a sign of maturity, but can also be a signal strength. Excellent sign here, as its in line with its peers (TIF, with 15.72) but a steal compared to UA, with PE of nearly 57, or KORS, with about 60.

Dividend: $0.30/share, with a dividend yield of 1.94% (Dividend yield, or DY, is the percentage of the current stock price that the annual dividend makes up. The higher the better, of course.) -- YAY, free* money!!! And a DY of nearly 2% for a cyclical consumer stock in the US is a great deal right now since many companies are keeping their cash to expand operations or to save in case of a rainy day that looks like 2008.

EPS: $3.35 -- Again, solid performance in the past year by COH. This means that if you'd bought 10 shares last year, you would have pocketed an extra $33.50 on your investment. Not bad at all.
So, there you have it. Narrative + numbers = a good buy. Coach looks like a pretty good one right now if you can afford the $62 per share.
Next time, I'll take you through the scary stuff: the financial reports. Don't be scared --- they're not that bad, and you don't need a CPA to get what's going on.
Til next time!

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* You know that old saying about the only two envitable things in life are death and taxes? Yeah, we'll talk about taxes later.

Hello, Good Buy (Part 2)

So, you’ve got the narrative. You know the industry well enough to know that this company has room to grow, or you know the company well enough to know that it will shoot for the stars and be on target. Your gut says yes.

But objectively, how do you know this stock is a good buy?

Let’s start with the price.

To find a stock’s price, you can go to nearly any finance-related website. My favorite for straight-no-chaser information is Google Finance (http://finance.google.com), but Yahoo! Finance (http://finance.yahoo.com) is a formidable competitor. I’ll use Google Finance on this blog, just to stay consistent.

Most finance websites these days will let you type in the name of the company to pull up data, but you’ll want to know the company’s ticker symbol as well. It’s basically an abbreviation that identifies the company most quickly on a stock exchange.

When the company profile comes up, the first thing you’ll see is the price per share of the stock. Ask yourself how many shares you can afford at that price. Some brokerages have a required minimum number of shares in order for you to purchase with them (often 1 share is enough). However, ING’s Sharebuilder is unique in that, with the right plan, it will allow you to purchase fractions of a share of stock. There are downsides, though: (a) you can only purchase on a certain day -- typically Tuesdays, (b) you have no control over at what time of day -- and thus, at what price -- the stock is purchased, and (c) you'll wind up paying full commission for a smaller portion of stock. For simplicity’s sake, I’ll assume on this blog that you have a regular broker that will only allow you to purchase full shares of stock. Either way, you should always buy a number of shares whose proceeds will make the cost of commission worth it (see Post 2 for more information).

So, you’ve got money and you know how many shares you can afford – great! But hold on.

Take a look at the information available, particularly:

Range

52-week range
Market Cap
P/E
Dividend
EPS

Range – This is the lowest and highest prices the stock traded at in the past trading day. Basically, it represents a stock’s volatility, or how much the price fluctuated in the past day. Normally, this doesn’t move very much (maybe $1 or $2, or just a few cents), but if the whole stock market went up or down, you’ll see more variability here. You should equate volatility with risk – generally, the more volatile a stock is, the riskier it is. But with high risk comes high reward [in theory]. That said, don’t be afraid if a stock moves up and down more than $2 – Under Armour fluxed between $94 and $102 today, so it definitely happens.

52-week range – Similar to the day’s range, but, in my opinion, a lot more important. This gives the range of prices the stock has experienced in the past year. It’s an even better signal of volatility, especially if the highest price is waaaaaay more than the lowest (like, 3 or 4 times as much). Sometimes, you can look at a 52-week range to judge how “expensive” a stock is – if it’s at the top of the range, you’ll probably want to wait until the price goes down to buy; if it’s at the low end….well, that depends. It could be a signal that the stock is really cheap, but if the company is not doing well financially, it’s a sign of the worst.

Market Capitalization (Market Cap) – This basically tells you how large the company is, financially-speaking (and even more specifically, equity-speaking. I’ll get to debt later.). It is the total of the number of shares the company has available to investors multiplied by the price per share. Generally speaking, large-cap companies like Wal-Mart and McDonald’s tend to have less-risky stocks than small-caps like Basset Furniture.

P/E – P/E stands for price-to-earnings (or price-earnings) ratio. I would say that it’s the most commonly used ratio to decide if a stock is expensive or not, though that idea does not always hold. The P/E ratio can be found two ways: by dividing the company’s market cap by its net income or by dividing its current price by the amount it has earned per share in the past year. Either way, you’ll get the same answer.

Basically, it tells how much you’re going to pay per share for the amount of money the company earned. If the ratio is high (and “high” depends on the company’s industry), you’re paying too much for the stock; if it’s low, you’ve found a bargain. But as I said, this doesn’t always hold. Older, more established companies like GE tend to have lower PEs (GE’s is less than 16) whereas newer companies, such as Lululemon, tend to be higher (LULU’s is 58). This is because the PE can reflect investors’ expectations of a company’s growth. In this example, one would think GE has grown as large as its going to grow, but Lululemon has room to spread itself around.

Dividend – Sometimes, you get a tip from the company to thank you for investing in it. It’s called a dividend, and it’s a portion of the company’s bottom line earnings that it felt it should share with its shareholders. Why would a company do that? Well, they want you to keep investing in the stock and sometimes, they don’t want to keep too much cash on them and a dividend is a good way to get rid of it.

EPS – Stands for earnings per share; it’s a measure of how much the company earned in net income for each share of stock it has available to investors. The higher the better, but this figure can fluctuate wildly depending on what’s going on in the company, the industry, and the world. EPS is also a shadow – what’s happened in the past. There’s no guarantee that the same (for better or worse) will happen in the future, but it can give you an idea of what the company’s stock is capable of earning.

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Now, you’ve got the story and you’ve got the numbers. Next, we’ll put them together.

Hello, Good Buy (Part 1)

By now, you should have your brokerage account set up and your idea of the company who's stock you would like to own.

But how do you know if this stock is worth buying?

Loook at your company two ways: qualitatively and quantitatively. (Don't be scared of the numbers! Actually, don't think of them as numbers...think of them as dollars. Makes things much less intimidating somehow.) You probably already have the qualitative story down and there's more on the quantitative to come.

The Qualitative Story

Let's take my journey Michael Kors, for example. Michael Kors, the American fashion designer and famous face of Project Runway, took his company public in December 2011 in an initial public offering, or IPO. When a company "goes public," that means that its stock is now listed on a stock exchange (generally the New York Stock Exchange or Nasdaq) and the company received just about all of the proceeds from selling its stock on the IPO day. After that, the shares are traded among investors, but the company does not get any more money; only from the IPO does the company recieve funds.

Anyway, I was ecstatic beyond ecstatic when Michael Kors went public because that meant that I could own, not just a watch or a handbag designed by the wonderful MK, but an ACTUAL PIECE OF THE COMPANY. Owning stock means exactly that -- you own a portion of the company. Empowering!!!

Qualitative analysis: I knew that Michael Kors is very well respected in the fashion community. He creates trends, but is not a [laughably] trendy designer. His designs are typically composed of clean lines and classic silhouettes that flatter girly girls and menswear women alike. His label's reach goes far beyond the US, into Europe and Asia. He is arguably the next Ralph Lauren.

For me, this came through knowledge of the fashion industry and being in touch with my own preferences. I know how much my friends love MK, and how much I look forward to his fashion shows (especially fall. There's always something about fall fashion that just gets you). Basically, it was women's intuition, my gut. I believe that women have a special edge in investing because we have less tendency to get laser focused on the numbers and take the broader picture into view.

From this intuition, I knew that his company was worth more than $31 per share, where it was trading when I first looked into it in early February 2012. I mean, an MK watch is $250 at Macy's! It HAD to be worth more than $31 per share because after the company recieves its money from the IPO, investors are essentially trading the company's reputation. They may sell their shares because they feel the company has done (or not done) something it should have, or the buy shares because they believe that it's an amazing company doing amazing things (see ticker symbol AAPL for an example). The stock price can be a reflection of investors' anticipation of all the great things the company will do in the future, short- and long-term. But sometimes, the stock price hasn't caught up with company's reputation, which I felt was the case with Michael Kors.

Sidenote: Crocs is a great example of the importance of looking at the narrative/big picture. In 2007, Crocs traded at nearly $70/share, and I predicted that it would come crashing down. Why? Because Crocs are ugly. Every fashionista around the world (including Anna Wintour herself) cursed the person who started wearing them outside of a hospital. Suburbanites across the US found them comfortable, and Wall Street cleaned up. Luckily, fashion (and a global financial crisis) slapped everyone, and Crocs now trades at around $20/share. Still worth too much in my view, but meh.

I was sure that MK was a good buy in qualitative terms -- I just needed the numbers to back me up. Tune in to the next post for details!