Expose Yourself For Fun And Rewards

May 11, 2012

She's smiling because she's AB-. That'll get you $20 a quart.

A company is struggling, and the struggle has no quick resolution. (How) can you profit off this situation?

Case in point, and a real-world example. We needed an polyurethane iPad Smart Cover, which is made by Apple and sells for $40. It’s the only accessory we could find that hit the multiple criteria of a) being made especially for the product it’s supposed to accessorize and b) coming from a trusted manufacturer (Apple itself). There are plenty of knockoffs available, but we’re not interested.

While we’re certain the Smart Cover does what it’s supposed to, we still wanted to take a look at it rather than just read the description on Apple.com. So we headed to Best Buy, America’s dominant electronics retailer since the demise of Circuit City. You can touch and play with the iPad Smart Covers there. We did.

Then we bought one on eBay for $23. With free shipping and no sales tax.

Here’s an immutable law of commerce that we’re already seeing regular examples of and will continue to for the next few years: Businesses that operate as showrooms, rather than as businesses, are at a huge disadvantage. Look at the position retailers such as Circuit City and Borders (and now Best Buy, and others to follow) have put themselves in. You can walk in off the street and examine the merchandise at your leisure. The employees range from obsequious to unobtrusive, but none of them are going to give you the hard sell. (Imagine a car dealership operating the same way. More specifically, imagine walking around the floor looking at new models and responding to every salesperson with “No thanks, I’m just looking.” The car dealership would kick you out within minutes. Maybe electronics retailers and bookstores need to place their staff on commission.)

The old business model isn’t just old, it’s counterproductive. Using a retailer/marketplace like Amazon or eBay, plus the wireless provider of your choice, you can walk into Best Buy, look at the items available, buy them from someplace else, then discreetly leave the store. If you really enjoy irony (as distinguished from coincidence), you can buy the items from Amazon or eBay with a phone that you bought at Best Buy. If you’re feeling really daring, you can do it with a floor model display computer.

There’s no obvious solution to this, either, short of Best Buy drastically lowering its prices. Either that or the company could get out of the retail electronics game, and operate exclusively as a seller and installer of large appliances and car stereos. When Best Buy hires us as consultants, that’s what we’ll suggest. Until then, our ideas are merely opinions.

As a customer, your options are plentiful. As an investor, you can make money here: you just have to be resourceful about it. Imagine a market so relatively free that it lets you sell stuff you don’t own.

BBY seems like a perfect example of something worth selling short. This is vastly different than selling a house short. You borrow the stock, hope it loses value, then buy it, then return it to the lender at the original price.

Sound like too much work? Heck, it’s an opportunity. The holder of BBY obviously thinks it’ll appreciate, so it’s only fair that there be a mechanism for profiting off daring him to be wrong.

The compact explanation is as follows. BBY is currently trading at around $20. Say you borrow $20,000 worth of shares, which you can hopefully figure out is 1000 shares. You wait 3 months, and the price has fallen to $16. You then buy $16,000 worth of shares, sell them to the entity you borrowed the original 1000 shares from, and pocket $4,000 (less borrowing charges.)

But instead of following the predicted downward trend for those 3 months, Best Buy gets a patent for a perpetual motion machine. Or finds an oil patch underneath its corporate headquarters (which would be noteworthy, seeing as it’s in a Minneapolis suburb.) The stock shoots up to $60, and the lender wants his 1000 shares back. That’s going to cost you, Ace. $60,000, to put a nice round number on it. You’ll be out $40,000 for your little exercise in semi-sophisticated trading (again, plus borrowing charges.)

What about the actual specifics of short selling? It starts by opening a margin account. E*Trade*, for instance, will let you open a margin account with a minimum balance of $2000 if you already have a regular account with them. When you use a margin account, you’re borrowing E*Trade’s money. You can’t run away from them if you come up short. They know where you live, and they have your money.

So say BBY falls in value, but not by as much as you’d like. After your arbitrary 3-month period, the borrowed money comes due with the stock sitting at $19.53. How much would you make?

This isn’t hard to figure out, and you can probably do it in your head. $470, right?

Go back and read the post again. From the top. E*Trade (or anyone else, other than a particularly dupable family member) is going to charge you interest. Your net profit for that imperceptible decline in the stock price is 0.

Never make an investment without knowing the interest rate you’ll be charged on any money you borrow.
Never make an investment without knowing the interest rate you’ll be charged on any money you borrow. 
Never make an investment without knowing the interest rate you’ll be charged on any money you borrow.

Should we say it once more, underlining this time, or did you get the message?

Brokerages start with something called the “base rate”. E*Trade set its at 4.14% a couple of years ago, and it’s remained untouched since. If you have half a million dollars in your margin account, you get to borrow money at the base rate. (Put a million in your account, and they’ll take 25 basis points off the base rate.) But the less your ability to repay, the higher the interest rate you’re charged. That’s why unsecured credit cards charge so much, which you shouldn’t be paying interest on anyway. With that $2000 minimum balance in your margin account, you’ll pay a 430-basis-point premium on the money you borrow. 8.44%. You’re almost better off borrowing on that credit card. Almost. Here’s the list of interest rates, segmented by size of account balance:

 

Making money’s a pain, isn’t it? For a beginning-to-intermediate investor, better to find something undervalued and buy it long than search for something overvalued. The worst thing that a stock you perceive to be undervalued can do is fall to 0. A stock that you think is overvalued, but isn’t, can rise so high that you’ll lose your margin account, your house, your 401(k) and the respect of your friends and family. Now, who’s up for some trading?

 

*Technically, the name is supposed to be in all caps. They should consider themselves fortunate that we’re deigning to indulge even one of their typographic fantasies by spelling the company name with an asterisk. The asterisked name spawned an asterisked comment, adding to the confusion, a confusion that this asterisked comment can’t hope to resolve. 

Filed Under: Investments, Making Smart Choices, Net Worth, Personal Finance

The Multimillionaires Who Need Your Money

April 4, 2012

This post ran in slightly different form (well, vastly different form) on Investopedia a few months ago. If you can’t get enough of us here, we’re all over Investopedia. 

Estimated net worth, $1.48 billion. In dire need of a handout. Or a hand up. Either is fine.

 

The Miami (né Florida) Marlins moved into a new ballpark this week. Total cost to taxpayers: obscene. But it’s justified, because a business location that size is far too large to be built with the owner’s own money. Besides, the stadium itself is an economic catalyst. With it, neighborhood businesses (“bars and restaurants” is the catchphrase we’re obligated to use here) see increased activity, and everyone wins.

Which is falsehood on a colossal scale. By the same logic, you can argue that taxpayers ought to foot the bill for every gas station, supermarket, movie theater and hardware store. Of course those businesses don’t get taxpayer funding, nor will they ever. And why not? Because politicians and blind fans have “civic pride” or something in their sports teams, but not their small businesses.

The Marlins play in a climate so conducive to baseball that major league teams from cold-weather cities have been training in it since decades before the Marlins were founded in 1993. Yet the Marlins routinely draw fewer fans than any other team, despite winning 2 world championships in their brief history. And the new park has a (retractable) roof on it. The Marlins estimate they’ll play only 11 or so open-air home games a year.

But because the Marlins used to play in a stadium they shared with a football team, they were losing money. They really had no choice. Now, the new park will enable cash flow, profits, and more importantly, a permanent presence in South Florida. The fans, such as they are, won’t have to worry about the Marlins moving to Indianapolis or San Antonio or some other city that’s big enough to house a major league team but that doesn’t have a stadium.

Is that true? Were the Marlins really losing money? Or any other team, for that matter? The official word is that most major league teams do operate in the red, which makes you wonder why the people who own the teams don’t bail out with their dignity and a few remaining dollars intact. But of course, this is all conjecture. You’d have to get your hands on a team’s financial statements to confirm. No pro sports team has been publicly traded since the Boston Celtics were, in the late ‘90s, so the documents are mostly unavailable to us.

Or were, until a few months ago when an anonymous source forwarded Deadspin the financial statements of several major league baseball teams. (Deadspin did the lion’s share of work for this post, but here’s full attribution.)

The statements included those of one of the perennially sorriest teams in sports, the Pittsburgh Pirates. They’re about to embark on their 20th consecutive losing season, by far the longest such streak in the history of North American pro sports. The Pirates moved into a new $216 million park in the middle of that streak, built courtesy of their generous friends the taxpayers. Did the new park boost attendance?

No. Ahead of the Marlins, the Pirates have drawn the second-fewest fans in the league in each of the last 7 years. (We told you they were consistent.) So the Pirates must be losing money hand over fist, right? Owner Bob Nutting has to be desperate to sell. Heck, if you’ve got a few bucks in the bank and a good credit history, you could probably name your price.

In 2008, a year in which the Pirates’ payroll was slightly more than the $45,047,000 it’s since been whittled down to, they lost 95 games and turned a $14,465,406 profit. On which they paid $57,157 in taxes. Or .4%.

Ticket revenue was $32,129,368, far too little to cover salaries. So how did the Pirates pay their players?

They didn’t. The other teams did. The biggest item in the Pirates’ revenue column is the $39,046,312 they received in transfer payments (“revenue sharing”). With that money, the Pirates could meet 77% of payroll. Fortunately for their opponents, the Pirates didn’t get “their” money’s worth.

A similar item, “Major League Central Fund receivable”, dwarfs all the Pirates’ other current assets. With it, the team’s partners’ equity thus totals $83,536,192. As major professional sports teams go, that figure is in National Hockey League/Arena Football territory. The Pirates’ value is to the Dallas Cowboys’ as the Cowboys’ is to Raytheon’s. Which is hardly big business, but it’s very healthy business: the Pirates enjoy a 17.3% profit margin. Then again, it’s easy to turn a profit when your competitors are covering all your losses and then some.

The unorthodox thing about owning a sports team, as opposed to just about any other enterprise, is that with the former you have an additional objective beyond the standard economic one. Every other business wants to maximize its profits. A sports team wants to maximize profits and, presumably, win. By slashing expenses, and thus relying on the largesse of his fellow owners, Nutting can put a consistently atrocious product on the field and not only turn a profit, but watch the value of his team increase.

Combine a perpetually irrational clientele (“This is our year! It’ll be just like 1979!”) with compliant opponents who agree to share revenue, and the Pirates have little incentive to ever improve. Otherwise, they’d end up with a $200 million payroll like the New York Yankees have, and would be net donors to the general fund, not net recipients.

Nutting’s case is hardly unusual. The Los Angeles Clippers are the NBA equivalent of the Pirates, albeit with one winning season in the past 19 rather than zero. Clippers owner Donald Sterling is notorious for his stinginess, one example of thousands being the time he fired the team’s trainer and asked the head coach to tape the players’ ankles. (Mercifully, NBA bylaws now stipulate what should have been unwritten, that each team must hire a trainer. And pay him.)

Yet the market value of the Clippers has increased considerably since Sterling bought the team for $13.5 million in 1982, even though Sterling himself didn’t do a thing to increase said value. We’re pretty sure that this wasn’t what JFK had in mind when he said that a rising tide lifts all boats. Enjoy the games, everyone.

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Size Matters. But Define “Size”.

March 9, 2012

The logo of the former largest company in the world, the East India Company. Graphic design was not a priority in the 18th century.

 

Quick, what’s the biggest company in the world?

If you’re a casual reader of the business news, or were last summer, you might say “Apple”. It was something of a noteworthy deal when Apple moved into the top spot, but what does that top spot signify? Does it mean that Apple sold its products for more money than anyone else did? That its owners got richer than anyone else did? That its owners would get richer than anyone else, if they liquidated their interest? Or something else? Are we thinking too hard about this?

Yes. The biggest company in the world is the one that generates the most revenue.
Isn’t it?

Sure, but what if there’s another company that generates slightly less revenue, but has significantly smaller expenses and thus keeps more of the revenue as profit?

Uh…yeah, you’re right. That’d make more sense. 

But isn’t value in the eye of the beholder? Say there was a company that took in even less revenue, and didn’t necessarily turn a stupendous profit. But, investors loved the company so much that they valued its stock highly. And if you wanted to buy this entire company, share by share, you’d have to spend more than you would to buy any other company.

Okay, you sold me. That should be the definition of the world’s largest company. There can’t be any other ways to interpret this, can there? 

CAN THERE? 

Well, how do you determine your own net worth? You add the assets and subtract the liabilities. Do the same thing on a macro scale and you have a company’s shareholders’ equity, which should be the definitive, absolute, certain way to determine a company’s magnitude. Aside from the other ways we just mentioned.

Okay, time for the real-world results.

REVENUE: The company that takes in the most money is Walmart. Last year, that meant $421 billion.

Walmart makes money on volume, not margins. Anything you buy at Walmart, Walmart bought for only a little bit less. Walmart doesn’t turn big profits on any individual item – the Birkin bag that the retailer buys for $45 and then turns around and sells to you for $20,000 isn’t on the shelves at Walmart. But the nickels and dimes that Walmart makes on every grocery item and article of inexpensive clothing keep its profits huge and its shareholders happy.

Which means Walmart spends tons on what it buys. It turns a profit, and a substantial one, but not as big as at least one other company’s.

PROFIT: Apple made $26 billion last year, despite selling a lot less than Walmart. How? Because while Apple sells less than Walmart, the profit on each item Apple sells is far, far greater than on what Walmart sells.

Last year somebody estimated that it costs Apple about $180 to make each iPhone. Meanwhile, new unlocked 4S models with 64GB of storage sell for over $800 on eBay. It’s hard to imagine a single product that Walmart makes a $620 profit on. Except the iPhones.

For the record, when Apple was announced as the largest company in the world in the summer of 2011 (or more to the point, when news of its financials trickled down from the business news departments to their knuckle-dragging counterparts on the general news desk), it wasn’t because of Apple’s profits. It was because of another metric.

MARKET CAP(ITALIZATION): Apple had the largest market cap in the world for a few weeks earlier this year, but ExxonMobil then caught up and regained its place on top. As of this writing, Apple has wrested the title away yet again. Right now, if you wanted to buy every share of AAPL it’d cost you $480 billion. That’s about ⅙ more than ExxonMobil.

Which leaves one remaining measure.

EQUITY: The company with the biggest difference between its assets and its liabilities is Bank of America, whose shareholders’ equity sits at around $228 billion.

Most of the top companies in shareholders’ equity are banks (both commercial and investment) and insurance companies. A major chunk of their assets come in the form of loans. What you and we sweat over, banks get excited by. Loans are their stock in trade, which sounds like an obvious point but is easy to forget sometimes.

How does this apply to your daily life? Well, to the extent that it forces you to think of multiple valid ways to look at the same problem. Who’s in a better place – the person who makes $150,000 a year, or the one who makes $120,000 and clears $60,000 after expenses while the first person spends every penny and then some? It’s a legitimate question, not a rhetorical one. And once you’ve determined an answer, how does that person stack up against someone who makes $70,000, but has a net worth of $5 million?

More money is better than less: if you don’t agree with that, you probably shouldn’t be reading our blog. But there are multiple ways to determine who’s in the most enviable financial position.

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