Yes, it has already been another month! Here’s my regular columnist, Mom2KG with this month’s column about eating out and a question about timing.

I live quite close to Yorkdale Mall, which is a regional shopping mecca, drawing visitors from throughout the Greater Toronto Area and beyond (as well as the de rigeur disaffected teens). I was in there yesterday, and I finally saw evidence that the recession is here. Normally, I have to fight my way up and down the wide corridors, any time of day. Yesterday, I was able to walk holding onto both my kids’ hands! There was practically no one at Yorkdale. We went into one of the family restaurants, and again, hardly anyone was there.

But eating out is fun, and can be a great break from all the troubles of the current economy. Here are my tips on how to make the most of your culinary buck:

1. Use the Internet

Everything is online now. So check out the restaurant before you go. Often, the menu, including, prices, are right there! You can figure out what you’re going to have (also good for those who count calories), and budget for it. There might also be specials and 2-for-1 deals, which can sway your decision of where to go.

2. Don’t order alcohol

Ask anyone with a passing knowledge of the restaurant biz: the markups and profits on liquids are huge. This is especially true of alcohol. So, stick with water, and insist on tap, which is perfectly acceptable, and better for the environment. Pop is relatively expensive too, but often comes with free refills. Same for coffee and tea.

3. Share

Appetizers are especially economical to share. Who needs to whole bowl of stilton-spinach-(fake) crabmeat? Spend less on starters – and desserts – and splurge on the main course.

4. Don’t order a main course

Dieters know this trick well. Instead of ordering an expensive main course, consider ordering two appetizers for yourself. Even better, order four or five between two people. You’ll get a lot more variety and, very likely, a lower bill. There are even many restaurants that now specialize in these “small plates” or tapas meals.

5. Order the chicken

If you must order a main course, the chicken is usually the most economical protein choice. Resist ordering substitutions – that is a great way for restaurants to make money on you. Stick with the garden salad or fries, instead of getting upsold on Caesar salad or veggies.

6. Eat beforehand

This is not totally counter-intuitive. We order lots because we’re legitimately hungry, often having waited hours since our last meal. An hour or so before you head out to your carefully-researched restaurant, why not have a piece of fruit, or crackers and cheese, at home? That will curb your worst hunger pangs, but not completely fill you up. You’ll feel less of a need to order a huge meal, reducing your costs.

7. Question the bill

When the bill arrives, read it carefully! Make sure it’s right, and point out any discrepancies. Often, restaurants will “comp” you for those mistakes, in order to keep you coming back.

8. Find a place and stick with it

If you like a particular place, keep going back there. Compliment the food, and tip the waiters nicely. They’ll get to know you too and will often give you something gratis for your loyalty. It might only be a coffee, but it’s something you don’t have to pay for. This may not work as well with franchise restaurants.

I want to end by hopefully stirring up a debate. I noted in my last tip to “tip nicely.” I absolutely tip well for good service, but I know people who refuse to do so, or don’t tip at all, citing a refusal to give in to “the man” and “society’s rules” about tipping (see the rant at the beginning of Reservoir Dogs). Part of the reason I tip is because, as I understand it, waiters are paid very little, and are expected to make their real money in tips. They also have to “tip out” to the kitchen, sharing their nights’ earnings with the busboys, etc.

What do TMW readers think of tipping? It can add a lot to your bill, after all.

I am off on a trip tomorrow for the rest of the week so this is my last post of the week (Mom2KG’s column is posted tomorrow). Given I was posting tomes last week, I thought I would give you, the reader, a welcome reprieve and post something a little more light-heatedly.

Specifically, how do you compare to your neighbors, your friends and your co-workers? The advertising industry makes us believe we all own houses, drive new cars and have fabulous jet-setting lives- and you have to keep up with everybody else by consuming. But, I mined some census data and you’ll be surprised at how modest everyone is living and has lived.

Consider:

1. You are in the minority if you own a home before 35: Historical rates of home ownership peaked in 2004 at 69% (in other words, housing was already on the decline 5 years ago) BUT if were under 35, only43.1% of your counterparts actually owned a home at peak historical ownership rates. In other words, if you are under 35 and renting, relax, you are in the majority. It is only between 35-44 of age that home ownership reflects national averages (high 60%’s and dropping).
2. If you are single, you have a 50% chance of finding your soul-mate. The average household size is 2.57 persons with only 50% of all households consisting of married couples. In other words, half of society is just as sad and lonely as you feel and your soul mate is probably out there.
3. “A Cavalier. It’s red. I have a red… it’s a red Cavalier…” (classic line from the movie, Swingers) The average life of a vehicle is now pushing almost 10 years. This is not a recent blip either. The mean age of cars has increased steadily, according to the National Automobile Dealers Association, since 1969. Cars less than 2 years old consist of less than 15% of all vehicles on the road. In other words, very few people actually drive a new vehicle and please walk away if you meet a woman at a party who asks you what kind of car you drive; I am no expert on dating but it will only go downhill from there.
4. The Jones financial advisor does well- but not that well. The U.S Bureau of Labor reports that in 2006 the median salary of a personal financial advisor was $66, 120 (although the highest 10% was taking home in excess of $140,000). Although certainly a good salary, one wonders why a prospective client who makes more than the average financial advisor would hire just an average one. What can they teach you? How to make less money than you?
5. Most of our money goes for the essentials. According to the advertising industry, the average family in 2003 spent 33 cents on the dollar on housing, 19 cents on transportation, 13 cents on food and 6 cents on medical related expenses. We spent more on entertainment than education and reading materials combined. No wonder we are such easy marks- all we do is watch tv or movies!

How do you compare?

There have been a trinity of recent news stories that should make anyone aware that the use of Facebook may not advance  your career. In particular, the stories merely confirm that using Facebook, or other social media, aside from the obvious productivity issues it creates, may cause one more trouble than anticipated.

The most recent news story involves a woman who called in sick because she was allegedly ill and needed to lie in the dark and away from the computer screen. She was allegedly caught using Facebook that same day and lost her job. Similarly, a Philadelphia Eagles employee (the Eagles are a football team) lost his job after disagreeing with the team’s decision to let go of a football player on Facebook, calling the team “retarded” (in the Eagles defense, Brian Dawkins doesn’t have much left in the tank but I digress).

The third news story, which has received a lot less coverage given the local nature of the story, should really send shivers up one’s spine. Leduc v. Roman is a motor vehicles accident case in Ontario. Leduc alleges that, as a result of Roman’s negligence which caused a car crash, his enjoyment to life has been lessened.

As part of Roman’s defense strategy, his lawyers asked that Leduc produce the contents of his Facebook page- even though it was on restricted access (which meant that you could only see Leduc’s name and photo)- to determine whether his claim that his enjoyment of life had been lessened was true or if Leduc’s Facebook page revealed the opposite of his claim.

Leduc won the initial motion to deny production of his Facebook page but lost on the appeal with Justice Brown, who issued the decision finding: ["t]o permit a party claiming very substantial damages for loss of enjoyment of life to hide behind self-set privacy controls on a website, the primary purpose of which is to enable people to share information about how they lead their social lives, risks depriving the opposite party of access to material that may be relevant to ensuring a fair trial.”

In other words, the contents of any of your social media page (Facebook, Twitter, MySpace, LinkedIn etc.) can be disclosed to third parties for their use if they can prove relevancy in seeking such disclosure.

The implications of this decision, which many legal scholars believe would likely be adopted in the rest of Canada and the United States, could be quite far reaching. Remember that disclosure was given to a restricted access page. An employer or potential employer could similarly argue that they need to see your social media page as a back-ground check, to measure productivity (even if your work locks out sites, you can still use a smart phone to post on social media) or to dismiss you with cause if you post negative remarks about your employer (see the Eagles employee above). You post, regardless of privacy settings, you may have exposed yourself.

What does this mean to you? While social media is increasingly being used as a job hunting tool, it is also a double-edged sword. By the intention of making your private life public, one is essentially declaring that you are free game for your current or potential employer.

While Facebook is in the process of allowing users to create multiple profiles, I am not sure this will actually have much legal weight if a third party argues that disclosure of all profiles is required for a relevant purpose. In other words, it may be time to scrub your social media page.

We continue yesterday’s discussion on the value of stock market research with Preet from Where Does All My Money Go (“WDAMMG”) and Brad from Triaging My Way to Financial Success (“Nurseb911) and myself (“TMW”). Today, we discuss topics such as what type of research is necessary for the do it yourself investor (again, this another lengthy post- clocking in over 1,900 words so be warned!)

RESEARCH AND THE RETAIL INVESTOR

TMW: Let’s address the second tension of independent stock research. Most retail investors are value shoppers and most DIYers want to rely on their own research. How do you, Brad, address the pushback from the retail investor?

Nurseb911: A lot of the time you get what you pay for; equity analysis and research is no different. If DIY investors want a discount analysis I can easily provide one. What they have to realize though is that I am not going to waste my time conducting research or an analysis on any business if I’m not compensated in some form for my work. Yes I am an author and enjoy publishing content on my website, but my time is worth something and if they’ve read my content for long enough they realize the effort and time that goes into what I publish.

In my private consulting I charge small business owners and individual investors a $75 per hour flat fee. When an investor considers they are receiving a SAML with a minimum of fifteen hours of work in it the retail price of $20 per report seems like a bargain to a lot of people and I’ve priced this program to be on par with the commission to buy or sell the individual stock.

The SAML program provides an inclusive stock analysis tool that I’ve already publicly published on my website (see Taking Stock in IGM). A fee only advisor would not provide this level of independent research or likely have the capabilities of providing one.

A DIY investor needs to think like the management of a successful company. You have to be proactive in your assessment of an investment instead of being reactive? Recognizing a fundamental shift in operations prior to it being announced publicly can save you a lot of money.

I would like to add that each analysis I’ve written has been chosen by a reader and currently I have a poll on my site for the next analysis: a Canadian Bank stock.

TMW: Preet- let’s look at this from the institutional side- is there sufficient push back from the institutions to not have independent research or do you think the industry says “yes, this is important that there is independent research and that the research is compensated properly”?

WDAMMG: I never found push back from access to independent research at all. In fact, speaking from my own experience, we had portals to third party research on our terminals from various sources: Credit Suisse, Reuters analyst aggregations, etc. Many advisors even paid for their own third party research through various research vendors. But this can partly go back to Brad’s comments on groupthink, or what Warren Buffett calls the institutional imperative. A lot of it looks the same, and how much easier does it become to push a stock when you have not one, but five different research reports to back you up?

TMW: So what you are really telling me is that institutions love research- as long as it helps them make a sale?

WDAMMG: Absolutely. From a compliance perspective, it can help cover an advisor’s butt too if investment recommendation and suitability is ever called into question – you have concrete support on the research indicating the relative volatility and other factors in writing.

TMW: From my perspective, I would divide the raging DIY and retail investor communities. The DIYers, many of whom are bloggers or commentators, probably have a better handle on the company than the analysts do since they are “normal people” and not subject to glass tower syndrome which Brad alluded to. I once joked on another blog that personal finance bloggers should form the government given that they write so extensively about money. The push back from the DIY crowd may have more of a “anything you can do, I can do better” theme which is great- with all due respect to both of you- since it should that people are actively interested in educating themselves about what they want to do with their money.

The retail crowd push back I would characterize as part of the trend of the financial industry to pretend that everything is free but the true cost is hidden somewhere else. As a result, we are conditioned to pay for nothing upfront. It is one of the more dangerous trends in financial institutions- telling your investors everything is free. The investor fails to see the input to output relationship. You have to input something (quality research, due diligence etc.) to get a positive output (good ROI).

KEY FACTORS IN RESEARCHING STOCKS

TMW: If a DIY wants to conduct their own research, what top three things should they be looking at as a basis for their decision making?

Nurseb911: An investor should always start with financial statements and the annual reports for the past three years at a minimum. While I understand the frustrations that many new investors have with analyzing financial statements you can’t do a proper assessment of a company without looking at them. These are the systems of what makes a company healthy and are no different than any physiological system within our own bodies. This is where you get a very good idea of what the company is about, what it does and any important trends that are occurring: are earnings rising, is book value declining, is the company growing sustainably, etc. Once an investor has an understanding of the overall business they need to concentrate on what makes a business successful: its products, services and people. If the business is something they understand, feel comfortable about and want to continue to pursue then there are three important fundamentals they should look for.

The first is profit; never invest in a company that isn’t making money. If a company isn’t making money they have to either borrow money to keep operating or burn cash/assets to continue operating. Take the time to examine the cost structure of the business, calculate their margins, compare them to industry peers and look for a competitive advantage if one exists. If the company isn’t making money put it on your watchlist. You might miss some upside as the company turns around, but you won’t be placing your capital at risk in a company that continues to decline.

The second is investor return; what you get paid back for investing your capital. Dividends count, but book value growth and return on equity (ROE) are vital components to evaluate. If a company isn’t growing revenue I want to ensure that management is being productive with their assets and increasing the value of the portion of the company I own. My capital is worth a lot to me and if I invest in a company I want to know that my capital is appreciating or that I’m being paid for the use of my capital (dividends).

The third is how the investment fits into your overall portfolio; does it help you to diversify from risk, sector exposure or another important component. Far too often an investor will choose an investment that doesn’t provide any meaningful diversification and exposes them to additional risks. Risk is what kills your returns. Investing is a balance between risk and reward, but an investor always has to be mindful of preserving their capital. If a company doesn’t fit into your portfolio don’t make it fit.

TMW: Preet- anything to add to this?

WDMMG: Not really, I’ll get on my soapbox instead:

There’s one free lunch when it comes to investing – you can reduce non-systematic risk by increasing the number of securities in your portfolio. Most studies peg 20 to 30 stocks as the minimum number required to effectively reduce non-systematic risk. Non-professional investors rarely have time to keep on top of 20 to 30 companies so I have to point out that a DIY investor with fewer positions than that is adding an element of risk to their portfolio that they may not be adequately compensated for. The relative return for that non-systematic risk may not be worth it, but it can also pay off for you (this is why many extraordinarily successful investors had concentrated portfolios, but many more investors with concentrated portfolios had extraordinarily poor results) – the problem is that if it works you can fool yourself into thinking that you have skill when all you had was luck.

TMW: This is more of personal opinion than anything else, but do you find most investors do not do enough research before buying. Preet?

WDAMMG: Not even close. If you are going to be buying individual stocks you should have the frame of mind of a business owner looking to take complete ownership of a business. If you wouldn’t be happy owning 100% of that business, why would you be happy owning 0.1% of it? And if you were going to buy a business, wouldn’t you spend weeks to open up the books, analyze your competitors, etc, and be prepared for a very long term commitment if you did decide to purchase? If you can’t comfortably decipher the financial statements, stop kidding yourself – you’re not an investor, you’re a gambler.

Brad?

Nurseb911: Absolutely.

I think if an investor can’t address the previous three items I listed regarding what to look for as the basis of their investing decision then they should have a clear answer of whether or not they’ve conducted enough research.

ETF’s and index funds are great products to invest in while an investor learns how to analyze individual stocks. My entire portfolio was indexed prior to starting to invest in equities and it gave me a great opportunity to practice portfolio rebalancing, dollar cost averaging and other important habits of investing. If you don’t have the adequate discipline to invest before you begin investing in equities what makes an investor think they can develop it on the run? Investing in individual companies brings a lot more risk than many investors realized prior to this current market decline. The rewards can be significantly higher, but also are the risks.

Far too often an investor rushes into a stock without having adequately done the research needed to understand the business. That might take 5 hours for you and 15 for me, but the important lesson is that we both understand our investment.

TMW: I tend to agree with both of you. The point being do not abdicate your responsibility to anyone. Only delegate it. Preet- your opportunity to give a shameless plug. What are you up to?

WDAMMG: For those who don’t know, I moved on from being a retail financial advisor to the institutional and retail sell-side with an index fund manufacturer. It’s a “me too, margin compression business” so it’s not without it’s challenges, but with a lean staff to keep costs down it means I get to wear a lot of different hats. But probably more interesting to the readers is that I completely embarrassed myself by auditioning for a TV hosting gig with the W Network. They had asked for audition tapes from anyone from any field of discipline. It started as an online contest with 400 submissions being whittled down to 20, and then those 20 reduced further to 7. The final 7, myself included, filmed for two weeks in March for three 30-minutes TV episodes to be aired on the W Network on June 21, 28^th and July 5^th (all Sundays, primetime, tentative) to declare an “Ultimate Expert”. Wish me luck! J

TMW: Good luck Preet. I’ll vote early and often if there is a chance. Thanks guys. Hope to do this again another time.

Welcome to my periodic insider series posts where I explore a topic in depth with some experts. Today’s insider series is part one of  a 3 way conversation between Brad from Triaging My Way to Financial Success , Preet from Where Does All My Money Go and myself about the topic of stock market research.

Just as a word of warning, these posts are extremely long (this post alone clocks in at 2700 words). For readability, I have alternated between normal text and italics. For shorthand, Brad is NurseB911, Preet is WDAMMG and I am TMW. Enjoy.

INTRODUCTION

TMW: Brad, let’s start with you since the genesis of this conversation is your SAML program which is making its way through the blogsphere. Tell me about it.

Nurseb911: The SAML (Stock Analysis Mailing List) is a subscription program I launched in January of 2009. Many readers over the past two years have enjoyed the various stock analyses I’ve published for free on my website. Often I took a rather tame approach to the analysis to discuss some background on the company, its investing prospects and various operational strengths that I felt could benefit a company in the future. In my private business, Triage Capital Management Inc., I conduct an analysis for clients on their business plans that bring together a wide range of topics including a situational analysis, competitive analysis, market analysis and strategic management.

Whenever I begin to research a company I want to invest in, say Coca-Cola (KO), I write one of these same styled reports in order to establish an understanding of the company’s current investment potential. I apply a series of the self developed Value Rules that I’ve derived from my own business/investing experiences and critically analyze a number of important criteria. I also update important information on all the companies I own or maintain on my watchlist over a period of time in order to get the best picture of a company’s current investment status: are earnings growing, are costs under control, has their target market changed, do they care about margins, how competent is their senior management, etc.

Essentially this program is a stock analysis tool that readers can use to learn how I conduct my analysis for any prospective investment. I have 41 free subscribers who use the program for various purposes; with some readers never intending to own the stock but acknowledge will use the analysis as a tool or template for learning how to examine another company. Alternatively non-subscribers can purchase the full analysis, after reading the public version I post on my site, if they are interested in the company or already own it.

HOW FREE IS RESEARCH?

Your program has been highlighted in Canadian Dream and Four Pillars and there appears to be push back to your research that I can be separated into two large categories:

1. Why do I need this research if my broker is already providing this and
2. Why should I trust your research?

Let me address the first pushback first- why you over, say, research provided by an on-line broker?

Nurseb911: It’s first important to realize a few things. Analyst reports and research provided by your broker are not free; the brokerage has paid for those reports in part with the commissions and fees it generates from your investing activities. Some reports are provided as a free service to investors, but for the most part these reports are quite expensive when you consider how high your trading costs are and how low the interest on cash balances is in your account. It doesn’t cost a company $19.99 to execute an electronic trade with today’s technology so where is that high cost coming from?

TMW: Preet- can you give me some insider views of the research department’s interaction with the retail sales force? As I understand it, analysts, with some notable expectations, are paid towards the bottom of the food chain in investment bankers relative to the sales staff. How does it work on the inside?

WDAMMG: The retail sales force (advisors) are profit centres. The analysts are cost centres. At a full service brokerage, the advisors have direct number access to the analysts. If a client had specific questions about certain companies the advisor can either call up the analyst for a detailed discussion, or even arrange a conference call with the client if need be. Many research reports publish the phone number of the analyst right under their name, you could just call them up too – my guess is that if you are asking the right questions, many of them would be happy to give you their insights. Phone calls with analysts usually lasted about 30 seconds to 2 minutes in my experience.

Analysts can earn big bucks. Before I actually got into the industry the original plan was to become a bio-tech stock analyst (I have a background in Neuroscience). My mentor at the time knew one of the higher rated bio-tech stock analysts on Bay Street and her income was close to the 7 figure range. You certainly have to put your time in before you get to those kind of levels, and you also need a certain amount of “celestial alignment” in the form of strong markets and strong relative performance. Analysts rank pretty high on the income side with respect to the average retail sales force I would say. You usually find one analyst per sector per shop (who in turn have a number of research associates). Analysts supporting a full service brokerage will have their research trickle down to the various different retail business lines (i.e. all the way down to the discount brokerages).

TMW: Preet, if analysts are indeed cost centres then and not the front line sales people, how do we make the leap from research for informational purposes to research for sales purposes? There’s something bridging that leap from informational- albeit completed for a sales purpose-to sales.

WDMMG: Well I think you have to take it all with a grain of salt. Over time roles have evolved. There was a time (still exists to a certain degree) where an investment bank’s sales force (in this case: the investment bankers who are facilitating primary market operations to raise capital for their clients who are businesses looking for money) pressured the research department to suit their purpose. At the very least it’s a conflict of interest. If you were leading a marketed deal, for example, your efforts would be helped by rosy research on the company. Conversely, I don’t think it’s a stretch to imagine that an analysts’ research report with high valuations has lured a business into securing an investment bank as their agent – think of a real estate agent who says they can sell your house for 10% more than anyone else. It’s tempting. Along the way, investment banks and full service brokerages have over time merged and grown into multi-business line financial services providers. Maybe I’m jaded, but research for information purposes never existed ubiquitously.

I should note that there are some analysts and analyst firms who just sell research and are not affiliated with investment banking operations or a retail sales force, but as far as I know, they are the exception.

IS RESEARCH A SALES TOOL?

TMW: So the question is, is it actually the analysts’ reports that are at fault or how they are packaged? I have to rely on some insider information myself since I have a few friends who work on the operational part of investment banks and they grumble that they read balanced research in which the sales department scratches out the downside risk and attempts to sell on upside- so is it the research per se or how it is presented? Preet, having been on front line sales staff before, why don’t you start?

WDAMMG: The use of research reports for the retail sales force is as follows. An advisor would sift through research reports based on the universe of stocks they actively follow (or clients hold or ask questions about). Research reports will generally have a 1 year target price for the stock in question which is based on all the available information in the market and the analysts’ proprietary valuation models. In many cases, an advisor would quote the target price first and foremost and then present a story, or thesis, which is also found in the research report. There are advisors out there who do their own research and compare and contrast with the analysts, but the majority rely on the research without second guessing it too much. One of the problems is that not many people properly frame the use of price targets (and the shortfalls). So as I said before, a target price is based on the assimilation of all known information thrown into a valuation model that is pretty much proprietary to the analyst or analyst team. The problem is that “all known information” does not mean “all information”. There’s a lot of unknown information. “Research reports serve to narrow the range in which we guess” is the better way of framing it, but how likely is it that a salesperson would use that tactic?

But that’s just my two cents. What’s your take Brad?

Nurseb911: I have no doubt that many analysts are honest, smart and good intentioned individuals. The problem I have with analyst reports and recommendations is that their purpose is to influence a target market (investors) to buy, sell or hold a stock. Analysts create reports in order to affect the behaviours of investors and not for educational purposes. No analyst report that I’ve ever read mentioned what important components of a qualitative assessment produced the company’s current quantitative results. The question of a conflict of interest is therefore a very important consideration for an investor who reads an analyst report or recommendation. If you don’t stand to gain a greater benefit from the information being provided then someone else is benefiting at the expense of your money. For an industry with an already established lack of transparency, reliability and open disclosure I think investors should be conscious and active in questioning how significant any established conflicts of interest are.

I don’t want to necessarily want to point fingers at who is at fault, but clearly the current model doesn’t benefit the investor more than the individuals writing or selling the reports. Sales people have to make money to live, but they’re paid very good money to offer an opinion which should be unbiased at best. Weeding out risk in an attempt to provide a compelling selling thesis doesn’t seem ethical or prudent for an industry already under the microscope of investors.

The research isn’t as balanced as it needs to be on operating fundamentals and I think that’s one of my biggest concerns. Far too often they’re spending time on profitability without addressing how those profits came to be and what operating fundamentals (qualitative factors) are going to protect profitability in the future. Commodities are a perfect example as everyone jumped on the bandwagon promoting buy recommendations on everyone who had metals in the ground. The problem was that costs were rising, supply was increasing from all the investment during the past 4 years and as demand slowed considerably a lot of these investments with high debt levels crashed 50-80%.

Adding to the conflict of interest is the significant groupthink that the industry suffers from. I don’t need to tell investors how often an analyst will recommend a stock as a buy, sell or hold only after something important has happened to affect the stock price positively or negatively. These professionals should be able to give better clarity to future developments and the impact of current fundamentals than looking to past earnings growth and profitability for future trends. If I’m going to pay for something I want to make sure that an analyst is proactive versus reactive on identifying the problems inside a business that I intend to invest in.

TMW: I think what you are getting at here is look at the source of the research. Groupthink is nothing more than symptomatic of any industry that consolidated like the financial institutions. As the old saying goes in business “no one every got fired for hiring IBM”- the modern equivalent is no one ever got fired for following the advice of Goldman Sachs and if a GS analyst said buy Citigroup, and I was an analyst at Merrill Lynch, I want to make sure I am saying the exact same thing since we are both chasing the same group of clients and don’t want to upset them with less than a rosy analysis.

Brad- I do feel that you are painting an overly broad picture of the analyst industry. Meredith Whitney first warned about Citigroup in 2007 while she was with Oppenheimer & Co.- a pretty white shoe Wall Street firm and she has continued to be critical of the financial industry since she has formed an independent research shop. Veritas – one of those independent shops Preet alluded to earlier- is a very good independent analyst shop which has criticized banks in the past- they have some outstanding research based on forensic accounting disciplines.

However, the better research comes from shops who are basically research shops only and do not have to feed the “sales” master sort of speak. It is also interesting to note that Whitney has become famous because she is not your typical Wall Street analyst- she’s female and relatively young- in other words, not another old white guy. My point being that if they are selling research and not trying to coax sales as well, the research tends to be freer, but not completely, without a conflict of interest. Let’s face it. They are in business and no one wants to buy from Dr. Doom but no one wants a Pollyanna researcher either who is a mouth piece for the sales department. It important to check your source of research.

Nurseb911: Whitney is a rare breed of analyst who has made a career of going against the groupthink of the business community. She doesn’t represent the majority and investors can learn a lot at times from looking at opposing views of certain stocks to gain a better sense of what risks a company is exposed to.

TMW: I do agree with you that Whitney is the exception rather than the rule. I think the lesson to be learned is get research from different sources; the opinions of big shops may be similar- the whole groupthink approach- but there may be some nuggets from boutiques which mainstream may not pick up on (sounds like business media vs. financial blogs!).

QUALITY OF RESEARCH

TMW: Let’s move on from the source of research to the quality of research. What about the argument that large institutional firms have access to CEO’s and CFO’s and, as a result, their research should be “better” since they hear it from the horse’s mouth (sort of speak)?

Nurseb911: I’m a firm believer that actions speak louder than words. Ask investors how many times they heard a CEO or CFO announce that a dividend was safe in the past twelve months only to later find out that their quarterly income from that company is now 50% less or more. It’s a question of perspective. If an analyst hears about a strategic initiative that will increase profitability likely their first reaction will be the impact on earnings. My first question is always, “Is this initiative practical?” Can the new initiative be implemented, make a difference and does the company’s management have the capabilities to do so?

Any CEO or CFO can dangle candy in front of an investor because they are polished corporate politicians. They receive training in public relations, sell ideas to the Board of Directors and are the face of the company. I’m more concerned with looking past all the talk to the actions or inactions of management.

WDAMMG: It’s very true that CEOs and other executives can roll out the red carpet when, say, a Fidelity analyst or fund manager calls as opposed to a small player. Part of this is due to the fact that institutional investors (like a mutual fund manager) can control a large portion of a company. They command significant voting power.

(part 2 tomorrow discusses, among other things, what research investors should conduct themselves)

During the height of the real estate bubble, real estate investment trusts (REITs) were popular securities to invest in. REITs offered steady distributions of cash plus the appreciation of real estate. When the bubble popped, many speculated that REITs would be in major trouble; after all, the REIT industry is reliant upon reliable available access to capital (the cheaper, the better) and a steady rental stream from residential and commercial tenants. With both under stress, how would REITs fare?

In the short term, things have been rough. For the medium term, the ability of any REIT to increase distributions, in a de-leveraging world, will be challenged.

THE SHORT TERM

Like any other industry, REITs have had a rough ride. For the first calendar quarter, the MSCI US REIT Index fell 33%; the Asian REIT index fell 13%, the European REIT index fell 19%. The TSX REIT total return took the best of the worse award only falling 8% (versus the TSX return of -2% for the same period of time).

The reasons for the decline in the REIT industry can be chalked up to the usual suspects: real estate valuations are falling, cost of capital is increasing, REITs who started construction are under financial stress (see H & R REIT), large tenants are difficult to find (see Brookfield Properties issues in a New York City without Lehman Brothers and a shrunken financial sector as a whole), the market is moving capital away from highly leveraged industries to low-leveraged investment strategies etc. etc.

In other words, REITs are a victim of a de-leveraging world and the stock price is reflecting it.

THE MEDIUM TERM

The more fundamental and medium term issue, for those concerned about distributions, is the uncertain future affecting a REITs’ ability to increase or maintain its distribution. The root cause of this concern is the cost of capital is going up.

RioCan REIT and Calloway REIT both recently completed debt raises, issuing 5 year debentures paying 8.33% and 10.25% respectively. More importantly, RioCan announced it would be using its proceeds of its 8.33% debenture to repurchase previously issued debt paying 5.29% and 4.938%. Calloway announced it would be using its proceeds of 10.25% debenture to repurchase 4.51% debenture. All the debentures being repurchased are maturing soon.

To state the obvious: (i) both REITs are paying an extremely high rate of interest to access capital, indicating it is pricing in the fact the market perceives REITs to be risky investments; and (ii) look at the spread between the new debentures and the old ones it is replacing. The cost of doing business just went up.

What is the natural implication of a higher cost of capital? The ability of a REIT to maintain, increase or decrease its distributions depends upon its adjusted funds from operations (AFFO), in lieu of a dividend payout analysis. I wrote about calculating a REITs AFFO in the past.

A higher cost of capital means greater expenses. Greater expenses in an environment of non-tenant growth results in reduced AFFO since you have increasing expenses which is not off-set by increasing revenue (in some cases, revenue may be decreasing). Reduced AFFO, over time, will result in either a REIT maintaining or reducing its distribution.

For example, RioCan’s AFFO for fiscal 2008 was $1.31/unit but it was paying out $1.36/unit, meaning it was paying out more than it was taking in, with a payout ratio of 104%. Given that its expenses are increasing with this recent debenture issue, RioCan’s ability to maintain its distribution will be under stress. Calloway faces a similar problem- one analysts believes its increased cost of capital may reduce AFFO by 9-10 cents a unit per annum.

THINGS TO LOOK OUT FOR

If you are interested in REITs, there are a few things to look out for in this environment (and let’s assume there will not be a positive change to the REIT industry for another 12-18 months):

1. Look for loan to value ratios (LTV). You have to dig into financial reports for this. LTV is the total debt as a percentage of appraised value of a REITs holdings. The lower the LTV, the better the ability of a REIT to borrow money relatively cheaply (given it has more assets to pledge as collateral).  For example, RioCan’s LTV is estimated to be 48% while Calloway’s is at 65%. This may be one reason why RioCan could raise debt cheaper than Calloway.
2. Look at cash positions. Assuming AFFO decreases, a REIT may have to rely upon dipping into its cash to maintain its distributions. Look at cash on balance sheets as a safety net for distribution payments.
3. Use common sense. A REIT that is concentrated in Class A commercial real estate is going to have a bleaker short-term future than a REIT with mixed residential and commercial holdings. Correspondingly, a REIT with mature properties is going to have better prospects than a REIT building out lot of projects which sucks up cash. Investing in real estate stocks has a lot of common sense in it given the tangibility of the underlying asset.

Like many other investment classes, REITs are struggling as a whole. However, a REIT which has low LTV, locked in loans for the long term and a diverse holding of properties can weather the storm. Good luck.

The North American stock markets have been steadily rising for over a month. Many of the major financial institutions are reporting a return to profits and an expectation that things are returning to normal.  Recent research by JP Morgan points out that most bear markets last, on average, 19-21 months and this bear market is on month 17. Is the recent rise in the fortunes of publicly traded companies a sign that the economy is recovering?

It could be. But, is the media focusing on the wrong source of where a true recovery will come from? Does the better sign of a true recovery reside in looking at the fate of  small and medium sized businesses (SME’s)?

Consider the following statistics:

• The U.S. government reports that 99.7% of all employer firms are businesses under 500 employees and employs about half of all private sector employees (in Canada, a 2003 study found about 55% of all employment is from SME’s which rises to over 60% if you exclude public sector workers).  If we assume that most of these firms are not publicly traded, it stands to reason that the majority of employers are private SME’s.
• Stats Canada found that a staggering 78% of all new net jobs in the period of 1983-2003 were created on the SME level (again, under 500 employees). The U.S. governments estimates SME’s are responsible for between 60%-80% of all new jobs. For example, in 2005, U.S. government data showed that businesses with under 500 employees create 78.9% of all new jobs (the consistency of Canada/US numbers at approximately 78% is quite errie). The conclusion? SME’s are over-overwhelmingly the source of new job creation.

Thus, while looking at broad based stock indexes may show how publicly-traded companies are doing, it may NOT be the best sign of whether a true economic recovery has began. It merely shows how a small segment of the overall economy is doing. If SME’s are the true job creators, and we assume job creation is a sign that the entire economy is turning for the positive and all the positive economic effects that result from a falling unemployment rate, the better place to determine whether a recovery is occurring is at the SME level.

Obviously, there is a multiplier effect when large publicly traded businesses expand and the interconnection between all businesses exists in a regulatory environment that has encouraged the free movement of capital. But, from a community perspective, publicly traded companies serve their shareholders and, as we saw during the apex of the out-sourcing fad, job creation on the publicly traded company level does not have the same localized effects as a SME expanding in your community. There is a better chance a local restaurateur who does well will spend it in the community over a large financial institution doing well.

We tend to fixate on the Dow Jones or the TSX 60 numbers simply because: (i) it is easy to obtain; (ii) most business columnist have high finance backgrounds, or their sources are in high finance, so they gravitate towards which they understand; and (iii) they tell us how our investments are doing.

However, a true recovery will occur when the local merchant feels confident not when the banker in his glass tower does. In other words, shop at your neighborhood merchant and not the big box store since you will see the effects more directly in your daily life.

I run a peroidic entrepreneurship column but Rick Spence devotes an entire blog on it (Seth Godin’s blog is also very good but with more a marketing spin). Check them both out.

The stock market experienced a slight bounce recently with the double announcement of Wells Fargo earning net income of approximately $3 billion in the first quarter of 2009, with particular strength in retail banking, and Goldman Sachs posting  $1.8 billion profit. Does this meaning that we have reached bottom and the economic recovery has began?

Not quite. At the end of the day, a true recovery will most likely begin on main street and not Wall Street. More to the point, the release of these financial statements may be indicative of a trend I wrote about recently: the tendency of publicly traded companies to use financial sleight of hand to meeting earnings expectations.

As reported in various blogs, Goldman Sachs has a new trick to meet or beat earnings expectations:  it simply did not report December in its first quarter financials. Goldman Sachs changed its fiscal end from November to December which means when it reported this year, it reported first quarter financial results from January- March rather than the previous November-February.

Of course, the firm also lost $780 million in December alone. But, because December is an orphan month, it was not included in the first quarter’s financial reports. There’s a new one for you.

Why bloggers, and not the regulators, have not flagged this may be the larger, more troubling, question. Imagine if you filed your taxes today and you told the taxman that you are not including December in your return?

Wells Fargo also announced impressive earnings. One problem. It was only a pre-announcement. The formal financial report is not issued until April 22. Given that one has yet to see the assumptions behind the earnings, it is too hard to get too excited since they could merely shift the goal posts to meet their earnings. It will be interesting to see what the financial notes say.

Typically, financial stocks do lead the recovery so these stocks are worth tracking if you want to read the tea leaves into when the recovery will occur. However, given that this industry also has very complicated financial statement to understand, the morale of the story is to drill down on the details and not merely read the headlines in making your investing decisions.

The United States Federal Reserve recently commented that it wants the amount of inflation conducive to a recovery. I would file the Fed wanting the “right” amount of inflation under the same category as bankers saying  circa 2002 that a little bit of above normal leveraging is acceptable (open Pandora’s box…now!). If, indeed, inflation is returning, does its return merely add another reason why the principal protected note is a bad investment choice?

To recall, a principal protected note (or guaranteed linked note) is a structured product which, theoretically, gives to the investor the upside of equity by linking a return to some basket of equities (an index, an industry etc.) while offering bond-like downside protection by guaranteeing 100% of the initial investment as long as the investment is held to maturity.

The issues of the principal protected note are well noted (high costs, investor is actually self-insuring, complexity etc. etc.- the best recent summary of the issues with principal protected notes is the Steady Hand’s blog on structured products). However, inflation risk was never highlighted as a plausible risk in a world of low inflation and inflation may yet undercut another pillar of the sales feature of principal protected notes.

Let’s step back 6 months. Many very complex principal protected notes have triggers known as “protection events.” In the event the performance of the equity side of the note was subject to a material adverse change (such as those seen in September 2008), the note, effectively, has an emergency brake and the entire portfolio converted into bonds and the investor is eligible to receive only the principal back upon maturity.

Is it that bad that one holds a principal protected note that will only return your principal? Better than losing your shirt right?

In the abstract, this is correct but the devil is in the details. Remember that you receive your principal back only if you hold the note to maturity (which, in many notes, is 3-5 years away). Assume the Fed cannot control inflation; a plausible scenario since the best way to control inflation is to choke off the money supply or raise interest rates- which are the last things you want to do when the credit markets begin to recover.

In 3-5 years,  every dollar of principal returned will be worth a lot less than when one invested it in a principal protected note. In other words, a principal protected note is giving you less than what you invested once you factor inflation. The longer to maturity the note and the greater the rate of inflation, the less one’s return. Given that most principal protected notes do not guarantee principal indexed for inflation, an investor is not even reaping the full effects of downside protection.

Many investors invested in these notes by re-allocating from a fixed income portfolio. In hindsight, they would have been better off leaving their money in fixed income which at least are interest rate sensitivity (or, in a real return bond, inflation sensitivity) and not stacked with fees.

One should never under-estimate the ability of the financial institution to adapt and sell bad products under new names. I do not doubt that we may see a new generation of principal protected notes with the principal indexed for inflation but why pay for this feature when you could buy a real return bond that accomplishes the same goal without the fees?

…and, as mentioned by many others, stocks, over the long run, are your best protection against inflation.

There is an increasingly large amount of ink devoted to how to find a job. There’s two things that most people don’t tell you- it takes a lot more time than you think and many jobs are not found conventionally through job searches, recruitment agencies, career fairs etc. One of the more over-looked aspects of job searching, networking, and, above all, citizenry is volunteering.

I volunteer at a small not-for-profit for the opposite reason; I work too much and it gives me balance. However, volunteering, especially in sectors that you are unrelated to what you do or did 9-5, does allow you to meet people and develop contacts with networks you otherwise would not come across. If you are devoted to the cause, people will want to help you. Who doesn’t want to help good people?

For example, a friend of mine once told me that one of her friends needed a passport in 48 hours- the request being made on a Friday. The passport was arranged in time because my friend happen to volunteer  on the same charitable agency with a political aide who could get ministerial approval over the weekend. Although not directly related to job searching, it does show the power of developing networks in diverse circles.

Volunteering also gives one opportunity to develop other skills. I have engaged in fund-raising, community awareness, policy-making- all skills I do not practice day to day. Now, to give some context, I volunteer at a small-ish not-for-profit. Many of my associates try to go straight to the top to the socially-chic foundations (yes, the Jones exist everywhere)  but they end up doing the same thing as they did during the day; the subtext is that, in larger institutions, new volunteers are sometimes viewed as tourists and there are a lot more people ahead of you in seniority. My suggestion is to find something smaller with a committed board and staff. It gives you a wider range of experiences and get your hands dirty in more things.

This may especially be helpful if you are thinking of transitioning careers. A new environment or learning new skills may give a glimpse into whether changing industries may be suitable.

Finally, one can’t job search 24-7. There are lulls in job searches such as this long weekend. Volunteering can provide a welcome change of pace.

If you are between jobs, do consider volunteering for a variety of reasons. Most of all, it is good for the community.