Blueprint Financial Planning LLC
Rick Konrad co-founded Blueprint Financial in 2001 and also founded Value Architects Asset Management. Prior to this, he was the Managing Director of Research for Ryan Beck & Co. He has extensive experience in investment management, having been a partner in Lincluden Management, a Canadian private asset manager with over $7 billion under management, as well as Sceptre Investment Counsel in Toronto where he was responsible for a $2 billion US mandate.
He is a graduate of University of Western Ontario in Canada, and received his MSF from Northeastern University. He received his CFA charter in 1988, his CFP® designation in 2004, and has completed the Harvard Business School Executive Program on behavioral investing.
Rick has been a member of the University of Western Ontario’s investment committee since 2008 as well as a member of its Board of Governors. He also has served on the Shareholder Advisory Council to Sallie Mae, the nation’s leading provider of student loans where he was involved in initiating changes in financial reporting and securitization as well as a change in senior management of the company. In his free time, Rick is an adjunct instructor of retirement planning at NYU.
MS, Finance, Northeastern University
BA, Biophysics, University of Western Ontario
It certainly is possible to sell a bond short, just like the process by which you sell a stock short. You are selling a bond that you do not own, so it must be borrowed. This requires a margin account and of course, some capital as collateral against the sales proceeds. There are interest charges for borrowing the security.
One other important provision. Just as an investor who is short a stock must pay the lender any dividends that are declared, a short seller of a bond must pay the lender the coupons or interest that is owed on this bond.
You may wish to consider using an inverse ETF. Inverse ETFs are designed to perform the opposite of the underlying index, though over longer periods of time, are not a perfect offset. Hence, inverse ETFs should only be used in the short term. Inverse ETFs are particularly useful for IRA accounts which are not allowed to use margin. The only way to employ a short strategy in an IRA account is through the use of an inverse ETF.
There are a large number of inverse Bond ETFs that are available that allow you to short bonds on the basis of maturity (20 year bonds versus 7-10 year bonds) or by credit quality (High Yield). The expense ratios tend to be much higher than their "long" counterparts because they require considerably greater effort and monitoring on the part of the ETF sponsor.
An example of such an inverse Bond ETF is TBF, the ProShares short 20+ Year Treasury ETF, which is among the largest of these with about $740 million in AUM and high average volume of over 700K shares over the last 90 days. But, management expense ratios are high at 0.93%.
There are inverse exchange-traded notes or ETNs, but we generally advise against these because they do represent credit risk that is associated with the issuer. There are lower management expenses associated with these (example, TAPR with a 0.43% management expense ratio), but as I said, there is credit risk associated with these.
Keep in mind that the prevailing wisdom for some time has been that rates are moving up. TBF has had only one positive return year (2013-the year of tapering) since 2010.
I hope that addresses your question.
You have asked an excellent fundamental question, how should we value a stock? Let's look at each of the approaches you have raised.
Book value is merely an accounting value. It reflects the difference between asset value (based on historical costs) less the debts and other prior liabilities. So, if the historical asset value based on the original cost does not reflect the current value, it can be a very misleading statistic. For example, many integrated steel companies had very high cost assets based on their historical valuation, yet were no longer economic and produced little cash flow or earnings. Companies like this traded at a discount to their book value, but were not really bargain investments. One other accounting wrinkle that I should mention. When companies are buying back a lot of stock at prices that exceed their book value, these actions actually reduce the book value. Consequently, there are many companies that have had active share repurchase programs where the book value can even be negative. Yet, many of these companies continue to grow revenues, cash flows, dividends, and earnings. There are other companies which may have understated values, for example, raw land that has appreciated over time, but is still reflected "on the books" for its original cost. So, book value is not a reliable determinant of valuation.
Enterprise value takes into account the stock market's assessment of the value ( the stock market price) plus the debt of the company less any cash holdings of the business. It's as if you were buying the entire business, paying off all the shareholders, as well as the debt holders, but you would finance part of this transaction with the company's own cash holdings.The cash is subtracted because it would reduce the cost of buying the entire business. Sometimes, one can find stocks with negative enterprise value, that is, the cash on the balance sheet exceeds the valuation of the rest of the business. This can be helpful in finding bargains.
The discounted cash flow method is one of the most commonly used approaches by professional analysts and investors. As others have described, it does determine the value of a business by taking a present value of all future cash flows from the business and adjusts these for the liabilities. However, there is "art" in using this tool. One must be able to make reasonable assumptions about the future profitability of the business and obviously that can change with competition and obsolescence. One must make assumptions about what sort of discount rate to use. That discount rate reflects not only the "cost of money," or the cost of financing, but your desired rate of return. In other words, how much return would you expect from this sort of a business. If a business has a highly predictable cash flow, you probably would demand a lower return. On the other hand, if the cash flows were somewhat unpredictable, or competition in the industry was rampant, you would want a higher rate of return, so your discount rate should be higher.
Most advisors do not attempt to value individual securities, but prefer to utilize professional active investors through Separately Managed Accounts or mutual funds or alternatively, use passive investing approaches. Proper security analysis requires education that goes beyond the scope of Series 7 holders or even CFP certificants. Individual investors should be mindful of the risks associated with security selection and inadequate diversification.
The discounted cash flow approach is the best tool that we have to determine "intrinsic value," but it does rely on assumptions which may be unrealistic and discount rates which depend on an assessment of the riskiness of the cash flow.
I would not dismiss REITs as a wealth creation tool. In fact, REITs have three huge advantages over direct ownership of property:
- Diversification- I certainly can't afford to own a 500 unit apartment building or a large shopping mall, but I can participate in the ownership through a REIT.
- Liquidity- I can sell a publicly traded REIT just like I can sell any other stock, but the frictional trading costs are much lower.
- Professional management- I don't have to deal with tenants, property managers, etc.
I agree with other comments about non-traded REITs. In my opinion, they can be a roach motel...easy to get in, but you can't get out. Beyond the illiquidity issue, the valuations of trading property from other elements of the real estate operator's business to your unlisted REIT are not always independently determined. This creates a huge potential conflict of interest.
Greater volatility is a bit of a nonsensical argument when you deal with publicly traded instruments versus something that is non-public. Every publicly traded security is subject to the behavioral whims of buyers or sellers, as Buffett and Benjamin Graham illustrated it, much like having a bipolar partner. But owning a piece of property is also subject to local markets. Same proposition here, if someone offers you a price you don't like, you don't accept it. The same principle applies to a publicly traded REIT.
The returns for publicly traded REITs over the long term have been the best of any asset class. That's not to say that they are always the best, your return depends on the price that you pay...no different than buying any other property or stock.
For perspective, let's look at the NAREIT index of Equity REITs (all of these are public) versus the S&P 500. Yes one can argue that this data is subject to survivorship bias, but the same is true for the S&P 500. Many of the companies in the S&P 500 are no longer around and have been replaced by new entrants. Data goes back to 1971 and goes to end of 2015 and is total return (capital appreciation plus dividends).
|Cumulative Total Return (based on 100 initial)||Annualized Return|
Let's look at a more current period, say starting in 2000
|Cumulative Total Return (based on 100 initial)||Annualized Return|
Now, one can argue that the comparison is unflattering because of high valuations for stocks in the Internet era of sock puppets and other tom-foolery that existed at the beginning of 2000. But the data demonstrates quite effectively, in my opinion, that REITs (publicly traded REITs) have provided great wealth creation opportunities.
Of course, there were some terrible years along the way just as in the stock market. They coincided with periods of interest rate concern as well as naturally falling real estate prices. For example, total returns in 2008 were down 41% for the NAREIT index. But as you suggest in your question, income for equity REITs has grown as properties have appreciated, as mortgage debt has been managed, and as rents have grown.
What characteristics should the individual investor look for in an equity (as opposed to a mortgage REIT- a whole different animal)?
There are many qualities to look for. Let's start with the real estate portfolio characteristics:
- What is the type of property? Commercial, multi-family, and numerous varieties after that!
- What is the occupancy of this property?
- What are the lease spreads like?- the difference between lease revenues and mortgage interest expenses
- What is the geographic spread of the REIT? Focused on particular states, regions or national in scope?
- How diversified is the tenant base? Too much concentration with a particular "shaky" tenant?
- How do lease expires look over the next few years? A lease expiry is an opportunity to renegotiate rents for both landlord and tenant.
Like any other security you would want to know the leverage, how much debt there is, and what the interest coverage is. Many REITs have publicly traded debt and preferred securities that have credit ratings which provide some "comfort" as to their quality.
Finally, you need to have some sort of valuation metric to appraise the REIT. The most common is Price/ FFO (see https://www.investopedia.com/articles/04/112204.asp)
Of course, an investment advisor or planner who is well versed in this sector can help construct a REIT portfolio that meets these criteria.
Another important aspect to REITs is that they must pay out a substantial part of their income in order to maintain their tax-free status as an entity. This also means that distributions received (akin to dividends) are fully taxed unless they are held in a tax-deferred vehicle such as an IRA or 401(k).
Hope this addresses your question. Good luck in your investments!
No, such a share repurchase would not appear in the daily "listed" volume reported by the stock exchange. Most share repurchases take place as "Open market purchases" which are governed by something called Rule 10b-18. Hence, there are limitations for companies to buy at the open and within the last half hour before the close. As well, volume cannot exceed 25% of average daily trading volume. Private transactions do not follow these limitations.
But in a private transaction, the share volume is not evident in the exchange's volume. But disclosure of share repurchases, either on the exchange or in a private transaction, must be reported in its next periodic report (10-Q or 10-K) of the total number of shares repurchased, the average price paid per share, the number of shares purchased as part of a publicly announced program, and the remainder to be purchased.
Private repurchases of stock are reported eventually through the Q or the K, but not in the trading volume.
Hope that helps!
It certainly is possible for a business to have extremely high gross margins (the difference between sales and cost of goods sold is gross profit and gross profit divided by sales is gross margin) and yet have negative operating margins (Gross profit minus operating expenses is operating profit and operating profit divided by sales is operating margin).
So if operating expenses are too high (for example, salaries, selling expenses,advertising expenses, administrative expense, legal and professional costs), the operating margins could be negative.
A good management will keep these operating expenses under control and implement cutbacks in order to achieve operating profitability and positive operating margins.