Carnival Cruise Line - Great Example of Overdramatization in Stock Markets

In the past year, I have already made two investments based on what I perceived as potential over dramatization of stock market emotion.  The first was the BP oil disaster and the second was the purchase of Greek debt.  If you don’t know what either one of these incidences were, please close this page and never come back to it.

QUICK RECAP: BP had a monster tragedy occur in the Spring of 2010 and I decided to pick up some shares after they were beaten down.  The shares, right before the disaster, were over $60 per share and I started to pick some up after they hit $34 per share and a few more on the way down to the $30 mark.  They ended up going as low as $26 or $27 per share before things got better.  The stock currently sits at $43 per share with a dividend yield of 3.8%.  At the time of my purchase, the dividend yield was over 10% BUT due to the $20Billion that BP had to put aside for damage relief, they suspended the dividend for some time to store up the money.

Now I bought BP because this disaster, while horrible, was hardly going to bury this company.  That, at least, was my assessment of the situation.  The company went from a market cap of $200Billion down to $80Billion or so at the bottom.  So, this estimated $20Billion disaster made the company lose $120Billion in market value. Does that sound like overly dramatic responses by investors? I would think so as well. In addition, it wasn’t like BP was poverty stricken. At the end of 2009, or just a few months before the disaster, BP had over $8.3Billion in cash and another $59Billion in receivables and inventory and other cash equivalents. That’s $67Billion in cash that they either had on hand or expected to have on hand within the year.  In addition, they paid out $11Billion in dividends in 2009, so after suspending that, it would only take a year of dividend reduction plus the $8Billion in cash to make up the $20Billion liability they took on. Either way, I am sitting on a pretty decent profit but MORE IMPORTANTLY, an investment in a great cash flow business that is known worldwide as a good brand.

The Greek Investment…This was basically speculation and for only a month. To read my article on this investment, please click the link below….

http://thecapitalistmanifesto.com/blog/2011/6/21/my-big-fat-greek-debt-investment-or-is-it-speculation.html

Carnival Cruise Line:

Ok, what I am about to say is NOT meant to be insensitive.  If anyone wants to say that it’s sick that I am trying to profit from tragedy, then this is not the place for you. I am making my comments and decisions on the events that occur each day.  Most of these events are good for some people and bad for others.  

As we all know, Carnival had a subsidiary in Europe that ran a cruise line that crashed into a reef and tipped.  Over 4200 passengers and crew evacuated this ship but, as of today, 25 are either dead or missing.  This happened over the weekend and of course, it was expected that Carnival would take a hit.  How big?  Who knows.  Markets opened on Tuesday (because of the Monday holiday) and the stock was down almost immediately 14%.  So I kept eyeing it throughout the morning and it kept going between 12.5% down and 14% so it seemed pretty steady. This was expected and by 3:30, I decided to buy some.  

Here is why I did this on the first day after the market opened.  This tragedy has an already expected outcome.  We know how many people are missing and we know how much the boat is worth.  There is very little information that isn’t already known. We know the insurance deductibles on the boat ($30MM) and what we can expect from loss of revenue and such.  It wasn’t like the BP investment that I made during the oil spill. It wasn’t known when the spill would stop! As for Greece, there still isn’t a deal to get the country out of trouble! The end isn’t in sight yet even now!

But Carnival…it’s basically there.  This is a strong brand with a strong company behind it.  They are the biggest player in the field and their margins are stronger than most.  They have good cash flow and they have already taken a beating because travel and leisure is the first to take a hit during recessions.  I bought at $29.59 at a P/E of 12 and a dividend yield of 3.3%. I am pretty pleased.  Just like BP, I am not in this for the short run (as of today, Carnival is at $31.30), but I bought this because it is a great company that is well-known as the premier cruise line and the best part…only 20% of the U.S. population has even been on a cruise! There is great growth potential here and abroad as other economies become stronger.  And better yet, the barrier to entry is huge! Do you know how much those ships cost to build?!? It’s in the billions per ship, from the last I read, so no average Joe can just build one and enter the market.

I feel comfortable with this investment and I expect to hold onto this for quite some time.  Remember, I don’t like to trade based on speculation very often, so when I can buy a good company at a good price because of the emotions of traders, I think I would be dumb not to jump at it. 

S&P vs Nominal GDP - Secular Market Changes Revealed

S&P/Nominal GDP
**This article will have a lot of information and data in it, so please reread sections as you go along.**

Not many of you may know, but I still invest in the stock market and I do see it as a great way to build wealth over the long run. Most people see what has happened over the past 12 years and think it is a waste of time.  I disagree. We are just in what is called a secular bear market, which we have gone through in the past and which we will get through eventually.  When?  No clue.  However, this article is about trying to identify the point where we will be out of this secular bear and into a secular bull market.

I imagine your first question is: what does “secular” mean when it comes to the stock market?  Well, we discuss “secular” a lot at our MGO Investment Research meetings, but we have found that not many financial advisors know what this is or are able to explain this to their clients.  It is an important term to know because of your age or where you stand when it comes to nearing retirement.  ”Secular”, for all intents and purposes, means “long term”.  It is important to know the opposite term here as well which is “cyclical,” which means “short term.”

Now, those aren’t the exact definitions, but for the most part, that is what they mean and that is how we will use them for this post.  As of right now, we, at MGO, believe we are in a secular bear market, which is a long term bear market.  A lot of “experts” believe this probably started around the year 2000.  Is this for sure?  No, but in all likelihood, we tend to agree.  Now, within secular bear and bull markets, you can have cyclical, or short term, bear or bull markets.  For example, if 2000 was the actual start of the secular bear market, 2003 thru 2007 would be considered a cyclical bull market and 2008 and 2009 would be considered a cyclical bear market.

Now to get into the meat of the blog post…since 1949, which is how far back my data from Economagic.com goes, we have been in four secular markets.  The first one was a secular bull market from 1949 until 1968.  The second was a secular bear from 1968 until 1982.  The third was a secular bull from 1982 until 2000 and the last is a secular bear from 2000 until present and still going on.  Click on the link below to see secular markets going all the way back to 1877.

http://advisorperspectives.com/dshort/updates/Secular-Bull-and-Bear-Markets.php

There are many metrics one can use to see if the stock market is under or overvalued.  Some of them include current P/E ratio, forward looking P/E ratio, 10 year P/E ratio, market dividend yield, etc…These are the most popular.  One that doesn’t get a lot of attention, however, is one that values the total stock market (or a certain index) to the Gross Domestic Product (GDP) of the United States.  It does make sense to look at this because the GDP is, basically, how the United States individuals and companies make in a year.  Naturally, the value of the companies cannot drastically outperform the overall growth of the United States, theoretically, and the S&P 500 is the top 500 companies, so these tend to be more stable and safe companies to look at.  

So what my friend at Economagic.com has created was a series that shows the ratio of S&P500 to Nominal GDP and it is at the link below.

http://www.economagic.com/em-cgi/data.exe/var/togdp-sp500:%28rev%29

I have also put the data in a convenient chart to show everyone what is going on with this information.

 

As you can see above, since 1950, the ratio has been quite high and quite low.  The average, over the past 50 years, has been a ratio of 805, so as of right now, we are at about the value of where we have been historically.

So what does that tell us?  Well, it basically says that if you were to buy today and if this chart is indicative of what we can expect to see, you should expect to get the average of exactly 10% per year, if you include dividends on the S&P (this is based on data from Economagic.com from 1970 until now as the information before that was not available for total returns, which includes dividends).  

Well, I was literally just bored last Saturday evening around midnight when I was looking at this data and I decided to pull something from our good friend, the P/E10, Ratio which basically takes out the short term fluctuations in stock price and earnings to show the long term, 10 year average of P/E ratio in a stock market.  For more information on that, read the link below…this is something we at MGO take a look at a lot and from the looks of it, this is why we believe we still have some up and down behavior to go over the coming few years.

http://advisorperspectives.com/dshort/charts/valuation/PE-ratio-overview.html?SP-and-PE10.gif

Anyway, so what I did was take the S&P/Nominal Ratio and even it out with 10 year averages to see where that curve was going to land and something interesting happened….

Now, if you look, this makes the chart looking like a moving average graph, which it basically is.  The points A, B, and C are points at which the 10 year average crossed the ongoing quarterly closing average.  Now…for the dates at which these points occurred…

Point A: January 1965
Point B: October 1984
Point C: October 2001

Do these dates look familiar to anyone?  Yep…they are eerily close to the dates at which started either a secular bear or a secular bull market.  

If you recall above (or just scroll up), 1968 was the start of a secular bear market. In this chart, point A is where the 10 year average went ABOVE the then current S&P/Nominal GDP ratio and it remained there until Point B, which is October 1984.  Now, the secular bull that started in 1982 was thought to have started in August of 1982, so it is still 2 years behind BUT the hard part about secular bears and bulls is that we usually don’t realize we are into them until years into them.  For example, I didn’t start hearing about being in a secular bear until 2008 when the markets started to crash and people realized that this wasn’t just a short term blip.  

Going on, Point C is in October 2001.  Many consider March 2000, which was the high of the market, to be the start of the secular bear market, so again, we are over a year past, but for a long time, even now, people still think we are going to be in a normal recovery and are in denial that we are in a secular bear market.  

Now, does this mean that you should buy or sell ONLY at those points? Absolutely not.  Look at January 2009.  At that point, the value of the S&P/Nominal GDP index was 556, which was 31% lower than the historical average! I don’t care that the 10 year average was still above the current average…it was still a GREAT time to buy, with today as the reference point.  There are still opportunities, especially during secular bear markets, where you can make good money over the long term by buying during bad times, like end of 2008 thru early 2009. 

What this chart can show is where the LONG term prospects of the stock market are looking.  Remember, the stock market doesn’t go up or down based on value in the short term. It goes up and down based on people’s perception of value, which can be horribly inaccurate and emotional.  Secular bulls tend to start when people think that you can’t make money in stocks anymore and secular bears start when people think that the stock market has nowhere to go but up! (Re-read this because this may be counterintuitive to a lot of people reading this blog) Think back to recent history. In March 2000, people complained if their portfolios weren’t up 35% each year! And think about March 2009…people cried that the Dow was going to go to 4000 or lower and the S&P was going to hit 400.  Did either one of those happen?  Nope.  

To wrap this up, being able to identify the start of secular bull and bear markets can be VERY lucrative long term.  Market timing is very difficult and I am not claiming to have found the secrets to it, but I will say that this data really was interesting and was kind of an “ah ha!” moment for me when I saw the chart.  I’d love to hear your comments on this matter. 

It's true, Management IS Everything

When I first got into real estate, I naively thought that a property manager is someone who just put people in leases and took maintenance calls and dished them out to the property maintenance men and collects the money that everyone will be dying to pay you.  It has been seven years since I really started managing on a large scale and I have gone through so many managers on so many different properties, it has, at times, made me wonder if I made the right decisions.  I have, through experience, confirmed to myself that once I find the right managers, I have decided to do what it takes to keep them (within reason of course)

This post is kind of a “Deal of the Day” merged with my topic of finding good managers and what to look for in good managers. Do I really believe management is EVERYTHING? Well, yes and no.  If you don’t buy a deal right, it doesn’t matter how good management is, you will still not do well.  And if you buy a deal at the right price (as is my example below), bad management can still make you money.  It’s a combination of both, but in my experience, getting out of less desirable deals is much easier with good management.

In May of 2007, I purchased a small 12 suiter in Columbus off of Holt Avenue.  Not the best area but definitely not the worst.  Twelve two bedroom units and there was only one occupied unit. The owner had inherited the property from her mother and had a manger in place (the one occupied unit) who clearly had no idea what was going on.  So she had to sell and we were able to buy it for a great deal $194,000, but we had to close in two weeks and with cash.  We did our property inspection and everything came out about where we thought it would and we bought the place. 

We, at that time, had about 130 units in Columbus so we had a management team there who was handling our bigger properties.  We asked them to do us the favor of managing this and I give them credit for doing it even though it was definitely NOT part of their business model, so I can’t really blame them for how it went.  It is just too hard for a large management company to efficiently run a small 12 unit building.  They filled it up quickly and it did OK.  And when I say OK, I mean we eeked out a few % points per year in gains but our real value was in the real estate long term, which goes against my principals of buying real estate for future value.  I knew we needed to start making some bigger bucks on the property.  It was good, solid, clean and had all 2 bedrooms, which is very big in the real estate world. 

Three years later, a good friend of mine in Cleveland decided to move to Columbus because her husband’s company was being relocated. She had some real estate in Cleveland and we had been chatting so I asked her if she would be interested in managing this property.  She loved the idea and jumped on it.  So I thanked my then management company and told them the burden was off of them and they were actually relieved.  My friend took over in September of 2010 and here is how it went…

From Jan 1 2010 thru August 31, 2010, we collected an average of $4120 per month in rent.  For 2011, a full 4 months after my friend got her feet wet and got her tenants in there, she collected an average of $4600 per month in rent.  That’s over one less vacant or uncollected unit per month by my friend.  That’s equal to 8.33% LESS vacancy. She ran a financial occupancy of 84.2% (and this is after evicting a few bad previous tenants), which doesn’t sound great, but the year before, we had run 75.9% financial occupancy.  But here is the best part…my expenses have gone down and we have actually had less maintenance issues because with the extra cash, we were able to put more than $15K into the property this year in capital improvements which included new driveway, new gutters, new security cameras, new foyer tile, and brand new wodden back stairwells for all the units.  This is huge for the look and feel of the property.

As part of my full disclosure (and remember, these numbers were altered to protect the actual amounts made), in 2010, the property had profit, before debt, of just $6100.  In 2011, the profit was over $26,000 (before debt)! The property went from a 3% return in 2010 to over a 10% return in 2011 AND the property is currently getting refinanced at a value of $392,000.  I will get all my money back on the investment and then some AND have a great cash flowing property because my interest charges will only be $800 per month.  We can EASILY afford that interest charge when we are making $26K in profit per year and growing rents.

So what made my friend so much more successful in managing?  Was she more experienced?  Absolutely not! She only had a few rentals in Cleveland and the first few months of her running this property for us, I got almost daily phone calls with questions on what to do. Even today, when it comes to a difficult tenant, I sometimes have to make a phone call for her, but it’s ok because she does a great job and she will continue to get better. Right now, we collect $452 per month in rent but we are bumping the rents up to $499 this year because our demand has been strong and we want to get better tenants (better tenants want to and are willing to pay more in rent).  So 2012 should be an even better year than 2011.

It was the same property this year as it was last year. Nothing had changed except the manager.  I have several other examples of this across our portfolios but just remember, when I talk about turning a property around, it has involved two major factors…rehabilitation of the property from a physical side as well as new managers that understand the process of managing or are willing to learn the process from us.

County Tax Auditors - Biggest Scam In the World…seriously

Over the past two years, you would be hardpressed to find many people who have bought real estate at prices HIGHER than the local county auditors tax value.  This is probably true unless the property was purchased from an owner who had owned the property for a few decades.  For those who are not aware of how the tax value system works, basically, the local county auditor will adjust values of the properties every X # of years based on what they think the value is (the # of years is based on the state/local gov’t rules).  However, if a sale has occurred, the tax value would go to the price of the sale…or so it’s supposed to be.

At Select Investment Group and Crossroads Group, we have purchased over 500 units in the past 3 years and not a single one (that I can remember) we bought was for above the tax value at the time of acquisition.  This is not a point of bragging, it is a point to show how ridiculous tax values are with my examples below.  Read on for the largest example of blatant theft I can think of over the past few years…

Example A: Let’s say there is a house you are looking to purchase.  It’s your dream home.  The asking price is $500K and the taxes are based on a tax value of $350K.  Now, you go out and look at other comparable homes and see that the house is really worth about $450K, but you REALLY want the house.  It has to be yours or you know you will regret it for a long time.  The selling real estate agent tells your agent there is another offer in.  They can’t tell you what it is, but it’s a good offer.  You sit down with your spouse and you guys remembered the bonus you got 10 years ago that is sitting in a money market doing nothing.  (By the way, overpaying for a house by using investment dollars is NOT a wise decision and I do not condone it) You decide to offer full price.  You justify it by saying that this is the last house you will live in and you will probably be here for 40 years, and what’s $50K over 40 years really?  So you offer full price so you know you will get it…and you do! That’s great!

Next year, though, you are surprised to see that even though you and you agent know the real value is $450K, your taxes are now based on $500K.  You complain and scream and cry like a baby to the auditor’s office and they respond by saying “The market value is what someone is willing to pay for it…and you were willing to pay $500K, so the market value is $500K.” Unfortunately, you are probably going up stream without a paddle on that one.  You’re stuck with that value.  Now, a few yaers down the road, once you are further removed from the purchase, you can appeal and get an appraisal done inexpensively (couple of hundred dollars) to show your value shouldn’t go higher for a while, but you will definitely eat the extra taxes for a while.

Now, jump to 2003-2006.  The real estate markets are going crazy! Bankers have decided to give everyone who had a heartbeat and a job for over 2.5 hours making the minimum wage a loan for $100K to buy the house they can’t afford.  So houses that were normally selling for $75K to $85K are now selling for over $100K! This is great news for the auditor’s office because as you saw in my example above, they know free markets (insert sarcasm here) and they know that a house on the market and available to buyers will go for what the market bears.

2008 rolls around…guess what…no one can afford their house…they give them back in the millions.  Banks are taking massive losses and selling these foreclosed homes for record lows.  (As a side note…we bought one house in a decent cleveland suburb for $1500…it wasn’t even falling over…that’s how bad it got…we did have to put $35K into it, but what did we care?!?!) Anywho…you’re now a savvy buyer who is buying up these homes for an average of $8K to $12K per home.  Great! Now the house tax bill comes in and you say “Ahhh. No big deal. I will appeal. After all, they have to take the value down to what I paid for it. That’s the market value, right?”  WRONG!!!!  Why would you be as dumb as I was to think that!?!?

Guys and gals…we have appealed DOZENS of home and property purchases in the last 4 years and I can only name 3 that we got lowered to the price we paid and it was because we paid a little less than what the then tax value was.  The counties have decided that since banks are rather wealthy (Now, I don’t know what banks they were looking at but it must not have been the hundreds that failed each year for a few years) and they “don’t have to sell” so therefore these foreclosures are NOT really market sales. 

So they basically (and this is NO exaggeration) decided to not take into consideration the only transactions that are occurring these days  because it hurts their cash flow.  Duh! Why wouldn’t they do that?  I won’t even get into the politics of changing whatever law/rule you need to in order to get money, but it’s just outright theft. 

So that is where we stand now.  My comments to all tax review boards:  If you want the upside of a good market, go for it, it makes sense.  But then you have to take the downside. I would usually say that “that’s the way true business goes” but then I remember what we are talking about…the wannabe businesspeople at the local county auditor’s office. 

I’d love to hear some tax appeal stories. Email me or comment below with your stories…we will start a support group.  I could think of a name right now but it would probably be horribly offensive to a lot of people so I will just it slide. 

Deal of the Day - Single Family Home Investing

 

At The Capitalist Manifesto, I am always spitting out bash sessions on real estate brokers and investors around the country who we don’t believe look for the right deals in the real estate market.  So to show that we aren’t just all talk, I am starting a recurring blog post that I hope to add to once a month or so called “Deal of the Day.”  This won’t always be the deal that makes us money. To be fair, we want to show our winners and our losers, or the deals that didn’t do as well as we had hoped. It’s always easy to brag about deals that make money, but I want people to see that we are conservative because we have screwed up as well.

When I threw this idea out to those I know very well (business partners and investors of mine), they were hesitant saying that it would give away too much about what we do, but I figured out a few easy ways around it.  1.) I won’t give exact addresses of the properties I am looking at. 2.) I won’t give the dollar amounts for our own good so people don’t know how much money we have made on our deals. So all data below is a proportional number to the actual deal we have done. 

The first deal I wanted to talk about is VERY important due to the fact that it is the reason we are in this whole financial mess to begin with…single family homes.  Back in 2009, we partnered with a few people to start buying bulk single family homes.  We purchased a total of 70 homes and rehabbed them fully.  When I say fully, I mean new kitchens, bathrooms, carpet, drywall, HVAC, roofs, driveways, garages, electrical, plumbing…everything.  We are VERY proud of these homes and we have taken investors on tours of these homes and the reaction has always been very positive with many saying “wow, I would live in this type of home.”  Now, granted, the areas aren’t the best, so I don’t know if they would live in those areas, but that’s not what they are saying. They are saying they are shocked, given the area, that we did such a great job, so that’s nice to hear.

Of the 70 homes, 55 of them are average everyday homes in the $70K to $85K value range, in today’s market, so I will concentrate on those.  The other 15 are high-end homes that we have flipped or used for other reasons and aren’t part of our rental package.  We will discuss the flips as well on this recurring blog post because we have done quite well with them. 

We are into these 55 homes for an average of $44K per house, so let’s put a total investment of $2.42MM (using investor $$$ and money from a credit line).  Now, let’s look at our cash flow, over the past three years, by year. (Keep in mind…the profit I am listing is BEFORE debt. I did use a credit line for part of the purchases, so I do have low interest debt until I refinance with permanent financing, which I am doing right now).

2009: We spent this entire year basically buying homes and starting the rehab.  We only had $6200 in total REVENUE for the year and showed a net operating profit of $995. 

2010:  We were still purchasing and rehabbing and trying to lease, so the large part of the year we were vacant…our revenues were: $342,522 and in this year, we only paid a little under half of our property taxes (we paid $46,750 of $106,520) because we were appealing them since we had purchased many of the homes for 20% of the property tax values.  Our net profit at the end of the year was: $40,653. So if you took out the taxes we should have paid, it would have been a net LOSS of $19,159.50.

2011: We spent this year only acquiring 5 properties and rehabbing them but we also had bad occupancy! We did a poor job of screening our tenants.  We were so eager to get the houses filled that we put some bad tenants in.  In 2011, we had 68% financial occupancy! It was terrible.  Even with that, our revenues were $467,696 with profit of $72848.  So, in a year where we paid $65,000 more in property taxes than was billed because we had to pay the taxes of the properties we lost on appeal AND had 68% financial occupancy, we still managed to make a return.

So looking at 2012, we expect to run in the 80% financial occupancy range and pay less in taxes, obviously.  If that occurs, we expect to have revenues of $530,000 and expenses of $298,188 for a total profit of $231,818 or a total return of around 9.6%.  Again, this is based ONLY on 80% financial occupancy and the same expenses as last year. Remember ,since we had so many evictions, many of our houses needed a lot of work done to turn them back around.

And the kicker…we are into these houses for $44,000 each.  They currently appraise, in this bad market, for $70K to $85K per house. In 5-7 years, when they have stabilized, we expect the average to be close to the $85K range, we will be able to sell and make $40K per house for a total additional equity of $2.2MM plus the net income of $200K to $250K per year along the way.  If we are able to operate at 90%, that NOI jumps up $60K extra per year.

So…again, it goes back to my previous blog posts…an investment isnt’ bad just because everyone thinks it is.  In fact, it’s usually the opposite.