Avoid high yielders

People looking for investing income often talk about high-yielders more than 12% annual return. Securities with this yield are not hard to find. Names like NLY, AGNC, and a handful of foreign stocks are returning as high as 16% return. But do the numbers make investing sense?

There is no free lunch in high-yield investing. Most high-yielders hand dividend at the cost of high payout ratio to attract investors. As yield continues or stays at high end, the risk of unsustainable return increases because no re-investing capital to keep pace previous high yield. Therefore, double digit yield is the moth's fire. More reasonable approach is pick high single digit yield and long sustainable dividend track record.

An example is U.K. pharmaceutical company Astra Zeneca (AZN). It has increased dividend since 2003. Current dividend is $4.9/sh or about 6.2% yield. PE stands at less than 10 while industry average 16. AZN's operating free cash flow is back to uptrend. New CEO halted stock buyback program recently to focus on acquisition. Hence we can see investing activities has since slightly reduced. AZN is rumored to take over AMRN for its Vascepa to fill AZN's pipeline. AZN paid $1.1 billion in April 2012 to buy Ardea Biosciences. Prior to that, AZN purchased MedImmune in 2007 for $14.7 billion. It also would pay BMY $3.4 billion to co-research new diabetes drug. To offset these expenditures, AZN will outsource some drug development.

AZN bought back $2.3 billion of stock before stopped the planned $4.5 billion. It is assumed the company would use the rest to acquire new companies. Because AZN has a policy of paying 50% of earnings in cash dividends. That translates to about $3 to $3.2 dividend in 2013 if the expected EPS from $6 to $6.3 is realized, which is a confirmed forecast. This dividend makes AZN significantly undervalued compared to its peers. The company reiterated earning forecast in the last earning call.

Therefore, AZN is a more reliable income source.

Who are benefiting from social networking companies?

There was a debate why the West Coast, especially the Bay Area, took the crown of high tech industry from other regional tech hubs. Widely quoted reasons are, first, the leading position was obtained by larger young workers supply from numerous highest calibre universities in the nation. Second, a handful of successful venture capitals helped quickly commercialize academic researches into profitable products. Third, maybe diversified culture play a critical role to inspire talents.

All these are partially true. Counter examples are that many regions have their funding mechanisms and good schools but never achieved such height. There is a research report on how and where small startups are more likely be successful. The conclusion is surprisingly unrelated to the above reasons. The main factor of successful companies is the density of population. In other works, if in some area, more people of the like squeeze in higher density, new ideas are more likely to flow and more companies are likely to succeed. The research predicted that next high tech hubs could be in New York City where many youths are cobbling for the next big thing. The other likely candidate is Israel because many young soldiers are forced to service the nation. Such environment is good to nurture future development, especially they have the needs. That seems reasonable because when people have closer communication and relationship, they can work together better and inspire each other. One of previous posts on why Standford is so successful illustrated this indirectly. Therefore, this conclusion has some footing.

So, would social networking companies help to fill geographical gap to bring people closer? The answer seems unlikely. The most successful social networking companies are in the Bay Area. If following the thesis, the reason of their current success is because the founders have great connections, then the handing social networking tools to vast audience and area won't stop this fact. Only physical and efficient connections matter in business world. So social networking companies do provide ways to acquittance people. Without noticing emotions, body language, tone and volume of voice and speed of movement, it is hard to develop personal awareness. What currently is missing is real emotional sharing, which by far can't be physically substituted by online communication. Anyway, more people in the network only benefits the already insiders, not the everyone in the network. In a sense, online social networking may not improve our social skill but weaken it because we have less time to actually face people to read them and interact with them.

A most insight to social networking company business model is summarized as companies provide platforms to get more membership while the biggest winners are the companies themselves.

After the election

The Colorado girl cried out election was finally behind us. Surprised or not surprised, we're back to normal life track. Immediately, media is talking about how to resolve the Fiscal Cliff and Europe Crisis. This is the job of the new congress and the re-elected president. Without much dividend, people would believe that the upcoming tax fight is the focal issue in the remaining 2012 schedule. At the same time, the stock market acting as another voting machine takes its stand after the election. But it seems there are hints in the election on where the market is going.

Not only the Democrat won the presidential election, they had more seats in the Senate and House. The Republican is still controlling the House but it lost one seat there. The Democrat is in majority in the Senate but less than 60 votes. So it seems the Republican is retreating. Before the election, 60-Minutes interviewed Harry Reid and Mitch McConnell in "Is the U.S. Senate broken?". Both leaders were annoyed by the lengthy negotiation to strangle recovery pace. So how fast the Senate will move on a consensus view on the Fiscal Cliff is unknown. The Californian rich tax increase may have provided clues.

Jerry Brown's Prop 30 was passed by California voters. Prop. 30 calls for a sales tax increase and staggered tax increases over seven years for individuals making $250,000 and families earning $500,000 or more. Along with Warren Buffet's more tax on rich appeal and big banks such as JP Morgan and Goldman are willing to pay more tax, the rich are responding. Therefore, we can project that even as Boehner said tax increase is unavoidable, it probably won't make too much noise. In the end, the ones who fall hardest off the cliff are the 1% or 5%, not the 99% or 95%.

An interesting side note on the Prop 30: neighbor state Arizona is putting on incentives on Californian CEO's to move to Arizona after the bill passes. The state thinks that more Californian companies will move to the state because of their tax advantages. No doubt small business will be impacted. However, the real question is, by how much?

A magic number

Anyone can try out the follow simple program (any language or spread sheet applications you like):

N = 100
for i = 1:N
loan(i) = .9^i;
res(i) = loan(i)/9;
end
sum(loan)+sum(res);

You will get an answer to the last line, 9.997. Now if you change N from 100 to 1000. You will get the answer 10 to the last line.You can make N even bigger, say one million, but the magic number 10 is still the answer. Of course, this is not magic at all because this is the convergent answer to an infinite series. The interpretation, on the other hand, is more interesting that the number itself. So let's see what the variables mean in the above program.

If the number N represents the number of banks all founded at the same time, and assuming none of them has capital, they just are called to be "banks". In order for them to do business, they must somehow get funding from somewhere. Then one day, one source appears and brings $1 to the first bank. The source tells the first bank that he can loan out only 90% of his asset and must maintain 10% of asset as reserve. The requirement must be kept for the sequential loans for all the banks. For example, the second bank can only loan out 90% of his asset (can be loan from the first bank) and keep 10% reserve. That explains the loan and reserve ratio to be 9.

Since no bank has initial funding except the first one, so the first bank pipes down his $1 to all N banks. Every bank follows the same lending rules; 90% lending and 10% reserve. Then when we calculate how much capital is circulating in the all banks, we find there is $10 total. Ten times larger than the initial $1. This is the multiplying factor in economy and used many times to stimulate liquidity.

This magic number will not exceed 10 no matter how many banks are allowed in the business. It will be converging to 10. However, in order to reach 10 all banks must follow the same sequence: borrow and lend. Otherwise this is a broken chain.  When this capacity is maximized, we feel there is much more money than we think, $10 versus $1, in the market. When some banks only borrow but not lend, combined capital is slightly smaller in a few digits after the decimal point. But if the initial fund is in trillions not $1, the a few digits would end up a significant amount. Nonetheless the model is still the same.

The 90% and 10% are what the Federal Reserve requires banks to maintain their loan ratio. These two numbers were typical number and the Fed actually has been adjusting these numbers according to economical conditions. This is a tool to control fund liquidity in the market many central banks use to macro-manage.

An example is that when the 2008 crisis struck, there was no liquidity in the market. So central banks around the globe worked together to inject capital to largest banks in the world. As a result, market flew again. Of course, the banks didn't loan out continuously to smaller borrowers because there were few qualified. That was another story that related to a more mysterious part of economy: inflation.