Should you invest in your companies 401K? April 18, 2014Posted by shaferfinancial in Finance.
Tags: 401K, 401K failure
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I regularly receive calls about and discuss with folks this question. Often the answer comes down not to mathematics but emotion. I have posted regularly on why I think the answer should be no, but the answer is usually long winded, rational, and mathematical.
So here it is in a brief statement:
By investing in a company 401K you trap your money in a bad investment for retirement income.
Key words are TRAP and BAD. I have long posted on why mutual funds are bad investments for retirement income. The rules for getting your money from a 401K are so onerous as to force folks to leave jobs in order to get their retirement accounts.
End of Story.
Give me a call if you want to put your money in a better place.
EIUL Update April 11, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: EIUL, EIUL Returns, Minnesota Life EIUL
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I start out this update with some facts:
From 1990-2009, the average mutual fund outperformed the average mutual fund investor by more than 300%, annually. Since ERISA was passed in the 1974, enabling 401k accounts, the market has returned an average of 11% per year. However, the average investor has gained only 3% per year. [Found on the Big Picture by Barry Ritholtz while trying to convince you to let him manage your money]
With those facts as background, most of my clients are receiving the maximum interest credits [cap rate] on their EIULs this year as they hit their anniversary date. These gains are now locked in and can’t be taken away by a downward swing in the market.
Minnesota Life still is my go-to company for EIULs. They instituted a post 10 year bonus last year, putting it back on top of my list. The product itself has been the best performer of the EIULs over the 10+ years it has been in existence.
Here are the actual interest credits you would have received if you had purchased this when it came out. [assuming a Jan. 1 anniversary date] using the actual cap rates at the time.
CAGR of 8.48%. Not to shabby for some fairly tough years that caused folks to panic that were invested in mutual funds and underperform by 2/3rds.
The actual index returned a CAGR of 5.1% during the same time period.
Real Returns, not theory on how this product might work.
And now folks will start getting their post 10 year bonus to boost returns even more.
If you have been waiting to get involved with this product, now is the time before the inevitable market down draft gives away your money.
The Truth about 401Ks April 8, 2014Posted by shaferfinancial in Finance.
Tags: 401K's, So you want to access your money?, Truth about your retirement
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Among the least discussed issue with 401Ks is the fact that you really don’t have control over that money. That is the deal the government and Wall Street has made with you. You get an up front tax break, but you lose control of what you can do with the money.
At least 5 times a year I get a call from someone wanting to move money from their tax protected savings plan into another type of savings vehicle. My first words are usually “are you sure you can move the money?” Invariably I get a “yes” and then after we have a great conversation they get back to me and say, “well actually I can’t get my money out.”
Let me say this directly, the government and Wall Street has sold you a savings plan that in exchange for a small tax break, you give up the ability to direct where your money is invested, are forced into “company negotiated” options that usually have higher expenses that you can get elsewhere for the same product, limit the options on type of investments [usually to mutual funds, company stock or money market funds], and have you obligated to pay taxes on what should be a much larger amount at some future date.
So the government increases the amount of taxes it gets from you and Wall Street gets millions of small investors forced into their products at high fees. And if you want out, you can’t. Or if you move jobs then you can, but you are forced to pay a 10% penalty tax as well as regular income tax.
Lyrics from Hotel California from the Eagles pretty much sum it up:
Mirrors on the ceiling,
The pink champagne on ice
And she said “We are all just prisoners here, of our own device”
And in the master’s chambers,
They gathered for the feast
They stab it with their steely knives,
But they just can’t kill the beast
Last thing I remember, I was
Running for the door
I had to find the passage back
To the place I was before
“Relax, ” said the night man,
“We are programmed to receive.
You can check-out any time you like,
But you can never leave!
If someone came to you and told you what I just said, would you buy into it?
Now you understand the magnitude of the propaganda machine the government and Wall Street has created.
Most people just shrug their shoulders and say “what can we do?,” or “I am getting a match from my company so that makes it all worthwhile.”
No it doesn’t. It doesn’t make it worthwhile, it doesn’t make sense, and it is a really bad retirement strategy that was never designed to be anything but an additional retirement bonus for upper level management on top of a defined benefit pension.
Just remember “you can check-out any time you like, but you can never leave.”
How quickly they forget…… April 3, 2014Posted by shaferfinancial in Finance.
Tags: Annuities, EIULs, Last time we went more than 5 years without a negative stock market year?, stock market, Time to get out of stocks?, You should fear the market, Your 401K
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Its 2014 and we are about 5 years since the stock market’s latest swoon [-39% for the S&P 500]. In the intervening years the market has gone straight up with +23%, +12%, 0%, +13% and +32%. Last year we went ahead of the high point in the market before 2008. When I talk to some clients, even some that know better, they scoff at my insistence that 2008 wasn’t an isolated case but a regular occurrence. Since 1950 their have been 10 occurrences of more than a 10% annual loss in the S&P 500. [1957-1966-1973-1974-1977-1981-2000-2001-2002-2008] So over the last 63 years 10 losses of over 10% or 1 for every 6.3 years. Going by decades the 1950s and the 1960s had 1 each, the 1970s had 3, the 1980s 1, none in the 1990s and 4 in the 2000s.
So we know that we will get one sooner or later. Now, I can’t tell you when, but I can predict what will happen to the aggregate of individual investors. Since a vast majority of them are invested in mutual funds they know nothing of the individual stocks they own. This lack of knowledge pushes the general panic we all feel when a down market materializes into overdrive. So what happens [every time in the post mutual fund/401K era] is people panic and sell after the market has crashed, or they have to sell their retirement funds because they get layed off, recent and near retirees bemoan their position and extend their work lives if they can, it becomes big news all over the media which reinforces the panic, and retirement accounts are left devastated.
Then the market goes into its upswing, we see years like last year, +32%, people gain confidence or don’t want to be left out, so they rush back into the market like we are seeing now. Everyone becomes a stock market maven and there are no losers.
I don’t want this to become an alarmist post……it is just an honest discussion of what happens with the stock market cycle. I do question why people want to be on that roller coaster ride? Some feel they have to because they are getting that company match [again]. Some simply don’t know any other way. Some believe Wall Street propaganda that other products don’t work or are expensive or are risky.
But whatever it is, people forget what just happened a couple of years ago.
Human nature is what it is ……psychologist label it recency bias…..it is still scary to watch.
Want off the roller coaster? Call me.
Oh and the last time we went more than 5 years without a down year? An 8 year time period starting in 1982. And that was the only time since 1950 we went longer than 5 years without a negative year. So we are already in an anomalous era.
Changes in my Portfolio March 31, 2014Posted by shaferfinancial in Finance.
Tags: changes in my portfo, My Portfoilio
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As I mentioned before, I am slowly decreasing my Berkshire Hathaway position from where it once was [80%]. I am doing this gradually with the idea of moving it down to around 30% of my portfolio over the next few years. After Berkshire reported its annual results it went on a little run, so I took that opportunity to sell some at close to what I consider fair value. I am doing this to pump up my dividend growth side of my portfolio as Berkshire pays no dividends. I was able to get around $124.90 for the B shares I sold.
I combined this with a weakness in the energy stocks I own. I was able to add on to my shares of SeaDrill and AWILCO. SeaDrill price dropped precipitously last month despite company assurances that the dividend was safe. Personally, even if they dropped the dividend temporarily, it would not bother me. But, I believe the company when they say it is safe at this point. My original thesis on oil demand hasn’t changed as I see demand increasing and productivity of existing sources falling. This means that drilling has to increase, both on land and in the sea. Although a short term weakness might play itself out this year in drill ship rates, we haven’t seen that yet for SeaDrill’s drill ships. After my recent buys in the $34s and $35s, my yield on cost is over 10%. My basis per share is $38.30, so currently 9% underwater. So if the stock does nothing over the next year, I will be break even with the dividends added in. The stock price has been moving up over the last week or so. Weekly fluctuations aren’t a real concern to me as the pedal will meet the road when the new leases are announced and the pricing is exposed.
AWILCOs price also dropped as the entire sector fell out of favor. I took this opportunity to add on to my position at $19.65. My yield on cost is now over 21% and my basis is $20.35. Currently showing a small profit. Again, my thesis is that drilling in the North Sea will continue and that there is a moat preventing others from entering that area to drill. I expect a small drop in dividends when the two drilling units are put in dry dock for a short period of time to improve the safety mechanisms. This is planned for later this year. There still are long term leases on these two units going forward into 2016. However, I think in around 4+ years I will have my money back here as long as we get no surprises. Obviously this is a higher risk play and AWILCO still is my smallest position.
Still following Buffett’s strategy of a concentrated portfolio of well run businesses with moats and built in advantages. Combining these ideas with building a dividend growth portfolio that can sustain me in retirement. [I think Buffett also likes getting dividends too!].
Once again, this type of investing is not for everyone and has some inherent risk. A world wide depression would devastate its value. But, I believe the dividends are sustainable and most likely will increase significantly over the next 5 years. I am now receiving 20% of my dividend goal for retirement.
My risks in SDRL and AWILCO are balanced out by my large stake in Berkshire which is about as safe an investment as one can find.
Let me know your thoughts….
Understanding Risk March 24, 2014Posted by shaferfinancial in Finance.
Tags: Financial Risk, how to avoid risk in investments, Mutual Funds and Risk
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Risk is something that folks do a poor job evaluating. Perhaps it is because we are emotional creatures tied to our emotions through our brain function? Or perhaps, as a generation we didn’t learn how to deal with risk? Whatever it is, facts demonstrate how poorly we deal with it. Because of this, most people have a hard time dealing with their finances, specifically how to deal with developing retirement income.
We fear risks that are extremely unlikely to happen and don’t worry about risks that are almost guaranteed to happen. Its common place for me to talk to people who are worried about economic collapses yet haven’t given much thought to the risk of the stock market they invest in. As regular readers know, I think mutual funds are the worst place to invest for retirement. It is full of obvious risk that is generally ignored especially when we see a 32% return like we did last year. One gentleman I recently conversed with on the internet was bragging about his 12% return over the last 23 years. Indeed, it was pretty impressive considering it beat the S&P 500 return by 20%. But, missing from the discussion is the fact that 1 year ago that return was 9%. What a difference a year makes! I calculated the 22 year return [life of the fund] for a commonly advised, low expense [.17%] fund the Vanguard Total Market Index Fund [VTSMX] and found it to be 9.4%. Not bad. But 1 year ago that return would have been 6.1%. Again, what a difference a year makes. Do people really understand that the sequence of returns make such a huge difference. Take the man above, he started investing at the beginning of the longest bull market in stock market history and now has tripled the value of his investments in the last 5 years. If he was retiring today, he can be considered one of the luckiest people alive. But he is not. He is leaving all that capital at risk for the last 10 years before his retirement. Crazy. Do you know someone like him? Maybe yourself? Do you know you can lock in those gains and guarantee future gains in the 7% range right up to retirement if you are in your 50s?
The peaks and valleys of investing in the stock market appears innocent enough until you start to understand what the real risk is. Those numbers above assume that you have a constant amount of dollars invested over the long haul. But is that realistic? For most people they have the least money invested in the first 10 years and the most in the final years coming up to when they will use it for retirement. How does that effect risk? Common advice is to ratchet down stock ownership and increase bond ownership as you age. Great, except now you don’t get the full advantage of a 32% up year when you have the most money invested. And what about those people that are just starting out. They get a 32% return, but it is on very little money.
Simply put, the final 10 years before retirement have a huge effect on the results. And if you are invested more in bonds than stocks over those years as some would suggest is wise, that decreases significantly the potential gains during the most critical period. And we haven’t even touched the damage down years can do the closer you get to retirement.
We are currently seeing much money going into stock mutual funds. Surprising? No, we just had a +32% year. Do these people have any understanding of what buying at high prices can do to their overall return? Probably not. Do they understand the risks they are assuming? No.
How did we get to a place where millions of nice, smart people are putting their retirements is such peril?
The easy answer is a combination of corporate malfeasance [moving from defined benefit pensions to 401K style retirement plans], government encouragement and Wall Street propaganda. But let’s not be glib here. We are where we are and we can’t change that. Neither can we change human psychology or the way the market works.
And it does critics like myself no good blogging to a couple of hundred people pointing out the obvious when there are tens of millions of folks out there with no idea the trouble they are in. But, what can be done is to reach out, person by person, explaining what is going on, explaining risk, explaining how to avoid it, advocating for folks to take over their retirement.
Not all risk is obvious and preventable. Humans have been dealing with this fact forever. But, there is no reason to assume known risks that are preventable. If you are still thinking that investing in your 401K, buying mutual funds, being fully exposed to stocks, or using strategies that are failing people, are the way to go because it is commonly advised, don’t call me. But, if you are beginning to see the cracks in the wall of using commonly advised strategies, starting to understand how it really works, starting to worry about the risks [both unknown and known] for these strategies, then give me a call. Hopefully, you will be open to how to redesign your retirement income using insurance products and/or real estate and/or dividend producing stocks to fix the fissures in your retirement wall!
Annuities and You March 21, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: Annuities, Equity Indexed Universal Life, Fixed Index Annuities, Market risk, retirement income, Sequence of Return Risk, Sleeping Well
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No where in the financial services field are there more folks arguing about where to put your money than in the annuity/mutual fund market. Well known stock salesmen [Like Ken Fisher] put out all sorts of scary information about annuities in hopes that you will give him your money to invest. So I thought I would put out my thoughts.
Annuities have their place in peoples portfolio when there is not enough funds to withstand market downturns or when there are so much funds that a save return is all that is necessary to fund a comfortable retirement. In short, it is my belief that market risk [including sequence of return risk] is the most dangerous risk out there for folks and should be addressed in a rational way. Greed is a constant of human experience and Wall Street has been using that against us for a long time. Their claims, whether mutual fund returns or stock returns, are attractive to us. But what they don’t tell us is what really matters. That is, even under the best circumstances, the stock market is a very risky place to put money that you will need at a certain time. The closer we are to that time, the more risk there is. Of course, for most people their 40s and 50s is when they have the most disposable income to capture for retirement. These two facts collide to make a dangerous stew that has proven to be a poor recipe for retirement income.
Annuities have been recently redesigned to fit into this paradox. As you approach retirement, how do you shed market risk, still get decent returns, avoid sequence of return risk, and deliver lifetime income? There are two possibilities, life insurance contracts like EIULs and annuities. Of the two, only annuities are able to guarantee that lifetime income.
Are there costs to this? Of course. The costs are you leaving on the table some potential market gains in exchange for that market risk reduction. But, here is the fundamental truth, the vast majority of people are not mentally structured to deal with stock market risk and its huge downsides. Most people, at the very least, lose sleep when the market goes down 20% or 25% or even 45%. When we look at the data of individual investor behavior we see many, perhaps the majority of folks selling low and buying high. So most people aren’t able to take advantage of the possibility of better market returns in mutual funds or stocks.
Let me outline it for the reader:
1. Human behavior causes most people to make major mistakes in investing in the market
2. Sequence of return risk, even if they don’t make mistakes, can and probably will damage retirement income significantly
3. Annuities are designed to give good returns [sometimes guaranteed] and high annual income guaranteed for life.
4. As people age, they should significantly reduce risk on money to be used for retirement income.
5. Annuities and EIULs should be considered as part of the financial planning process because of the strategies employed in them reducing market risk.
6. Using insurance products for retirement income is a more conservative choice than using stock market products like mutual funds.
7. Current 401K levels prove the veracity of #1 through #6.
Yes, I am biased because I sell fixed index annuities and EIULs. But I could easily sell mutual funds and stocks if I wanted. But, I have been clear about the dangers of those financial strategies and refuse to go along with the easy way of simply selling what is popular. Follow the popular trend with mutual funds if you want, but you have been warned.
Contact me, I am always happy to talk to people. It makes my day~
Berkshire Hathaway 2013 March 14, 2014Posted by shaferfinancial in Finance.
Tags: Berkshire Hathaway, My Portfoilio
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Warren Buffett’s letter to stockowners was again insightful as to how Berkshire Hathaway is doing. However, I found it less interesting than previous letters and a little defensive in tone, for which he doesn’t need to do. I will outline the highlights here:
Berkshire made two major purchases [1/2 of Heinz and NV Energy] for a little over $30 Billion.
Mid American had $10.8 B in pre-tax earnings last year up around 8%
Smaller businesses had net earnings up around 20% last year
Berkshire made another underwriting profit [11 years in a row]
Berkshire spent $3.5B to acquire remaining shares of Marmon and Iscar
The two equity manager now invest $7B each and outperformed the S&P 500
Berkhsire increased ownership in American Express, Wells Fargo, Coca-cola and IBM
Investment value increased 13%
Earnings increased 12%
Book Value increased 18%
Float increased to $77B
Over $48B in cash and equivalents
So, it was another good year for Berkshire. Note they spent over $30B in investments and yet still have over $48B in cash. Berkshire produces cash at an amazing pace. This, of course, is both good and bad, good because it it what a business is suppose to do, and bad because it creates so much cash that Buffett has a hard time investing it for outsized returns.
My ownership of this stock goes back to 1997. I added on significantly over the next 12 years. I am pleased with my ownership. It is a very safer place to invest. However, it was such a high percentage of my portfolio [80%] that I am starting to sell some and replace it with dividend paying stocks. My ultimate goal is to live off of the dividends and Berkshire doesn’t pay them. I have now around 55% of my portfolio in Berkshire having sold a few shares when it went up over $124 [B shares]. Once again, this is about my strategy not any problem I see with Berkshire.
In 2013 the price rose 33%. Since the first of the year another 4.6%. I think it is fairly valued to a little low. I would not surprise me if it ran to around $200,000 [A share] or dropped down to the $170,000s again. The market is a little choppy now.
Results from the 3 energy stocks in my portfolio March 3, 2014Posted by shaferfinancial in Uncategorized.
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I will start with a thought on stock investment from Warren Buffett: He believes you invest in a small [for me] piece of a company and therefore should not invest in any company you don’t have confidence in the management. That sums my thinking on these three investments. I mention this because 1 of the stocks has had a dramatic last month due to a couple of analyst assertions that the dividend was in trouble. But I am getting ahead of myself. I will talk about these stocks in order of the size they represent in my portfolio.
SFL [Ship Finance International] is a owner of various ships including drill ships, which it leases out. They have added several ships over 2013 and will continue to add over 2014. They have a relatively large store of cash for which to increase their asset base [$216M]. Their debt maturity is staggered with very little coming due until 2018-2019 because they were able to refinance much last year under good terms.
Net income for 4th quarter compared to 3rd quarter increased 36%. Their backlog is $4.8B. Recently, they sold 2 underperforming ships for a profit. They have 4 ships scheduled for delivery Q4 2014/Q1 2015 that are already chartered out. They have 2 ships that the shipyard is behind schedule on and might be canceled.
Finally, the one area of concern in the past, their charters to troubled Frontline, have been managed well and those 15 ships will start sending much cash to SFL in 2014 under the new agreement. Meanwhile any remaining loans on those ships are below scrap value. So, if that counter-party would fail their would be no negative repercussions to the cash flow or dividend. They also just put a drill ship into lease and will start getting cash flow from it at good rates. Finally, they note an improving oil tanker environment that could increase cash flow even more.
They increased the dividend to $.40 per share an increase of 3% over last year. But my analysis points to a significant rise in dividend toward the end of this year. My yield on cost is now 11%. Bottom line is a safe dividend currently compounding at 11%.
Seadrill owns and leases out drilling ships to the biggest energy companies in the world. About 1 month ago some analyst woke up and discovered that it is highly leveraged at the current time in order to purchase the latest rendition of deep water drill ships know for its increase safety and efficiency. In fact it brought on 13 drilling ships in 2013 and has 20 more rigs under construction. It has a total of $20.3B order back log including long term contracts on 3 of the rigs still under construction. It has contracts on almost all of it’s rigs for 2014 and over 72% of its rigs in 2015. In short, the next few years are covered with good contracts for the majority of its fleet.
It has plenty of financing in place to complete its purchases. For the time being, it will take a break from ordering more ships until it has a clearer picture of the demand post 2015. Now here is what the analyst have gotten all upset about. It has sold old assets to a sister company to have the cash flow to pay out its generous dividends [10.7% yield]. This is the model, purchase the newest and best drill ships that will command the highest day rates and attract the strongest counter-parties using debt and cash from sales of older drill ships. Maintain an exceptionally high dividend as a reward to its owners. I knew this when I bought in last fall. Yet, suddenly some analyst find this troubling and downgraded the company. Over the last few months these analyst have driven down the price around 10%. Good for them and me. I bought about 20% more at substantially lower prices than my earlier purchase.
Buffett March 1, 2014:
“It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings – and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state – how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.”
Now on to last quarter:
Net cash from operating activities went up 7% year on year. Cash available doubled.
During the last quarter of 2013 SDRL had 23 floaters, 22 jack up rigs and 3 tender rigs available. They expect to take delivery of 7 new drill ships in 2014, 11 in 2015 and 3 in 2016. Well over 90% of their fleet is last generation meaning they are the highest demanded version in the market. All current rigs were leased. The jack up rig had a utilization rate of 97% while the tender rig utilization rate was 95% and floater were 94%.
One oil driller with an old group of drill ships had issues getting a couple of its ships leased and took a cut in day rate in order to accomplish it. This was another issue that sent he market into a tail spin. However, the company has stated that it doesn’t see issues with getting its modern drill ships leased at good rates. There is some downward pressure as energy companies face increasing cost of exploration and recovery. Expenses on land based wells in the shale oil regions of North America have gone up as well as the cost of exploration. Movement to the Arctic, off of Africa and Brazil have increased expenses. However, Mexico has now decided to be more aggressive with its off shore drilling programs and SDRL has entered into a partnership with a Mexican private equity group to own and drill off of Mexico using 5 SDRL ships. This is the first time a non-Mexican company has been allowed to do this. By getting an established relationship, SDRL should be able to leverage more leases in the GOM off of Mexico. Despite all this teeth knashing the future looks very bright for SDRL and its asset positioning.
They raised the dividend another 3% and plan on keeping it there for a few quarters. Meanwhile they are creating a special dividend account and placing 20% of the profits from sales of old rigs in it. My current yield to cost is 9%. So, while we wait for the new ships to come on line and start producing cash flow, I will take the 9% dividend. And by re-investing the dividends that dividend should compound. Hopefully, the price remains attractive during this process!
Awilco Drilling [AWLCF]
This is the simplest to deal with and the riskiest. AWLCF own and operate two drill ships in the North Atlantic. There is currently a wide moat around drilling in this area so it is unlikely to see much increased competition. It all comes down to performance, or more specifically how many days it keeps its drill ships working and what its expense are.
It has a current back-log of $724M. Current leases go through to February of 2016 with one 3 month window that could be picked up by the current leasee but hasn’t. They had 99% operational up-time in the last quarter, but weather caused significant “waiting on weather” which are lower rates bringing the revenue efficiency down to 95%.
Operational cost were $88K per rig per day in-line with expectations. Day rates remain solid because of tough UK rules on adding drillers in the North Sea. As long as oil remains in the same value range, AWLCF will continue to make outsize profits.
The dividend declared for $1.10. My yield on cost is 21% before the current dividend is paid in 2 weeks.
Currently, the dividend looks solid going forward, but if there were some performance issues and the dividend needed to be cut obviously there is much to work with.
I intend on increasing my position by about 50% after I receive my dividend as long as the price remains attractive.
Now here is the part that is most important. I believe in the management of all 3 companies.
I believe that all 3 are well managed and capable of dealing with issues as they come up.
Short term 2 out of the 3 are down since I bought them.
For the total of the 3 I am up around 8%. But that is really irrelevant to me because I have no intention of selling the three anytime soon. Combined, my dividend yield on cost is 12%. Compounding 12% plus any dividend increases is not bad. And over time the price of the stock has to connect with the dividend.
I am long on all three.
My Thinking on Energy Stocks March 2, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: AWILCO, Energy investing, My Portfoilio, SDRL, SFL
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Buffett in his letter to investors March 1, 2014.
“What the economy, interest rates, or the stock market might do in the years immediately following [two personal investments he made in 1987 & 1994] was of no importance to me in making those investments. I can’t remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU.”
Does anyone think that the global use of oil products is going down in the future? So my analysis starts with that premise, backed up by data of increasing demand [even with China economically in a lull], that oil will continue to be in demand.
Again Buffett: “Focus on the future productivity of the asset you are considering.”
Now some people have asked me why I invested in deep sea drilling companies instead of land based oil & gas drilling companies? My analysis was pretty simple here. Even a cursory look at what is happening would draw into question the “future productivity” of land based shale oil plays. That is, the wells drop in productivity by as much as 60%-70% in the first year and are played out in a few short years. This forces companies to continually drill wells incurring expenses not yet accounted for.
Now SDRL, AWILCO and SFL all have future productivity that under the premise of growing long-term world demand for oil, are assured barring major management miscues.
Buffett: “If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so.”
Hence, I look at the dividend payments schedule for these companies. Consider shale oil drillers Chesapeake Energy at a dividend yield of 1.35% or Encana Co. at 1.48%. I note that these independent drillers spend $1.50 for $1 worth of profits. Continental Resources reported increase production of 35%, yet net income decreased 39% from the last quarter due to increase expenses and derivative losses. Expenses increased 69% over last year! They pay no dividend. Their issue is the rising cost of getting that oil against the supply/demand equation. The more oil they produce, the greater chance the price of oil decreases meaning they will lose even more money. Sitting out there is OPEC which could increase its production decreasing the price of oil. That’s why we are seeing major energy companies selling their land [Shell, Hess, BP]. They simply don’t like the economics of the shell oil play. They need to drill and produce more oil to make a profit, and yet if they do that the price of oil could drop below their cost of drilling.
Current yield for the three energy companies I purchased are 10.7%, 8.5%, and 21.2%. All those companies have billions of dollars in order backlogs securing their current dividends. [I will discuss specifics of this in a later post]. All have increased their dividends over the last year.
So looking at future productivity and current yield leads me to the place of investing in drillship owning companies with huge backlogs of leases. And if the price of oil goes down they can simply lower their dividends temporarily.
Now a long term decrease in the use of oil products is the major risk here. I am comfortable assuming that risk while my dividends are reinvested causing my dividend income to increase exponentially over the long term.
Finally, Buffett: “It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings-and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his-and those prices varied widely over short periods of time depending on this mental state- how in the world could I be other than benefited by his erratic behavior?”
I picked up some more SDRL last week when the market pushed it down into the $35 range. I was happy to buy it at $41, and more than happy to buy some for less than $36. I sold some Berkshire and will increase my AWILCO after I get my dividend. All part of the plan to develop dividends enough to live off of in retirement.