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Frequently Asked Questions

What happens to shareholders if General Motors files for bankruptcy? What strategy was recently arrested money manager Bernard Madoff supposedly following to produce those steady returns? What’s the January Barometer and does it work? Answers to these questions and more in today’s column.

Q): I am retired and invested my 401K in several preferred stocks, including General Motors. What happens to my preferred shares if GM files for Chapter 11 and reorganizes? Will GM keep paying the dividends? Will I lose my investment?

A): Unfortunately, if GM files for bankruptcy, it will probably stop paying dividends on its preferreds. Then, preferred shareholders will become creditors, in line behind bondholders, but ahead of common stock shareholders. While anything can happen in a specific case, usually in a bankruptcy, preferred and common shareholders get nothing.

Q): I’ve read that busted investment advisor Bernard L. Madoff purportedly employed a strategy that many investors successfully use to reduce risk. Is that so?

A): Bernard L. Madoff, as you probably know, was arrested on charges that he orchestrated a $50 billion investment fraud. Until the end, it appeared that Madoff had devised an investing formula that produced eight to 12 percent annual returns, year in and year out, regardless of what the overall market was doing. So what was this magic formula?

Madoff described his strategy, which he dubbed the “split-strike conversion strategy,” in general terms over the years. It involved buying stocks belonging to the S&P 100 Index (the largest 100 stocks of the S&P 500) as well as buying and selling various types of options on the stocks and on the index.

You can read a detailed description of Madoff’s strategy on Wikipedia (www.wikipedia.org). Find it from Wikipedia’s homepage by searching for “madoff” and then selecting the “Bernard L. Madoff" link.

It turns out that Madoff’s split-strike strategy is similar to an “equity collar,” a relatively well-known strategy for reducing the downside risk of owning individual stocks. The main difference is that Madoff’s strategy involves an index of 100 stocks, rather than individual stocks. For more on the single stock Equity Collar strategy, go the Options Industry Council site (www.optionseducation.org) and search for “collar.”

Q): What’s the January Barometer, and does it work?

A): The January Barometer theory says if the market moves up in January, the entire year will end up in the plus column, and vice versa. It turns out that the barometer was on the money this year. In January, the market, as measured by the S&P 500, dropped 6%, the biggest January loss in recent years. However, the barometer isn’t perfect. Over the 15 years (1994-2008) that I checked, the barometer was only got it right 11 times. Actually, its batting average was better in up years than in down years. The barometer gave the right signal in eight of the 10 up years, but only in three of the five down years.

Some people say that the first week in January also works to predict the year. It turns out that it does, but not as well as using the whole month. The first five trading days in January correctly predicted the entire year in five out of the last 15 years.

Q): What’s the U.S. Dollar Index?

A): The index compares the value of the U.S. dollar to a basket of foreign currencies including the euro, Japanese yen, Pound Sterling, Canadian dollar, Swedish krona and the Swiss Franc. Thus, the index gives you a snapshot of the value of the U.S. dollar on a global basis.

The index traded mostly in the 80 to 95 range from the 1980s through the mid-1990s. In the late 1990s the index started moving up, meaning that the dollar was strengthening, until it reached 120 in 2000. In late 2001 the U.S. dollar began losing value and the index bottomed at 71 or so last summer. It started back up in August and peaked at 88 in November. Since then, the index has dropped and was trading at 80 the last time that I looked.

You can see current and historical values of the U.S. Dollar Index on Barchart (www.barchart.com). From Barchart’s homepage, select Dollar Index in the Market Indices section. Select “chart” in the Technicals section to see the data in chart form.

Q): In a recent column, you advised sticking with firms with debt/equity ratios below 0.5. But when checking banks such as Bank of America or Wells Fargo, I see ratios of four and higher. What gives?

A): The debt to equity ratio, a debt measure, compares a firm’s long-term debt to shareholders equity (assets minus liabilities). Companies with no long-term debt have zero ratios, and the higher the debt, the higher the ratio. Considering the tight credit markets, it makes sense to stick with low-debt firms, and in general, I would avoid firms with debt/equity ratios above 0.5.

Banks, however, are a different story. They operate by borrowing at short-term rates (ideally from depositors) and lending at higher long-term rates. So, for banks, borrowed funds are their inventories and debt/equity ratios aren’t very useful. You can see a firm's D/E on many sites, including Yahoo's Key Statistics report.

Please keep your questions coming. However, keep in mind that I can’t give personal investing advice, and I can’t answer questions about income tax issues.

Have a great holiday and a happy and prosperous New Year.

Here Are More FAQs From Earlier Columns

Where can I find alternative energy stocks? Do actively managed mutual funds outperform index funds? These are some of your interesting questions that I’m answering today. 

Q): Given skyrocketing energy prices, this might be a good time to invest in alternative energy suppliers. Where can I find information on alternative energy stocks?

A): The Cleantech Blog (www.cleantechblog.com), run by Neal Dikeman, a partner is a San Francisco-based merchant bank that focuses on new energy technologies, is a good place to start. The site, featuring a new article almost every day, keeps you abreast of industry developments.

The Cleantech Index (www.cleantechindex.com), not related to the Cleantech Blog, is a list of 46 stocks that the site’s sponsor, the Cleantech Group, considers to be industry leaders. That list would be a good starting point for building an alternative energy portfolio.

You can find an exhaustive list of alternative energy stocks, both in the U.S. and around the world on InvestorIdeas.com. From its home page (www.investorideas.com), click on Stock Directories, and then select “Renewable Energy Stocks Directory.”

Q): Do mutual funds that employ a manager to individually pick stocks outperform index funds?

A): That’s been a controversial topic since John C. Bogle, founder of The Vanguard Group, started the Vanguard 500 Index Fund in 1975. An index fund tracks a fixed list of stocks that changes infrequently. In theory, an actively managed mutual fund that can shift its portfolio to accommodate changing market conditions should outperform an index fund that doesn’t have the flexibility to dump faltering stocks.

The emergence of exchanged-traded funds (ETFs), which are indexed mutual funds that trade like stocks, makes it easy to find out if managers do outperform a corresponding index. ETF sponsors have created indexes that track just about every imaginable market segment: value stocks, growth stocks, China stocks, energy stocks, small-cap stocks, you name it.

Last week, using data from Morningstar (www.morningstar.com) I compared the returns of managed vs. exchange-traded funds specializing in four market sectors that, over the past three years, have been especially volatile, but with different characteristics: Energy, Latin America, China, and Financial.

Both Energy and Latin America stocks were strong overall, but Latin America was much more volatile along the way. For the energy sector, managed funds beat ETFs, returning 33 percent, on average, annually over the past three years, vs. 27 percent for ETFs. However, for Latin America, it was a tie. Both averaged 48 percent annual gains over the three-year timeframe.

China stocks (firms based in China) had been hot until the beginning of this year, when the category fizzled. Again, the three-year returns were a virtual tie, both managed funds and ETFs averaging 31 percent annual gains.

The financial sector, crushed by the credit crisis, was a loser for everybody. Here again, it was a tie. Over the past three years, both managed funds and ETFs averaged five percent annual losses.

Granted, my study was hardly exhaustive. Still, from the data, even considering energy, it’s hard to make a case that managed funds outperform index tracking funds.

Q): Many of the Canadian Royalty Trusts that you described in a recent column are traded in Toronto, but not on U.S. exchanges. How do I buy them?

A): You can trade many Toronto-listed stocks by using their OTC Bulletin Board ticker symbols. For example, ARC Energy Trust trades in Toronto using the ticker symbol “AET.UN.” However you can buy or sell it through a U.S. broker using the symbol “ARQFF.” You can usually find the U.S. ticker using your broker’s symbol lookup function. If not, you can find it on Yahoo (finance.yahoo.com).

You get the exact same shares that pay the same dividends whether you buy on the Toronto exchange or you use the OTC ticker symbol.

However, to avoid unpleasant surprises, specify a limit price when buying or selling using OTC ticker symbols. When buying, the limit sets the maximum per-share price that you’re willing to pay. When selling, the limit sets the minimum sell price.  

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Q): I can’t find the Reuters stock screener that you described in an old article that I’ve saved. Is it still available?

A): Stock screeners are programs that you can use to search through the entire market for stocks meeting your specific requirements. Reuters discontinued its PowerScreener Lite, one of the best free screeners, a few months ago.

MSN Money’s Deluxe Screener is the only remaining comparable free screener. Find it from MSN Money’s homepage (moneycentral.msn.com) by selecting Investing and then Stock Screener. The screener only works with Microsoft’s Internet Explorer browser.

Morningstar’s free stock screener, although less capable than MSN’s product, is easier to use. Find it from Morningstar’s homepage (www.morningstar.com) by selecting Stocks and then Stock Screener in the Tools section.

Also, many stockbrokers offer user-friendly, free screening programs to customers on their websites.

Q): I am a beginning investor. Where can I learn the ropes?

A): The American Association of Individual Investors (www.aaii.com) is the best place to start. Membership costs only $29 per year and for that you receive a monthly journal full of investing tutorials, fund investing guides, an annual income tax guide, and more.

Look for the list of local chapters on AAII’s Website. Most have an active event calendar, including presentations by accomplished investing professionals. Even better, chapter events give you the opportunity to learn by mingling with other individual investors who have probably already solved the same questions that you are pondering

 Q): Where can I find charts that show a stock’s total return, including dividends? 

A): Your total return on a stock is the sum of its share price appreciation plus any dividends received while you hold a stock. Nevertheless, the stock price charts shown on most financial sites show trading prices only and ignore dividends. In fact, these sites don’t offer total return information in any form.

Morningstar (www.morningstar.com), however, does tabulate total returns over periods ranging from one-month to 10-years. Morningstar also displays a chart going back five-years comparing each stock’s total return to its industry and to the S&P 500 index. Find the total return data in the Dividends & Returns report for each stock, not in the Charts section. The price charts shown in the Charts section show trading prices only, the same as on other sites.

Q): Where is the best place to track my portfolio?

A): My favorite portfolio tracker is on MSN Money It’s flexible and easy to use. You can track stocks, mutual funds, exchange-traded funds; just about any security. You can view returns by individual security, by account, or for your entire portfolio, over a variety of time spans. You can use MSN’s preset portfolio views or define your own custom views.

The Portfolio Review report shows you just about anything you’d want to know about your portfolios including allocations (stocks, funds, cash, etc.), potential income tax liabilities, returns by portfolios, top holdings, and recent transactions. From MSN Money’s homepage  (moneycentral.msn.com), select Investing, and then Portfolio Manager. You may have to download special free software to get started (disclosure: I also write investing columns for MSN).

Q): I’ve heard some stock market gurus say they follow a “top-down” approach to picking stocks. What does that mean?

A): The two basic strategies for finding stock investing candidates are called the “top-down” and “bottom-up” approaches.

The top-down method starts by picking economic sectors, that in your view have the strongest outlooks, and then picking the best stocks within those sectors. For instance, say you think that interest rates will fall next year, and that large banks would outperform the market in a falling interest rate environment. In that case, you would look for the best large bank stocks, based on growth prospects, profitability, recent price action, or whatever factors you think most effective for picking stocks within that sector.

By contrast, bottom-up investors don’t try to predict which sectors will outperform. Instead, they look for individual stocks that best meet their selection criteria.

Generally, top-down investing works best if you prefer large companies in well-defined industries. For instance, large pharmaceuticals such as Merck and Pfizer, or energy firms such as ExxonMobil and Chevron, tend to move together. Bottom-up investing works best if you’re looking for fast-growing, smaller companies, which generally aren’t affected much by overall economic conditions.

Q): Where can I find fundamental information such as annual sales, profitability measures, and valuation ratios for stocks?

A): Yahoo’s Key Statistics report is the beast place to start. Yahoo lists a wide variety of current data including valuation, profitability and financial strength ratios, insider and institutional ownership measures, and dividend data. Find it from Yahoo Finance’s homepage (finance.yahoo.com) by first getting a price quote and then selecting Key Statistics report.

If you want to see long-term trends, MSN Money’s Key Ratios 10-Year Summary is a good resource. From MSN Money’s home page (moneycentral.msn.com), get a price quote, select Key Ratios in the Financial Results section, and then 10-Year Summary.

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Q): What happens to my shares if I own stock in a company that files for bankruptcy?

A): Most often, a firm files for bankruptcy when its debts exceed its assets and it sees no way to dig itself out of that hole. Several airlines have recently found themselves in that situation. While a bankrupt firm could face total liquidation, larger companies usually keep operating while creditors work out a recovery plan. Creditors usually have to settle for less than what’s owed to them. Since creditors have priority over shareholders, the shareholders typically get nothing when the company gets reorganized. By that I mean; their shares become worthless.

Interestingly, not all players accept that notion, and frequently, a bankrupt company’s shares continue to trade for months, and sometimes years, after a company has filed for bankruptcy.

Q): I’ve been told that the dividend yields listed on financial websites are not accurate. What gives?

A): Dividend yield, as commonly used, is the return you expect to receive over the next 12 months from dividends. It’s calculated by dividing the expected next 12-month’s dividends by the latest share price. For instance, the yield would be 5% for a stock trading at $20 that is expected to pay $1 per share in dividends over the next year.

The problem is, in most cases, nobody knows how much a company will actually pay in dividends that far into the future. Companies typically only announce dividends one at a time and reserve the right to change subsequent payout amounts as they see fit.

So the dividend yields listed on financial websites are calculated assuming that each firm holds its dividend constant for a year. For instance, if a stock pays quarterly dividends, the estimated total dividends over the next 12-months is simply the last payout multiplied by four. Ideally, you want to pick stocks that regularly increase their payouts. If that happens, your actual yields will be higher than what you see listed on financial sites.

Q): Is the dividend yield the same as a stock’s return?

A): A stock’s return is the total of dividend yield plus stock price appreciation. For example, your total return is 15% if a stock you own paying a dividend equating to a 5% yield goes up 10% over a year. Unfortunately, that calculation also works in reverse. In the same example, a 10% share price drop would result in a 5% loss for the year.

Q): You often advise sticking with no-load funds you’re describing how to pick mutual funds. I have several load-funds that I’ve already purchased. Should I sell them?

A): Loads are basically sales commissions that mutual funds charge to pay the financial advisor or stockbroker who sold you the fund. These people should get paid if you rely on them to help you pick funds. However, if you are picking funds on your own, there’s no point in paying the fees, so, in that case, it makes sense to stick with no-load funds. 

However, once you own a load-fund, usually, you’ve either already paid the load up front, or you are obligated to pay when you sell. So, all else equal, at that point, there is no advantage to dumping your load fund to buy a no-load fund.

Q): In a recent column you said that Money manager Ken Fisher, who writes for Forbes Magazine (www.forbes.com), correctly predicted the bursting of the tech bubble in 2000. What about Bob Brinker who made a similar forecast on his national radio show in early 2000?

A): My column was about the Guru Grades section of CXO Advisory Group’s website (www.cxoadvisory.com), which tracks the accuracy of 31 different commentators’ forecasts. However, CXO only tracks forecasts that are available for free on the Web. So, it wouldn’t have known about Brinker’s call (after this column was published, CXO had advised me that they are now tracking Brinker's market calls).

Q): How can I backtest my stockpicking strategies?

A): Backtesting is a way of trying your stockpicking ideas without risking real money. For example, say that you’ve decided that the key to success is finding stocks with P/E ratios between 25 and 30 that grew sales at least 25 percent over the past year.

Screening allows you to search through the entire market for stocks meeting your selection criteria. Backtesting involves using a screening program to find stocks that would have met your criteria had you run the screen at some point in the past, say two-years ago. The program tells you how you would have fared had you bought those stocks two years ago.

Portfolio123 (www.portfolio123.com) is the only site I know of that offers backtesting. Its screener allows you to backtest as far back as March 31, 2001, and offers a larger variety of screening choices. However, use of Portfolio123’s backtester requires a premium membership which will set you back $40 per month.

Q): I tried setting up the stock screen for finding value stock candidates using the MSN Money screener as you described in a recent column. But the MSN screener didn’t work as you described.

A): Stock screening is a process for scanning the entire market for stocks meeting your specific requirements. The MSN Money Deluxe Screener is one of the better stock screeners available, and it’s free. However, the MSN Deluxe Screener is only available if you’re using Microsoft’s Internet Explorer Web browser. If you are, you must download free software to activate the screener. You can do that from MSN Money’s homepage (moneycentral.msn.com) by selecting Investing and then Stock Screener (left menu). Once there, click on the Deluxe Stock Screener link to download the screener program. 

Q): I have recently graduated from college and want to start investing in stocks. I have a job but I don’t have enough money saved up to open an account with a regular stockbroker. Are there any brokers that cater to people just starting out?

A): ShareBuilder (www.sharebuilder.com) is set up for small investors who want to set up a regular investment program.

There are no minimums. If you set up an IRA account, the total fee is $25 per year. However, if you don’t have an IRA, it costs $4 for every transaction. That can be significant if you’re investing small amounts, say $50 per month. In that case, it would be better to invest $100 every two months.

Q): Where can I see the dividend history for a stock?

A): I’m a big fan of dividend paying stocks because they are the only stocks that pay you to own them. One of the most important factors to evaluate when you analyze dividend stocks is whether the dividends are likely to increase or decrease while you hold the stock. Increasing dividends usually lead to higher share prices. For dividends, history is a good teacher. Stocks with a track record of consistent dividend growth are likely to continue on that path.

Yahoo is the best place to check on historical dividend payouts. From Yahoo’ s Finance homepage (finance.yahoo.com), get a price quote, click on “historical prices,” and then select “dividends only.” Yahoo lists the dividends going back to August 1986, if the company has been paying them that long.

Q): In a recent column, you used the term “200-day moving average.” What does that mean?

A): A moving average is the average of a stock’s closing prices over a specified number of market days. For instance, the 10-day moving average would be the average of the last 10 days closing prices.

Many investors believe that stocks move in trends. They compare a stock’s last closing price to its moving average to determine which way it’s heading. If it’s above its moving average it’s considered to be in an uptrend and likely headed higher. Conversely, a stock is in a downtrend if when it’s trading below its moving average.

The most widely used moving averages are 50 days and 200 days. The 200-day average reflects the long-term trend, while the 50-day shows the shorter-term action. A stock trading above its 200-day moving average, but below its 50-day average would be in a long-term uptrend, but a short-term downtrend. In other words, a dip.

Many investors think the best time to buy a stock is when it has already been trading above its 200-day moving average, and has just crossed above its 50-day moving average.  

Q): I enjoyed your column about PowerShares exchange-traded-funds (ETFs), but I’m not clear on how I actually buy shares in an ETF. Do I need to open an account with PowerShares?

A): Exchange-traded-funds are similar to index mutual funds except they can be bought and sold just like stocks. So, if you have an account with a stockbroker, you are already set up to trade ETFs. You’ll pay the same trading commissions that you would for stocks.

Q): What is a reverse stock split, and is it good for shareholders?

A): You’re probably familiar with a regular stock split. If it’s a two-for-one split, shareholders end up with two shares for each share they originally owned. However, the shares usually trade, at least initially, at half the pre-split price. So even though you’ll have twice as many shares, the value of your holdings remains the same.

A reverse stock split works the opposite of a regular split. Shareholders wind up with fewer shares than they held before the split, but, initially, the new shares trade at a higher price.

For instance, communications equipment maker JDSU (formerly JDS Uniphase) shares are currently changing hands for around $2. Many institutional investors have rules precluding them from buying stocks trading for less than $5 per share, so they can’t buy JDSU.

To overcome that obstacle, JDSU plans to propose a reverse split in the range of one-to-eight, to one-to-ten, at an upcoming shareholders’ meeting. If JDSU decides on the one-to-ten split, shareholders will end up with one share for every ten they held before the split. But, at least in theory, their shares will be fetching $20 each, so they won’t have lost any money.

Of course, there’s no guarantee that the JDSU’s shares will stay at that level. That depends on how the market views the firm’s future earnings prospects. 

Q): I’ve heard that institutional trading is what moves share prices. Where can I see whether these big players are buying or selling a stock?

A): Institutional investors such as mutual funds, pension plans, and other big holders often control the bulk of a company’s outstanding shares. So it makes sense that their buying and selling account for much of a stock’s price movement.

Unfortunately, institutional holders are only required to report their holdings quarterly, and even that information can be almost three months old by the time they report it. With that in mind, I find MSN Money (moneycentral.msn.com) is a good place to view institutional holdings . Get a price quote, then select Ownership (under Research), and finally, select Institutional Ownership to see the report.

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Q: Explain the debt ratios you mention in your columns?

A: I plead guilty to sometimes using stock market lingo without fully explaining the terms. The two debt measures that I usually mention are the current ratio and the debt/equity ratio.

The current ratio gauges short-term debt and the debt/equity ratio measures long-term liabilities. What’s short and what’s long? Your credit card bills are short-term debts because they are due within a year, but your 30-year mortgage is a long-term liability.

For reasons known only to accountants, the two ratios are calculated upside-down from each other. Here’s what I mean.

The current ratio compares current assets such as cash, inventories and accounts receivables to current (short-term) debts. The ratio would be 1 if short-term assets equal liabilities and 2 if the assets were double the liabilities. So, if you’re looking for low debt, higher ratios are better.

By contrast, the debt/equity ratio compares long-term debt to its book value (shareholders equity). Here, the lower the ratio, the lower the debt.

The total debt/equity ratio that I mentioned in my recent column about picking the strongest stocks is similar to debt/equity except it takes both short- and long-term debts into account. That’s important, because in recent years, some firms have shifted long-term debt to continually renewed short-term loans.

There’s nothing wrong with debt if, say, a firm can generate 10 percent returns on money that it borrows at five percent. However, I prefer low-debt firms because its makes for easier analysis. You don’t have to worry about solvency issues or whether debt-servicing costs will drag down earnings if interest rates increase.

As a rule of thumb, I usually require a minimum 1.5 current ratio, and a maximum 0.4 total debt/equity ratio. However, you can’t apply these rules to banks and similar institutions. For them, money is their inventory, and they all look high-debt by these measures.

You can see the debt/equity and current ratios on many financial sites. But to my knowledge, Yahoo (finance.yahoo.com) and Reuters (investor.reuters.com) are the only places you can see total debt/equity ratios. Reuters' Ratios report is especially useful because it compares each firm’s ratios to its industry and to all stocks making up the S&P 500 index.

Q: Where can I see earnings and balance sheet data for a stock going back 10 years?

A: Morningstar’s financial statements have earnings, profit margins, taxes, cash flows, balance sheet figures, and tons of other annual data items going back 10-years. From Morningstar’s home page (www.morningstar.com), enter the ticker symbol and then select Financial Statements or Key Ratios.