investing

Start-ups, are you buying investors online?

Capital Markets, equity crowdfunding, Investors, Issuers , ,
Start-ups, are you buying investors

I have been writing a lot about crowdfunding lately and speaking with other people in the crowdfunding industry.  From our conversations, it is obvious that most do not share my perspective on the entire business.  I see crowdfunding as continuing an evolution of the capital markets already in progress when I started on Wall Street in 1975.

In 1975 the stockbroker was king. People did not buy investments, I was told early on, stockbrokers sell investments.  Good stockbrokers, especially those on their way up, aggressively sold stocks. The sales pitch was often about one particular stock, frequently supported by a report prepared by research analysts.  Analysts were “ranked” every year and firms paid the “1st, 2nd and 3rd All-American teams”, handsomely.

While there were certainly stockbrokers who met their clients for lunch or at the club for golf who came back to the office with orders in hand, much of the “selling” was done over the telephone.  Young brokers were encouraged to stay into the evening and engage in a ritual known as cold calling.

During my training, I spent an evening with a single page from the NYC phone directory, script in hand, dialing for dollars. Most people had those old, heavy rotary phones.  I swear, I could hear the receiver sucking in air as it was being slammed down onto its cradle.

What cold calling teaches us is that some percentage of the calls you make will respond favorably, and buy what you are selling.  If you want to make more sales, you need to make more calls.

I mention this only as a backdrop.  This “sell-side” focus has shifted, significantly. Today, a great many retail stockbrokerage customers, make their own decisions about what to buy and what to sell in their stock or retirement accounts.  These customers are enticed by lower costs. They respond to advertising, and they will rely upon information delivered to them online.  Without these investors, crowdfunding could not exist. 

If I were teaching Law and Economics today, I would look back to 1975 and say that is where it all started.  Changes in the law, a new one enacted and an old one discarded, were the catalysts for enormous changes in the way the capital markets operate. The market responded to those changes by bringing in millions of new people who were affirmatively looking to invest and who brought trillions of new dollars with them.   

ERISA, enacted in 1974 created the tax-deferred Individual retirement account (IRA).  It was intended to incentivize millions of small savers to put their money into a bank or the stock market and to leave it there for the long term. 

In response to this new market of small investors who might start small and add a few thousand dollars every year, John Bogle opened the Vanguard Mutual Funds. Mutual funds provided a simple way for small investors to participate in the market.

Mutual funds had been around for a long time by then.  They were commissioned products sold by many stockbrokers.  And while an IRA account was the perfect vessel for mutual funds, what I would stress to my students would be the shift in the way mutual funds were advertised and sold directly to investors.

Vanguard and the other mutual funds actively advertised for investors seeking to make direct purchases.  Instead of dealing with a stockbroker who would call whenever they had, something that they wanted you to buy or sell, with a mutual fund, an investor could just put their money into a fund and the fund will do it all for you.  Somebody called it “passive investing”. Instead of touting the skill of their analysts to pick winners, these mutual funds sold convenience.

In 1975, both the State of New York and the City of New York were functionally bankrupt. The stock market had tanked and lending had ground to a halt.  The economy was in the midst of abnormal inflation.  People responded to the idea that they take some risk to grow their retirement funds in the stock market rather than save it in a bank so they could keep up with inflation.

Also in 1975, the New York Stock Exchange repealed its long-standing rule that had fixed the commissions that NYSE Members charged for each trade.  Mainframe computers were being installed up and down Wall Street. The costs of everything from executing trades to sending out confirmations and monthly statements were going down.

When commissions were fixed, the customer was charged a commission that reflected both the costs of execution and the “other” services that the brokerage firm provided, most notably, research that would tell the customers what to buy and when to sell. As commission costs became a source of competition, Charles Schwab and others were already talking about “unbundling” the cost of executing a trade from the research component that had always come with it. 

Schwab and its “discount” competitors demonstrated that a great many investors were happy to sit at home and make decisions on what to buy and what to sell, based only on what they read themselves. And while Schwab and other discount brokers now offer research reports, very few customers of discount firms are exposed to the type of research available to institutions. 

The stockbrokers’ response to this unbundling can be encapsulated in their advertising slogans of the time: “Thank you, Paine Webber”; “When EF Hutton talks, people listen” and my personal favorite: “Smith Barney makes its money the old-fashioned way, they earn it”.  The mainstream industry doubleddown; they were selling advice and they were proud of it. 

Without good advertising and a lot of it, the full-service stockbrokers, the discount firms like Schwab, and the entire mutual fund industry would not have grown into the behemoths that they are today.  The result of all of that advertising is a market full of millions of investors who are comfortable making their own investment decisions.  This includes a significant number of baby boomers who still represent a very large pool of capital that is available for investment. 

What does this have to do with crowdfunding in 2021?

If I have learned anything from watching the growth and evolution of this market since 1975, the one thing that stands out is that for companies that are selling investments, good advertising works. There is a cost, certainly, of acquiring investors for any given offering, but if you pay that cost, you will get enough investors to pony up the investment that you seek.

The best people in marketing who are working in crowdfunding understand that it is very much a “numbers game” just like “cold calling”, although now much less expensive and efficient. Modern data mining techniques enable each company that is seeking investors to present its offering to an audience that is more and more specifically targeted. 

I call it “buying investors online”. What do you call it?

I have sat in marketing meetings for various players in the financial services industry many times. Depending upon what these companies are selling and to whom, the marketing and sales strategies differ greatly.

The common denominator of these varied strategies is that they are all measured by the same standard, CAC, the cost of acquiring each customer or investor. The object of any marketing campaign is to attract the most customers (and their ‘orders’) from every dollar spent on any advertising directed at those customers. 

In crowdfunding, while statistics are few, it is obvious that the costs associated with acquiring investors varies greatly, offering to offering. Some offerings fail because investors do not find them attractive, most, I think, because they lacked marketing muscle.  

Personally, I find it painful to watch a company that has hired me to prepare the paperwork for their offering fail to acquire the investors they need.  Often, these company’s campaigns fails because they hire the marketing company that was the lowest bidder.  I try to steer my clients to a marketing company that may not be the least expensive, but gets the job done.   

The Regulation D, private placement market has found enormous success using crowdfunding for investors.  Even now, a sponsor can identify potential investors for the purchase of an office building who can afford to invest, who have an interest in real estate, and who live close enough to the property, to drive by if they want to look at it. And the data mining techniques that created these targeted mailing lists are still in their infancy.

Crowdfunding for capital has become a simple process.

Step one: create an investment that will be attractive to investors

Step two: create advertising copy that can be pre-tested and shown to be effective

Step three: put those ads in front of your pre-targeted lists of prospective investors.

Step four: Repeat step three until you raise the money you need.   

I have written elsewhere that I believe that crowdfunding has reached the point where it will now quickly grow to be a major source of capital for start-ups and small businesses.  A major reason will be that companies seeking funding can now approach crowdfunding with a high degree of certainty that they will get funded. With the proper perspective, those companies can appreciate that they are buying investors online. 

 

If you’d like to discuss this or anything related, then please contact me directly HERE

Or, you can book a time to talk with me HERE

 

Is Mom Still In The Market?

Capital Markets, Investors ,
Is mom still in the market

Millions of retirees are about to get screwed by taking the advice they are getting from their financial “professionals”.  Older investors and retirees are being told to stay invested in the market regardless of the current risks.  It is foolish advice that a lot of foolish retirees will follow.

A lot of people have done quite well in the stock market “buying and holding” during this long bull market. But the time to hold is likely behind us and the time to fold’em is right now. 

Many of these retirees have the same poorly diversified portfolios of stocks they have held for a long time.  It is improbable that the price many of those stocks will continue to appreciate. If anything, the risk that they will continue to go down is greater than the likelihood that they will continue to go up. If they are not going to go up in price, there is no reason to continue to hold them.

Concerned Mother

Last week, I got a call from a friend whose mother was concerned that her account had taken a 6 figure loss in value for the first quarter of this year. His mother is divorced and already retired. Her account is with a large, national brokerage firm. She is concerned that her account balance dropped so much and so fast.

Her broker is telling her not to panic which is always good advice. Investment decisions should be based upon mathematics. It is not very hard today to do the math and realize that holding on to the portfolio you had last year does not add up. 

Her portfolio today is worth less than it was 3 years ago and as I said, down over $100,000 in this last quarter alone.  Her broker told her to “stay the course” because “these corrections happen and the market always comes back”.  

is mom still in the market

As I have said before this current correction is my 7th or 8th and no two were exactly alike.  In the last two, 2001 and 2009 there were clear indications that the market averages were too high and likely unsustainable many months before the bottom. There was plenty of time to sell out and save some money but many brokers then, as now, told their customers to just hang on. 

The mainstream stock brokerage industry chose to ignore the same indicators that they used when they predicted that stock prices would go up. It is ignoring the indicators that this current market is still far from its bottom.

I wrote an article just two months ago when the pandemic was still tangential to everyday life.   I did not think that the government’s tepid response in January would be so consequential by April.  

I noted the various conflicts of interest behind the brokerage industry’s desire for investors to stay invested.  Recessions hit Wall Street hard.  Profits and bonuses disappear. A lot of people typically get laid-off.  The idea that people might sell their stocks and put the funds in a CD to sit things out gives Wall Street indigestion.  

Just Do The Math

Investing is governed by mathematics. Large institutions control most of the money that is invested in the stock market. Most use the same method of Fundamental Securities Analysis first described,in 1934, by Ben Graham in his book of the same name. That book is still used in virtually every major business school.  A large investor like CalPERS or an insurance company will have hundreds of analysts on staff.   

At its basic level, the analysts are using one primary metric; earnings both current and projected into the future.  A projection of higher earnings for next year would be an indication that the share price will be higher next year as well. Analysts are always looking at a company’s business to see if its revenues and profits are likely to increase 6 months or a year down the road.

What do these analysts see today?

Right now, it is pretty clear that a great many companies will continue to struggle at least until the end of this year. When these companies report their earnings for 2020 next spring, they will show that earnings, if any, will be down from earnings last year.  Lower earnings should indicate lower stock prices.

Every indication is that the stock market is likely to be lower next year. The risk that people who stay in the market for the next year will lose money is high. So why would any financial professional recommend that their clients should stay invested especially clients who are already retired? How much can retirees afford to lose in a bear market?

Regulators Agree

A lot of people who got the same advice to stay invested no matter what eventually watched their account values decline to the point that they finally realized that their broker was full of shit. They sold their portfolios and realized the losses that they had were a result of risks that they never wanted to take.

I handled many customer claims against their stockbrokers recovering losses from the last two corrections. The stockbrokers always make weak defenses when confronted with losses that their customers never expected and which they could ill afford.

These claims are handled as arbitrations run by FINRA, the brokerage industry regulator. They are fast and cheap. Like most court cases, FINRA arbitration claims usually settle before the hearing. Retirees who lose money in the market can often recover some or most of what they lost.

 When every stock brokerage account is opened, there is a question on the new account form that asks for the customer’s “risk tolerance”.   A typical form might ask investors to identify the account as  “conservative”, “moderate”, “aggressive” and “speculative”.  They represent an ascending willingness to lose money. But a willingness to lose is not the same as a desire to lose.

For retirement accounts, especially as the retiree gets older, there is a consensus that the account should become more conservative.  Once people stop working and are using their retirement funds to pay bills, preserving those accounts becomes the paramount concern.

Diversify

A diverse portfolio of stocks and bonds was always considered to be a “moderate” risk account. And then something unusual happened.  The overall market itself has become riskier and many of those diversified accounts took on the risks of an “aggressive” account. 

There is no justification for a stockbroker to tell a customer looking for a moderate risk account to stay invested when the risks of the portfolio they are holding have gone up past the customer’s level of comfort.  Many retirees have already lost more than they can afford to lose.

A stockbroker is required to have a reasonable basis for every buy, sell, or hold recommendation that they make. When arbitrations over losses in 2001 and 2009, went to a hearing, there was nothing that the brokers could point to in their files that showed they had a reasonable basis to tell people to stay invested.

If your brokerage statement shows losses that you did not want, send your broker an e-mail asking for his/her specific advice as to what you should do now.  Ask them for the research reports that support their recommendations.

If they tell you, “the market has always come back” remind them that past performance is no indication of future results. If they tell you that no one saw the pandemic coming, remind them that price to earnings ratios were way above their normal ranges for months before the virus.

If your losses are too high and you get insipid answers from your broker, just send me an e-mail. I will be happy to refer you to an attorney who will help you recover your losses.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

Investing for a Global Pandemic

Capital Markets, Investors , ,
Investing for a Global Pandemic

I have a better than average understanding of investing and the capital markets, but I never give investment advice nor do I tout individual stocks.   I do listen to what others think and I pay attention to who is investing in what. I read a lot of articles and research reports every day and I frequently speak with professional investors and advisors.  

Correction or Crash

Last week’s market correction was the 7th or 8th I have been through since I began on Wall Street in the 1970s. No two were exactly alike. I learned a few things each time. 

No one can accurately predict where the DJIA will be in 30 days or 60. That has always been true; but the underlying cause of this correction, the portent of a global pandemic, adds some unique variables. 

I know this article will likely just get lost in the blizzard of financial content that a 3,500 point drop in the Dow will generate. Still, the opportunity to take a stab at “Investing for a Global Pandemic” was just too good for me to pass up. 

I already know the advice that customers of the large wire houses will get. They will be told not to panic, but rather that it is always best to hold for the long term. They will be told that the market always comes back so there is no need for them to liquidate anything.   

That advice is nothing more than an uneducated coin flip. Professionals who are paid to help people invest should be able to do much better than that.

Even worse, that advice is conflicted. Financial firms know to the dollar the cost of acquiring new customers. They do not want existing customers to cash out and potentially move away.  Advising the customers to “stay the course”, strongly implies “stay with us”.

Shares owned by customers can also be used to collateralize the aggregate borrowing that the large firms must do to finance the margin debt held by their customers. The margin rate “spread” goes right to the firms’ bottom line.

“Always hold for the long term”

The “always hold for the long term” strategy is also designed to cover up the fact that much of what passes for financial advice is just wrong. Many customers have portfolios using “asset allocation” which was supposed to contain “non-correlated” assets to hedge against catastrophic losses and yet their balances are down substantially.    

Many customers will be looking at their account balances and wondering what happened. This is especially true as this is tax time, when many people will have their year-end 2019 statements in hand as they prepare their tax returns.

The “big lie” of course will be that no one could have predicted this correction would happen. The brokers will claim that they saw nothing that might make them want to suggest to their customers that they might consider actually realizing the profits they have accumulated during this long bull run.

The underlying economic conditions are still good. Interest rates are still low and employment is still high.  Still, a lot of people have predicted a correction because the primary market indicator, the overall price/equity ratio has been way out of its normal range for some time. Even after last week the P/E for the S&P 500 it is still high.  It should eventually be expected to revert to its normal range even if everything had remained “normal”. With the reality of reduced profits next quarter and next year because of the pandemic I can find nothing to support the idea that the market will be higher next year.

There are always external events that can traumatize the market. One good blizzard or hurricane can cause billions in lost sales across wide regions of the US. The US frequently gets more than one blizzard and hurricane each year. 

There is always political discord or a war somewhere. Unions have gone on strike and closed industries and ports for months. There is always a fair amount of news about events that can and do disrupt markets.  Still, the markets survive.  A global pandemic, however, conjures up the image of the potential for a truly mass disruption.

Governments

The world spent several weeks watching people trapped on cruise ships being quarantined while the virus spread. Cruise ship passengers tend to be middle class and their plight was clearly noticed by the middle class investors many of whom no longer saw the wisdom of holding cruise line shares in their portfolios.

I certainly noticed how poor the reaction was of the various government agencies involved. The Japanese, by leaving infected passengers on board the cruise ship and in proximity to uninfected passengers did not contain the virus very well. The Chinese were filmed adding thousands of hospital beds when the story everyone wanted to hear was that they had effectively contained the virus, not that they were expecting thousands more to get sick.  

The governments of several hot spots of the infection around the world have been accused of under-reporting the number of infections and deaths. The corker was the US government which flew several infected passengers to an air force base in Solano County in California only to have people off the base become infected very quickly.

Is it improper of me to expect that modern governments in the 21st Century should respond differently to a pandemic than the characters in Monty Python who wheeled a wagon around a plague-ridden medieval town singing “Bring out your dead”? 

Good, Bad or Really Bad?

From the standpoint of the stock market the question may not be how bad this crisis gets, but how long it lasts. The next 10 weeks are likely to tell the tale. If not contained by then, with the number of new cases significantly down from their peak, the DJIA may truly reflect an apocalypse. 

The virus might be contained and crisis might be downsized by May. The market might have resumed its climb with new highs by then.  Japan Airlines might be adding extra flights for the overbooked Olympics in August.  But right now, that is not the way people are likely to bet. If they do not think that will happen, there is no reason for them to stay in the stock market.

If the Olympics are postponed or cancelled, it will mean that containment is not in the offing. The number of people infected by then will be significant and the fear widespread.

The crisis will hit the US hard when people stop going to restaurants, sporting events, super markets and malls. Recessions start when waiters get laid off and cannot pay their rent. Given that so much of what is manufactured and sold in the US relies upon parts made elsewhere, a slowdown, at the very least, seems inevitable.

Stock Picker

If I had to pick out stocks to invest in right now I would think that a good recession would be positive for companies that sell alcohol or cannabis. If Americans can’t work, it is a safe bet that some will be on their couches with a joint, a six pack or both.  

Investing for a Global Pandemic

For serious investors the drop in the DJIA and the market in general has lowered the price and increased the yield of a lot of stocks of good companies that pay a steady dividend. Buy some this week and if the market continues to crash you buy more and average down.

I am not really expecting a pandemic that will kill millions of people, but it would not be the first time. And, given that we live in an interconnected global marketplace, a much smaller event could still have devastating economic consequences. 

The fact that there is so much discussion about this spreading virus and that its impact could be huge, is scary in and of itself. That alone is not good news for anyone still holding stocks which is roughly ½ of the households in the US.

The real story should be the very pedestrian and ineffective steps taken in the US that might contain it. When action is needed right now the worst thing that the government can do is fail to act even if the actions it does take are the wrong ones. This government, our government, has been remarkably slow to act.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

How I know that the stock market is coming down

Economics, Investors

Every investor would like to be able to predict the future. It is not always easy to do, but neither is it that difficult. It helps if you stick to the math.

Income investors aside, most people buy stocks that they believe will appreciate in value. If you own a stock and do not believe it will go up any higher then why wouldn’t you sell it?

The majority of shares in all financial markets trade between large banks and institutions. They have access to much more relevant information about the shares they trade, the world economy and the markets in general. Good research is the key to purchasing good investments.

For the average investor good research is a non-starter. Most people do not know how to do basic research on a company or where to obtain it. That has not deterred millions of people from investing trillions of dollars based upon bad information. Much of that bad information comes from the financial services industry itself.

Companies in the financial services industry need to grow and to be profitable. They grow by adding new customers and by encouraging existing customers to add more money into their accounts.

It should be obvious then that the one word that the industry is least likely to utter is: sell. If you sell, you might ask for a check and take your money elsewhere. That is something that the industry would like to avoid at all cost.

This is the reason that many financial professionals will tell you not to “panic” when markets start to go down. They will tell you to “stay the course” and that you should not worry because the market will “always come back”.

This is a sales pitch. It is not based upon facts or analysis. The charts that you will see accompanying this advice are bogus. The facts the charts assume are never about you and the facts they assume about the market are never real.

Consider that the market decline in the last month has been widely attributed to two factors, slower growth in China and a sharp decline in oil prices. Upon examination neither would seem to have a negative effect on the US economy.

The Chinese market for US goods is not growing as fast as it has in the recent past. China is not in recession. Certain industries and certain companies will surely be impacted. Overall, there is no indication that China will buy substantially fewer goods from US companies this year than it did last year.

Volatility in the Chinese stock markets is also cited as problematic for the US markets. In truth, very little US capital is at risk in the Chinese capital markets. Volatility and higher risks in the Chinese markets will usually cause capital to seek safer markets. That means more capital coming to the US. This is positive for the US economy.

Oil has been priced by a cartel since the 1970s. The current sharp decline in its price is being caused by a political decision to increase the international supply and to force US suppliers out of the market. Dramatically lower prices are not good for domestic oil companies and domestic oil workers.

Lower prices are also not good for the very largest oil producers whose margins and profits are likely to decrease. Shares of large oil companies are found in many portfolios and account for a significant amount of the weight in the Dow Jones Industrial Average and other indexes. So, yes, declining oil prices will bring averages down, but do not negatively impact many industries like pharmaceuticals or housing.

For the rest of us, dramatically cheaper gas prices increase our buying power for other goods and services. They should reduce the price of any goods that are shipped by truck which is almost everything.

Cheaper gas prices should not crash the market. Indeed low gas prices coupled with lower prices for other commodities and low borrowing costs should all continue to bode well for the US economy.

Why then do I believe that the market is coming down?

The upcoming market “correction” will be the 7th or 8th of my career going back 40 years. Throughout, the single factor about which most professional investors concern themselves is a stock’s price to earnings ratio.

Historically, across the market those ratios fluctuate between 10 to 1 and 20 to 1 with a mean in the middle at 15. It should cost $15 dollars to purchase one share of a stock in a company that is earning $1 per share.

So ingrained is the notion of price to earnings ratio as a market indicator that each of the corrections that I have witnessed over 40 years has been characterized as beginning from a point where P/E ratios where at the high end of the range. Markets usually fall from there to a point below the mean and then begin to level off.

That P/E ratios will always revert to the mean is a verifiable and well known fact.

At January 1, 2016 the average P/E ratio for the overall market was in the neighborhood of 20 to 1, which is at the higher end of the range. It might go up a little higher first, but history and mathematics would suggest that it is likely to drop to the 12 -13 to 1 range before it starts back up.

If you stay in the market, your portfolio will sustain that loss. It might take several years for the value of your portfolio to return to where it is today. If you “stay the course” you will have wasted the earning power of those years. You will have ridden the market down and back up and essentially be back to where you are today.

The better strategy would always be sit on the sideline while the market is going down and to invest in the companies that you like when they are cheaper. There has never been a better investment strategy than “buy low, sell high”.

If you do stay in the market then your portfolio should contain stocks that pay dividends. Dividend paying stocks generally decline less than stocks that do not pay a dividend. If you do sell now and accumulate some cash, you will be able to buy these stocks at lower prices and lock in a more attractive yield going forward.

I know for certain that all but a few market professionals will tell me that I am out of my mind. I submit that a great many of these professionals will have a personal stake in your decision to leave the market or stay the course. If every customer decides to sit on the sidelines these market professionals will be washing cars or waiting tables.

If you would like to “gut check” your broker, ask him/her what the average P/E of your portfolio is today and what your portfolio’s value would be if you do stay the course and your portfolio’s value does decline to a ratio of 15 to one or less. Like I said, do the math.

If you stay the course, you will be robbed of the profits that this bull market has given to you.