I was in Manhattan last week attending Grant’s Fall Investment Conference. The U.N. General Assembly is meeting there, and the streets were blocked off in places. The NYPD was out in full force. I heard one passerby complain about the inconvenience of it all to one police officer. He responded, “Don’t blame the NYPD, blame the General Assembly.”

With the General Assembly in Manhattan and the G-20 in Pittsburgh, government has taken over the headlines this week. It seems half the world is mostly preoccupied with telling the other half what to do. No doubt, bossiness is in a bull market.

At Grant’s conference, I heard presentations on gold, the dollar, oil, real estate and more by a slate of luminaries, including John Paulson. Paulson is one of the best hedge fund managers in the world. There were many others, including Grant himself, who has created something of a stir lately.

Jim Grant, the host and editor of Grant’s Interest Rate Observer, has turned bullish on the recovery. In a Wall Street Journal piece on Saturday, the great bear turned in his claws and picked up the horns of a bull.

In a phrase, Grant’s thesis runs this way: The sharper the decline, the stronger the rebound. For this, he finds ample evidence in the historical record. The economy bounced back strongly after each sharp contraction — such as those in 1893-94, 1907-08, 1920-21 and 1929-31.

In the current recession, GDP (a rough measure of economic activity) contracted nearly 4% from peak to trough, which is a sharp recession as these things go. So, Grant reasons, the rebound will follow the historical pattern.

Grant loves to challenge the consensus. And the consensus this time around is that the recovery will be weak. I loved the quote he pulled from economist A.C. Pigou: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant.”

Grant makes an eloquent and thoughtful case, as he always does. He goes on to conclude in his editorial: “The world is positioned for disappointment. But in economic and financial matters, the world rarely gets what it expects. Pigou had humanity’s number.”

I hope Grant is right. It is an appealing case, but I don’t buy it. Too many of the problems of the prior boom remain unresolved. There is still too much leverage and debt in the system. And on a more basic level, business is not good across a spectrum of sectors. The contraction is still ongoing. I’m inclined to remember the old bearish refrain that things are never so bad that they can’t get worse.

It’s All About Markets

It’s true we’ve had a sharp contraction, but there is no rule that says we can’t contract more. A nearly 4% decline in GDP could turn into an 8% contraction when all is said and done. The move from 4% to 8% would be painful, indeed. Even then, we would be a far cry from the dark woods of the Great Depression.

In some ways, the whole discussion is irrelevant anyway. As investors, we care about markets, and not GDP growth. There is a great fallacy out there that if the economy does well, stocks should do well (or if the economy does poorly, stocks should do poorly). Hence, too many so-called investors waste an inordinate amount of time talking about recovery, or lack thereof.

It’s possible that Grant is right: GDP does expand strongly. But investors could still lose. We have one glaring historical example: From 1964-1981, GDP grew 370%. And the sales of the Fortune 500 more than sextupled. Yet the Dow Jones industrial average went from 874 on Dec. 31, 1964 to 875 on Dec. 31, 1981.

As Warren Buffett once wrote: “Now, I’m known as a long-term investor and a patient guy, but that is not my idea of a big move.”

For investors, it is all about the price paid. The really relevant question is not one of whether or not the economic recovery is real. The question is: are stocks cheap enough? To answer that, you have to look at stocks and compare them with the alternatives.

My answer is some stocks are cheap and some are not. It is hard to generalize. In my view, investing is a craft of the specific. It is in the picking of the trees in which investing skills pay off the most, not in assessing the forest. There are, undoubtedly, specific stocks that will prove nice investments over the next few years. Finding them is what we are all about.

Sincerely,
Chris Mayer

Source: Are the Bears Turning Bullish?

But first, there’s a catch…

These “Trump Cards” aren’t traded very often. And you can’t find them on an exchange. That’s what makes them so lucrative. You see, it’s this lack of liquidity that makes these high-yield bonds, as they’re called, double and even triple overnight.

Once you get past the sometimes-frustrating volume issue, you’ll find many advantages high-yield bonds use to trump regular stocks.

First, there is the time element. You can hold a stock indefinitely, as long as the company stays in business. Bonds, however, mature at a certain date. They can even be called away. But unlike options, bonds use time to work in their favor. The closer to maturity date, the better. Time adds an extra benefit, because once it runs out, investors get paid.

Bonds are also higher on the importance scale for a company. Even if the unfathomable occurs and the issuing company liquidates, bondholders are paid first. Next come preferred stockholders and finally common stockholders.

The most important advantage bonds have over stocks is their guaranteed value. Stocks are bought and sold with a constant moving target. Each investor has his or her own target value. Bonds, however, have a face value. That face value, usually $1,000, is the price those holders will receive at maturity. This gives us a clear picture of what our investment will pay us. It can also give us a guaranteed double or triple.

Say you buy a corporate bond with a face value of $1,000 and a maturity date of August 2011. Instead of paying the full $1,000, you’ll oftentimes receive a hefty discount. Let’s say in this case, the bonds are trading at around $330. That’s a guaranteed triple as long as the company doesn’t go insolvent.

Here’s why the guarantee is so important. Even if the company does go belly up, every asset sold will be used to pay you. Common shareholders might receive a few dollars of whatever is left in the end. But you are paid first.

Don’t want to wait until 2011 to have your payday? No problem. Just trade it in early. As you can see, that’s an equally lucrative choice.

Instead of waiting until October 2027 for a 614% payday, investors on this bond could’ve cashed out today for a 5-month 186% gain. It’s easy enough to flip that gain into other fast moving high-yield bonds.

To get you started, here are two of the top traded bonds:

• Realogy Corp 10.5% Coupon Maturing Apr. 2014 (CUSIP: 75605EAT7)
• Clear Channel Communications 10.75% Coupon Maturing Aug. 2016 (CUSIP: 184502BB7)

Note: Be careful trading these. Corporate bonds can be extremely volatile.

The coupon rate is the original yield based on the $1,000 face value. This is also a large selling point for income investors as the yield becomes inflated with lower prices.

The CUSIP is the equivalent of a stock’s ticker symbol. Although, instead of using it to place orders on an exchange like stocks, the CUSIP is used for bond traders to quickly identify each particular issue.

To find your own high-yield bonds, you can check out any free bond screener such as Yahoo! Finance’s. Just enter the criteria you are looking for – like coupon rate, maturity date, and credit rating – and scan through the results until you find one you like.

Sincerely,
Jim Nelson

Source: Your Guaranteed Triple with the Stock Market ‘Trump Card’

Sell stops ensure that your capital is protected and your profits don’t slip through your fingers.

However, one subscriber took me to task, saying that a trailing stop guarantees you won’t “sell at the top.”

Quite true.

However, “selling at the top” and its corollary, “buying at the bottom,” are not realistic investment goals. Here’s why…

The Danger of Selling High and Buying Low

For one thing, you never know the top or the bottom until you’re looking in the rear view mirror. And given enough time, all-time highs and lows are usually exceeded.

For example, you may sell a stock at its 52-week high – not a good idea since you should always let your winners run – and find that it goes on to double or triple from there. Likewise, if you buy at the all-time low, the stock may head still lower (after all, that’s the direction it’s heading).

Our trailing stop policy works, in part, because it accepts the uncertainty that is an inevitable part of equity investing. Sure, you may get lucky and buy at the bottom or sell at the top from time to time. But hoping to “get lucky” isn’t much of an investment strategy.

And there’s yet another iron-clad reason to use trailing stops…

How Trailing Stops Can Maximize Your Gains & Mitigate Your Losses

It’s a little-known but depressing fact that the vast majority of individual stocks post negative returns over the long run.

This may come as a shock to those who’ve been told that equities are the very best long-term investment.

• But research by the investment management firm, Dimensional Fund Advisors, found that form 1980 to 2008, the top-performing 25% of stocks was responsible for 100% of the gains in the broad market.
• The bottom 75% of stocks collectively generated annual losses of 2% over the past 29 years.

It’s pretty sobering to realize you were three times as likely to own losing stocks as winners.

However, this data makes the fundamental assumption that you actually held all these stocks over the entire period.

Many stocks make spectacular runs before crashing and burning. By using a trailing stop, you could have participated in an awful lot of upside without sticking around for the Battle of Little Big Horn.

Likewise, even if you picked a stock that went south immediately, a trailing stop would have kept your losses small and acceptable.

Don’t Argue With the Market… Use Trailing Stops Instead

The bottom line is this: Anyone can plunk for a few shares. Getting out at the right time is the true art of investing.

The key is to make sure you’re cutting your losses and letting your profits run.

Emotions like fear and greed (and hope) can prevent that. But trailing stops enforce a discipline that takes the emotion – and the second-guessing – out of the investment process.

Understand that market prices reflect facts about a company better than opinions. So don’t argue with the market.

When you buy a stock, enter a trailing stop below it to protect your principal. And as the stock rises, keep raising the stop to protect your profits.

This is the best way for you to minimize your losses and maximize your gains – even if some of the stocks you own are on their way to Waterloo.

Good investing,

Alex Green

Source: Investing Without Trailing Stops: Here’s Why 75% of Stocks Are a Sucker’s Bet

In its simplest form, the phrase refers to buying the pullbacks whether it’s in the market indexes or individual stocks — as long as they are at some sort of support level. So let’s take a look at most recent dip and the most recent rip over the last week.

For us, it all starts with the short-term index charts. From there we move into the individual stocks, as three out of four stocks generally trade with the overall trend of the market. Lately, that overall trend has been up, and stock investors have been enjoying gains in a big way. In fact, in the last month alone, the S&P 500 has gained nearly 5% as stocks bolstered by signs of economic recovery took back some of the losses they suffered in 2008.

As you can see, support is clearly defined and the full stochcastics are in oversold territory. Those are your clues to get ready. This tells you that you are “In The Zone” and its time to see if individual stocks are showing this as well. Here’s a recent example in Perfect World (NASDAQ: PWRD):

In just a week, this stock rocketed from $36 to $44. That’s a home run in the world of swing trading, and it’s a gain that any investor could have had a chance at by just buying the dips and selling the rips. All you have to do is follow the formula…

What I want you to notice is what they all have in common:

1. All have been pulling back off highs — The Dip
2. All pulled back to at or near the 50-day moving average (the blue line)
3. All have the full stochastics in oversold territory.

So now, what do you do about it? Well, there are two ways to take these trades.

One is to take them right there at a support level — at or near the 50-day moving average with a 10% stop. The other is to wait for the crossover of the pink line as shown to the upside. The latter is the safer trade, however from the dips lows of the 50-day average or a support level is a lot of room that would be missed by waiting for that to occur. This really means that you are paying up for the stock by waiting for the pink line trigger.

Sincerely,
David Grandey

Source: Deciphering this Trader’s Simple Profit System

You’ve probably heard a lot of people talk about the P/E ratio. It’s one of the most popular fundamental analysis numbers out there. Moreover, it has earned a reputation as one of the key ways we value stocks. And in my book, it’s one you simply can’t avoid.

In a nutshell, the P/E ratio gives us a clue into the real value of a stock. It does so by taking the price of the stock and dividing it by the company’s earnings over the last 12 months. Spelled out:

P/E Ratio = Stock Price / Yearly Earnings

Let’s say XYZ is selling for $20 a share. Over the last 12 months, the company has earned $2. As a result…

XYZ P/E Ratio = $20 / $2 = 10

Since XYZ stock is currently selling for $20 and over the past 12 months the company has earned $2 a share, XYZ’s P/E ratio is 10.

So getting the P/E number is pretty straightforward. But by itself, figuring that XYZ has a P/E of 10 doesn’t really do much for us. It’s just the starting place that makes valuing a company easier. Without it, we’re sort of left in the dark about whether a stock’s price is really worth what people are paying for it. So now we need to dig deeper.

Using the P/E Ratio Makes Valuations Easier

Think about it a second. In our example above, XYZ is selling for $20 a share. But how do we know that $20 a share is a fair price for XYZ?

First off, we take XYZ’s P/E and compare it with other companies in XYZ’s industry. If other companies in the same industry carry P/Es lower than XYZ’s, then we say the XYZ is “overvalued.” Let’s look at a real-life example…

As you can see from this graph, IBM carries a P/E ratio of 12.8. That means its share price is valued at nearly 13 times its last 12 months of earnings. The average P/E for companies in IBM’s sector is just 10.7. As a result, we can figure that IBM is slightly overvalued.

In other words, compared with other companies in its marketplace, you’re going to pay a little bit more for IBM than other players. And the P/E ratio helped us get to this determination very quickly and with very little fuss.

Since IBM is slightly overvalued, does that mean we shouldn’t buy the stock? Not at all. While the P/E ratio tells us something about IBM’s value, it’s not the whole story.

IBM (NYSE:IBM) is an industry leader. So just as with any big-name brand, you’re going to pay a little bit more for it. And in my book, the slight difference between IBM’s P/E of 12.8 and the sector’s 10.7 is well worth the premium.

Now, if you are looking to invest in a company with lots of solid growth prospects, you’re quickly going to see that the company’s P/E ratio could easily be much higher than IBM’s 12.8. And the reason that’s so is pretty simple…

Companies with high growth prospects command a higher P/E ratio because investors believe the growth rate is going to translate into higher stock prices down the road. And since stock prices reflect what investors think is going to happen to a company, these high-growth companies usually carry higher P/Es.

Should these higher P/Es drive us away? Not necessarily. Companies with higher growth rates are going to deserve higher P/Es. But the higher P/Es have to be justified by other solid fundamental factors, like exciting new products, top management and good financial operations.

Look at Both the “P” and “E” for Historical Comparisons

In addition to comparing a company’s P/E with its sector, I also like comparing its current P/E with what’s happened in the past. Let’s take another look at XYZ…

Currently, the company carries a P/E ratio of 10. But let’s say that a year ago, XYZ’s P/E was 8. So what does this tell us about the value of XYZ?

Looking just at these numbers, I would conclude that XYZ is becoming higher valued. In other words, investors like the growth prospects for XYZ and are bidding up the stock’s price to prove it.

But before we pop open the champagne, it’s a good idea to take a look at what’s happened to both parts of XYZ’s P/E over the last year.

If the “P” – the price – of XYZ has gone up and XYZ’s “E” – earnings – have gone up, then we’re looking at a growth company that’s commanding a higher stock price. In my book, that’s a positive.

But if the “P” of XYZ has gone up and the “E” has remained the same – or, worse, gone down – then investors are piling into XYZ without much care for earnings. While that’s not always a bad thing, a lower “E” with a higher “P” is certainly cause for concern in my book.

P/E for the Broader Market

No matter what kind of company you’re looking at, it’s always a good idea to have an idea of where its P/E stacks up against the stock market as a whole. And a good way of doing that is to look at historical P/Es for the S&P 500. Take a look at the next graph.

As you can see from this graph, the P/E ratio for the broader U.S. stock market fluctuated between 17 and 25 from March 2005 to September 2008. In fact, the average P/E for the S&P 500 was 19.5 during this period.

In December 2008, the S&P 500’s P/E ballooned to 61. With my data going back to 1936, this is by far the highest P/E on record. And with the mess the market and the economy were in, it goes without saying that this astronomical P/E wasn’t driven by high growth and excellent earnings.

So what’s the takeaway? Simply, that when looking at P/Es for the broader market, it’s important to pay attention to long-term trends with exceptions – like last December’s quarter – taken into consideration.

Drawbacks to the P/E Ratio

Just like every indicator in the book, the P/E has drawbacks. And you need to keep these in mind when you use this popular ratio.

First off, the bottom of the equation – the earnings part – is calculated by the company based on accounting rules. And while many of these rules are in place to protect investors, there’s little doubt that figuring out how a company arrives at its “E” is a monumental task.

Companies can also massage numbers to make their “E” more attractive. And I don’t have to tell you that the unscrupulous ones aren’t above just plain falsifying their books.

But that’s not all…

The P/E ratio can also be calculated using different time frames for the earnings part. The one we’ve used here – the trailing 12-month historical P/E – is the most common, but sometimes the P/E is based on projections that haven’t happened yet. As a result, projected P/Es are less reliable to me than historical P/Es. And you have to know which kind of P/E you’re dealing with.

Best wishes,
Wayne Burritt

Source: The Secret of Wall Street’s Most Powerful Number

Whenever a recommended stock closes 25% below its closing high – or our original recommended price – we sell, no questions asked…

Why do we do this? Number one, a stock trader needs to have a sell discipline or he’s simply flying by the seat of his pants. Anyone can plunk for a few shares. But getting out at the right time is the true art of investing.

Your timing will never be perfect, of course. No investment system devised will ever beat the uncanny success of hindsight.

But the key is to always cut your losses and let your profits run. Easier said than done, however…

Using Trailing Stops to Overcome Emotion and Second-Guessing

Emotions like fear and greed (and hope) often get in the way. Even professional investors and money managers are prone to rationalizing.

But using a trailing stop enforces a discipline that takes the emotion – and the second-guessing – out of the investment process. Prices reflect the facts about a company better than individual opinions. So we don’t argue with the market.

However, some investors tell me they are just too busy to keep up with the trailing stops on their stocks. This makes no sense. It’s tantamount to a driver telling you he doesn’t have time to keep his eyes on the road.

Fortunately, Richard Smith, President and Founder of Tradestops.com – and a PhD in mathematics – has a solution…

A Foolproof Sell Alert Service

Tradestops specializes in helping individual investors protect their profits and investment capital.

The service is straightforward. On the site you can enter the stocks you own, your price paid and the percentage trailing stop you want to use.

If any of your stocks close beneath your selected stop, Tradestops sends you a text message – to your cell phone, e-mail account, or page – alerting you.

Tradestops not only covers all three major U.S. exchanges, but London and Toronto, as well. It can even alert you to stops on your mutual funds and option positions.

Some firms, like Fidelity, offer trailing stop alerts with their accounts. But they generally expire after 30 or 60 days. TradeStops’ information never expires. It’s important to note, though, that Tradestops notifies you, not your broker. It does not enter sell orders.

Personally, I prefer it this way. Anyone who has seen “2001: A Space Odyssey” doesn’t want HAL taking over their account trading.

With Tradestops:

• You can track up to 50 stocks at a time (and whenever you stop out of one, you can replace it with another).
• Tradestops even offers a 30-day risk-free trial.
• Tradestops is easy to use (it’s specifically designed for technophobes) and it’s reasonably priced.
• Ordinarily, the cost is $7.95 a month or $79.50 a year. (If you’re an Oxford Club member, you get a special rate of $39.95 a year.) There are also additional services available for dedicated short-term traders who want even more.

For complete information, feel free to visit: www.Tradestops.com.

And, remember, if you own individual stocks, trailing stops are essential. They don’t just help cut your losses and let your profits run… they guarantee it.

Good investing,

Alex

Source: Trailing Stop Discipline: How to Know When to Sell Your Stocks

Should the markets follow the script I’m about to lay out below, we test the Blue support levels. Then, we can look for a bounce. This could be considered a tradable bounce, followed by a final move to those June breakout levels in the DOW near 8900 — 950 for the S&P 500.

For now, we’ll take it one step at a time..

This first chart tells you why Friday’s run stopped where it did:

Why? Because those are multiple resistance levels as shown above in the Red Line and the pink downtrend channel as well. Sure, it skirted the line, but we aren’t reading into it too much due to low volume pre-holiday trade. Now you know why we call charting an art and not a science. Also, you can also see in the chart above that the full stohcastics are in nosebleed territory once again.

In addition to those support and resistance levels, Elliot Wave fans can see a few short-term scenarios above, namely the BLUE Waves 1,2,3, and 4.

If true, then here comes wave 5 down to the 9100 Dow level and 975 level on the S&P 500. You can also see the RED Waves 1 and 2 — if this is true, wave 3 to the blue line levels stated above could be in play as well.

This week, we’ll find out soon enough it they want to take the Dow and S&P 500 back up to retest the highs in a “Just Because We Can” move…

All the ingredients are on the table should the markets want to pullback from here. What we’ve seen thus far is a market having a hard time following through. That is, most individual stocks out there have been pulling back in a corrective fashion vs. a fast and furious move to the downside.

Should the markets follow the script laid out above, we test the Blue support levels and then look for a bounce that would be the start of the right shoulder by the way when viewing the daily charts. This could be considered a tradable bounce then a final move to those June breakout levels in the DOW at 8900ish and 950ish in the S&P 500. So we’ll take it one step at a time..

Sincerely,
David Grandey

Source: Get Ready for a Tradable Bounce

But now the stock market’s on the mend. In my book, a 49% rally off the bottom for the S&P 500 qualifies as healing.

The economy’s showing signs of improvement. First-time jobless claims have dropped more than 15% since peaking in April.

As for the M&A market, well, it’s still suffering…

Through the second quarter, volume dropped 40.2% worldwide. Deals involving U.S. companies fared worse, dropping 57.5%, according to Thomson Reuters. And July marked the first month in over a decade when not a single deal worth $5 billion or more was announced.

But if you’re serious about investing, you need to know when the M&A market is on the upswing and should be tracking it religiously.

Why?

Because nothing causes stock prices to rise faster and further than an unsolicited takeover offer.

In fact, if we invest in a company before a deal is announced, we stand to pocket an average gain of 43.5% to 53.7%, according to the numbers crunchers at FactSet (NYSE:FDS) MergerStat. In a single day! No other investment strategy can boast the same lightning fast rewards.

Tracking M&A Market Activity With High Credit Spreads

If you’re looking for one number to predict a full-blown rebound in M&A market activity – and signal the best time to invest in takeover targets – try high-yield credit spreads. The spread is simply the difference in interest rates between junk bonds (the typical vehicle used to finance M&A) and comparable U.S. Treasuries.

• When the spread is high – above the historical average of 590 basis points – it means banks consider the risk of lending to suitors to be above average. In turn, they compensate for the higher risk by charging higher interest rates, thereby choking off M&A market activity by making financing too expensive.
• On other hand, when the spread is below the historical average, it means banks consider the risk of lending to be low. In turn, they charge lower interest rates, which encourages M&A activity as companies capitalize on the cheap financing to go on buying sprees.

Right now the spread stands at 857 basis points. At first blush that seems terrible, until you look at this chart.

http://www.investmentu.com/images/iu081209chart.gif

Following the collapse of Lehman Brothers, spreads hit a high of 2,180 basis points! So we’re actually down 61% from that level, with momentum squarely on our side.

As this trend continues, financing will become more affordable. In turn, I expect M&A market activity to come roaring back.

The markets remained littered with historic values. More importantly, there’s a mountain of cash waiting to be leveraged and put to work.

Private equity funds alone are sitting on $1.02 trillion in dry powder, according to London-based research house Preqin. Almost half of that – $472 billion – resides in buyout funds. If they don’t find it a home (i.e. – start buying companies), they’ll be forced to return it to investors.

How to Play The Imminent M&A Market Rebound

In previous columns on the takeover boom, I explained my strategy for uncovering the market’s most promising takeover targets and highlighted sectors and companies ripe for the picking.

However, if you’re looking for a more conservative way to play the imminent M&A market rebound, and the acquisitive nature of private equity funds, consider The Blackstone Group (NYSE: BX).

Here’s why…

• Private equity firms typically enjoy the best returns from investments made in a down market. And Blackstone’s sitting on a $26 billion cash pile to take advantage of all the bargains and practice its expertise in distressed investing, deal making and restructuring.
• Sure, other options exist to get exposure to the private equity space and the M&A market, namely Fortress Investment Group, LLC (NYSE: FIG) and Och-Ziff Capital Management Group (NYSE: OZM). But neither stack up to Blackstone in terms of experience, expertise or financial resources.
• Plus, by investing in Blackstone you get a portfolio of companies that are much healthier than the market. Roughly two-thirds of the companies will report positive or flat earnings, compared to just 35% for the S&P 500. And almost no debt is coming due until 2013, eliminating the refinancing risk plaguing countless other businesses.

Tack on an annual stock dividend of $1.20 (equivalent to an 8.4% yield) and this is a no brainer. You’ll get paid to wait for the M&A activity to rebound and the Buyout King to get back to buying.

Good investing,

Louis Basenese

Source: The M&A Market: When This Number Falls, Expect the Takeovers to Heat Up

A record setting 367 companies reduced their dividends during the second quarter, no doubt leading many shell-shocked investors to conclude that income is dead.

But there’s more to this story. A total of 283 companies actually said that they boosted their payouts, and an even-larger group of companies maintained their current dividend payouts, Standard & Poor’s Inc. reported.

Not surprisingly, each of the two groups of companies featured some defining characteristics. The companies that had cut their dividends were largely domestic in nature, or at least had a decidedly domestic emphasis. By and large, the firms that were able to maintain or even boost their quarterly payouts were internationally focused, with the potential for some explosive business growth in the world’s key emerging economies.

A Tale of Two Markets

To understand the divergent fortunes of the two groups of companies, just look at the divergent performance of the two world economies that are most talked about today: The United States and China.

At the time of this dividend report’s recent release, the U.S. stock-market benchmark – the Standard & Poor’s 500 Index – was up a respectable 7.26% so far this year.

By comparison, China’s Shenzhen 100 Index had quietly risen 110.10% during that same period.

Such a steep run-up in stock prices often spooks investors. That’s understandable. We always evaluate such situations with caution, too.

But while most investors are worried China’s stock market could take a tumble, we would look at it as a minor near-term setback – and a major long-term profit opportunity.

Even with the double-digit – or triple-digit – run-ups the stocks of many China-based companies have already experienced, many Chinese companies remain stunningly compelling buys, especially when they feature solid dividend payouts, as well.

And China’s not the world’s only upbeat investing opportunity. The story is much the same in other parts of the world, too. Right now, there are more than 100 international income funds that feature yields of 6% or better.

So how do you tell which companies have a promising payout future? Or which ones figure to be dividend duds?

There are three key areas to examine.

International Sales: It goes without saying that fast-developing economies such as China and India will almost certainly leave their U.S., European and Japanese counterparts in the dust.  Therefore, it makes sense to begin the hunt for the world’s best dividend players by looking at companies with a significant business exposure to these and other emerging markets.

If this causes you to step out of your investing “comfort zone,” well, let’s just say that’s great.

Some 74% of the world’s economic activity currently takes place beyond U.S. borders, so it makes no more sense to confine yourself to U.S.-only investments than it does to make the same mistake twice.

My favorites include companies that derive 40% or more of their sales from the Pacific Rim, as well as from China. The fact that China’s been growing at a double-digit clip for years means that other countries in that region are experiencing spin-off growth. Taiwan, for instance, has solid manufacturing ties with Mainland China – and the relationship between those two one-time political sparring partners is closer than ever, thanks to several trade agreements signed in recent months.

Granted, one can make all sorts of arguments about the sustainability of China’s growth, but history shows that you are better off hitching your wagon to strong horses than weak ones. Because most people still tend to view China as a Third-World, Communist-led, economically backward country, they’re often stunned to discover that China has had the world’s largest gross domestic product (GDP) for 18 of the last 20 centuries.

And it soon will again – and probably a lot sooner than most investors are prepared to accept.

In fact, I’m predicting that China’s stock markets could have a larger market capitalization than their U.S. counterparts within the next five years, but that’s a story for another time.

Payout Ratios: This is one measure that allows you to gauge the relative security of your investment in any given company. In case you’re not familiar with the term, a payout ratio is the percentage of a company’s profit that it pays out to shareholders in the form of dividends.

While there are exceptions, if the payout ratio approaches 100%, and the choice I’m considering is not a Canadian Trust or Limited Partnership created expressly for dividend-payout purposes that, to me, constitutes a waving red flag. If business conditions plummet, or management doesn’t have as good a handle on cash flow as it thinks it does, any decrease in earnings will obviously affect future dividend payout plans.

On the other hand, if the payout is around 50%, history suggests that this is a sustainable level and that management is unlikely to severely decrease the company’s dividend payment. That’s barring a catastrophic earnings reversal, of course.

Distribution Source: Thanks to all manner of accounting tricks – politely called “adjustments” in corporate accounting-speak – it’s harder than ever to determine where a company’s income is coming from. For example, some investments – especially Canadian Income Trusts and shipping partnerships – prefer to pay dividends from available cash flow, as opposed to bottom-line profits, like most other public companies.  That can increase the aforementioned payout ratio, and can also mislead investors as to the sustainability of future dividend payments.

But you should look anyway.

Generally speaking, dividends come from earnings, making them reasonably predictable. The stuff that isn’t predictable is often the result of special distributions based on short-term or long-term capital gains. Because this type of income often results from one-time sales of assets, or from accounting transactions, they are usually paid semi-annually or annually (as opposed to being paid quarterly, which is the common practice among most U.S. public companies). And while these “special dividends” can provide a nice bump in payments, don’t confuse this type of payout with the cash you received from ongoing operations.

The other type of payout that can throw a monkey wrench in things is called a “return-of-capital” event. While it can result in big cash payments that investors enjoy tremendously, it’s not a regular payout, either. Like the short-term and long-term distributions we just discussed, return-of-capital transactions are not part of regular earnings. They’re typically the result of tax savings, depreciation or other changes in the assets a firm owns. Write-downs and write-ups are good examples of what I’m talking about here.

Either way, return-of-capital transactions are a danger sign in my book because the firm may be trying to return your original investment – which is a strategy often pursued when a dividend cut is imminent and not yet announced.

And that’s the last thing you should want right now.

Source: The Secrets to Global Dividend Investing

Since March 9, the S&P 500 is up 48%. The small-cap index, the Russell 2000, is up 65%. The EAFE international index is up 67%. And the MSCI Emerging Markets index is up 79%.

Yet five months ago, investor sentiment was black as Halloween night and equity mutual funds were experiencing massive outflows.

How did millions of investors get it so wrong?

The short answer is they didn’t know what they didn’t know. They didn’t know that the economy can’t be reliably forecast and the stock market can’t be consistently timed. They didn’t know that abject pessimism is the long-term investor’s best friend.

Why We Were Never Heading Into Another Great Depression

And, perhaps most importantly, they didn’t know that it was never likely that we were heading into another Great Depression.

Read your history. The Depression was caused by policy errors: tight money, higher taxes and protectionist legislation.

The Federal government has done a lot of things wrong since this economic crisis began. But it hasn’t been so foolish as to make the same mistakes it did almost 80 years ago.

• The Fed has taken short-term rates to zero, a powerful tonic.
• Bernanke is flooding the system with money.
• Plus, Uncle Sam is spending money like there’s no tomorrow. (Too much, in fact.)
• And there have been no trade wars with foreign nations.

Bear in mind, economic knowledge in the 1930s was like medical knowledge in the Victorian era. We’ve come a long ways since then. No one is going to bleed the economy with leeches.

The Gloom-&-Doomers See Clouds in Every Silver Lining…

Yet the gloom-and-doomers, the folks who see the cloud in every silver lining, have never understood this.

Not only have they completely missed out on the stock market’s big gains, but the highest-yielding money market in the nation yields less than 1%. Gold is stuck in neutral. And many with the strength of their convictions are holding double-short funds that have lost most – or nearly all – of their value.

These investors never seem to realize that the media delivers the world through a highly distorted lens.

When you hear five times a day that…

• The economy is in contraction
• Unemployment claims are increasing by more than 400,000 a month
• The U.S. housing market is spiraling down
• Consumer spending is anemic
• Business investment is down and credit is tight

…It’s tough to muster much confidence to buy stocks.

The Greatest Buying Opportunities of Our Lifetimes

But as I wrote in this space just one week before the market bottomed:

“Irrational exuberance is as dead as Che Guevara. And while true contrarianism is by definition a lonely business, 10 years from now this market is likely to be viewed as one of the great buying opportunities of our lifetimes. Many investors will disagree, of course. And that’s fine. As George Santayana famously said, ‘Those who cannot learn from history are condemned to repeat it.’”

It hasn’t take 10 years, of course. Or even 10 months. (Although it’s unlikely that we’ll see this bull market reach much higher levels without a few interruptions.)

Two of our core principles are:

• Number one, owning a diversified portfolio of profitable businesses is the best way to protect and enhance long-term wealth.
• And number two, the best time to buy will always be when the majority of investors are despondently selling.

Yes, these principles have served us in good stead.

That’s why we call them principles.

Good investing,

Alex

Source: How Did Millions of Investors Get It So Wrong?