Good evening, hope your day has been well. On to the update.
Today | 7 items
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1. Twitter enters the S&P 500
On Monday it was announced that Twitter (TWTR) will be apart of the S&P 500 index, replacing Monsanto.
What’s the big deal?
Vanguard, State Street, and Blackrock own the three largest index funds that track the S&P 500. Collectively, those funds manage more than $700 billion in AUM(assets under management).
It’s a big deal because those funds will be required to buy Twitter shares. In other words, Twitter found a new group of investors.
Who determines what companies make up the S&P 500?
Before we get to how the companies are selected, it’s important to remember that the S&P 500 represents 500 of the largest companies(not necessarily the largest 500) whose stock trades on the NYSE or NASDAQ.
The components of the S&P 500 are selected by a committee. While not strictly rules-based, here are a few of the criteria they use when making their selections.
- A market cap of $5.3 billion
- Headquartered in the U.S.
- At least a quarter-million of its shares traded in the previous six months
- The majority of its shares in public hands
- At least half a year since its IPO
The head of the committee who decides which stocks are in and which are out is David M. Blitzer. The WSJ wrote a nice profile about him.
For a real doozy, you can read their full methodology. PDF
2. Twitter: position update
Enough time has passed that I feel comfortable sharing a position our members hopefully took in Twitter on October 30th of 2017.
This stock represents 5% of our portfolio. The position, not the portfolio, has gained over 85% since we entered.
I do not share this brag. I’ve had plenty of losing trades and will have more in the future. I share because I hope it brings value to your investing process.
Let’s walk through this trade.
(Click chart to enlarge)
• Entered position at $21.17 (orange arrow)
• Our stop was $17 (red arrow)
• First target was $35 (blue arrow)
• Reward/risk was 3.32 to 1. Meaning we would make $3.32 for every $1 risked if the trade worked out.
Why did I buy?
I bought because the buyers gained control from sellers above $20.
Take a look at the 4 short red arrows on the chart. Those represent times where the sellers maintained control below $20. In other words, every time price approached or briefly traded above $20, the buyers could not maintain control above that level.
Until the week of October 30th. The buyers finally maintained control above $20. That’s why I bought. Something changed from the previous 4 times that caused the buyers to lose control above $20. In addition, the upside(price appreciation) justified the downside(my stop) so that if I was right, I would get a nice payout.
What was it that caused buyers to maintain control above $20 on their 5th try? I’m not smart enough to know. Nobody is and no one was talking about Twitter when I bought it.
Which takes me to my main point.
I believe price moves before fundamentals.
The short green arrow on the chart represents the week Twitter reported 4th quarter 2017 earnings. Those earnings came in 10 cents better than expected and the stock popped.
Most investors wait until good news to buy a stock. Which is fine if that is your strategy, but you often miss the best time to buy.
The best time to buy is when people believe the future is bleak, which has been the case with Twitter.
I hope this gives you some insight into how I think about investing. It’s not the only way I think about investing, just a framework that’s useful when gauging the risk/reward of potential investments.
Investing is a game of probabilities, not certainties. In my early days as an investor, I was “certain” about a lot of things. Losing money is a good recipe to reshape your thinking.
3. Tech companies have outstanding margins
A chart that caught my eye.
EBIT means earnings before interest and taxes. Basically, operating earnings. Let’s look a leg up on the income statement to gross margins.
Gross margins are revenue minus cost of revenue. They show how profitable a company is selling their product or service before taking into account business operations such as salaries, office supplies, etc…
For some context, in 2017, Facebook had a gross margin of 86%. (red arrow)
In contrast, Nike had a gross margin of 44% in 2017. (red arrow)
Why do tech companies have above average margins?
One word-Marginal costs.
Marginal cost is the additional cost added by producing one additional unit of a product or service.
Tech companies tend to be asset-light relative to older industrial style companies that make physical goods.
Once a piece of software is created, it can be duplicated to infinity with little additional marginal costs. It cost Facebook nothing if I tell you to download and start using their app.
In contrast, if we went to a burger joint, each additional burger sold would have costs associated with it. Such as meat, bread, packaging, condiments, utensils, etc.
That doesn’t mean non-software companies can’t be good businesses. Large capital investments can give companies a moat.
Look at Amazon. They’ve made huge investments in warehouses near major cities that give them an advantage when it comes to delivering products to their customers.
There’s a reason VCs like software companies. Once they find product-market fit, they can throw off a lot of cash and do not require large capital commitments to get started.
A talented coder can create more value banging away code than a company with billions of dollars in physical inventory.
Just something to keep in mind when evaluating companies.
4. Is low unemployment bad for stocks?
Going back to 1955, there have been 45 months in which the unemployment rate has been as low as or lower than it is now. The average stock market return, as measured by the S&P 500, of those months: Just 0.3 percent. By contrast, when the unemployment rate has been 10 percent or higher, the market has clocked an impressive average monthly return of 3.4 percent reports Bloomberg
My thought bubble
Using economic indicators such as the unemployment rate to time the stock market is hard and a waste of time.
Warren Buffett sums this article up nicely when he said:
Be fearful when others are greedy and be greedy when others are fearful
It sounded crazy to buy stocks in 2008/09 but it was the right thing to do. Today, everyone appears to be a genius because stocks have gone up for a decade. I’m not saying stocks are going to crash but I am saying that it matters when you put money work.
Investing new money at today’s prices will likely yield less than it did if you invested in 2008/09.
5. Turkey, Turkey, Turkey
Looking for a high-risk play in a country that is being taken over by a dictator? Turkey is for you.
(Click chart to enlarge)
The above chart is the ETF TUR, an iShares product.
Currently, this ETF is testing a major trendline (see chart above). Maybe you don’t believe in trendlines or charts. No worries, just putting it on your radar.
The goal of TUR is to give investors a broad range of exposure to companies in Turkey. The expense ratio is 0.62% or 62 basis points. You would pay 62 cents for every $100 invested.
Here are the top ten holdings:
For a deeper dive into the political climate in Turkey, check out this article by The New Yorker (metered paywall).
6. Best and worst state economies
Come on Mississippi… Check out the full article for the methodology they used.
7. How to get wealthy (over time)
The whole article is worth a read.
Thanks for reading and have a great night,
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