Violet’s Questions and Insights
I’m behind in responding to Violet’s good questions from last week. Let me start by saying that she is clearly thinking through the concepts she is learning and the implications. For example, in a recent post I talked about reasons I might sell an investment, including competitive pressures. I also appreciate her thoughtful question regarding how to know if a company is failing or just experiencing rough seas and the oftentimes irrational investor fears.
Failure on the Horizon or Just Volatility?
“My question as I read through the article: How can you tell when a company is failing versus when it’s just going through normal ups and downs? The answer I gathered from reading a separate article called Selling Investments Rule No. 1 is that I should watch for dramatic and unpredicted drops in Dividends and the overall value of the company.” – Violet
Signs of Possible Doom Include Shorts
I like the fact that Violet dug deeper and read a second post to gain more insight. Because my blog has discussed many topics in the last few years, sometimes the answers are already there. Having said that, lets look at another data element so as to avoid riskier investments in the first place.
One indicator that a company’s stock is overpriced is called “short interest.” For example, GameStop Corp (GME) has a short interest of 11.94%. This means there are a substantial number of investors who think the current price and perhaps even the future of the company is questionable. If the short interest is big, it shows some investors are very pessimistic about the stock. However, there is also the danger that they are wrong. If the stock price climbs quickly, the shorts have to buy shares and take a loss to cover their shorts. Apple Inc, (AAPL) in contrast, has a short interest value of 0.61%. In other words, investors tend to be bullish about Apple and some are bearish about GME.
Seeking Alpha is one place I go to look at the short interest of a stock. Bear in mind, that if an investor is short on a stock, they may potentially profit if the price declines. It is considered bearish for a stock to have high or rising short interest. If the short interest keeps growing, watch out! However, this doesn’t mean the company will go bankrupt or out-of-business. However, before you speculate on a stock like GME, remember there are wise investors who think it isn’t a good investment at the current price.
A good general rule is to invest in companies with growing revenues, growing profits, and growing dividends. If you have less than $100,000 to invest, avoid speculation. If you have $1,000,000 to invest, be wise. Unwise and greedy speculation can turn a million dollars into $100,000 very quickly.
Competition: Ford, Toyota, General Motors, Tesla, or Volkswagen?
There are many companies that make cars, SUVs, trucks, and minivans. Sometimes, it is hard to know who will win and who will lose. Violet asked, “Last year in microeconomics I learned about the factor of competition in the market. How does competition effect investing? Do you ever think about competitive factors when evaluating whether to buy or sell stocks? For example: barriers to entry and number of companies in the marketplace.”
Competition Matters
When it seemed that Tesla (TSLA) was the best game in town for electric cars, Tesla’s stock shot up. It now trades over $800 per share. Some are saying it could go as high as $2,500 per share. Perhaps it will, but it may take longer than the Tesla bulls envisioned. The reason is quite simple, while TSLA has a head start, they are now being threatened from several sides. There are the old-guard auto manufacturers like General Motors and Toyota, but there are also new upstarts like Lordstown Motors Corp (RIDE). (RIDE, however, has a short interest of 27.37%, so it doesn’t look like investors believe their story.)
When I am investing in any company, I use the Seeking Alpha tool that shows me the top stocks in their competitive arena. For example, the top stocks in Automobile Manufacturers are Daimler AG, Ford, General Motors, Thor Industries, Honda, Nissan, and then Tesla. The following image sheds some light. In general, at current prices, I am more inclined to invest in the top three now. At the present time your grandmother and I own shares of Ford.
Understanding the Impact of Inflation
“Today I learned about Inflation and Interest and how interest is affected by inflation. For instance, if your interest over 2 years is 4% but inflation is 2% your real interest is only 2%.” – Violet
This wasn’t a question, but it is a very wise observation. If you are earning 0.5% on your savings, and inflation is 3%, you are losing purchasing power. If you do this long enough, you will lose even if you still keep your dollars. When I was a boy, a BIG Hershey milk chocolate bar was ten cents. Inflation has caused it to shrink in size and grow a lot in price.
But there is another hidden danger in the inflation monster. For every dollar that you keep “safe”, you are losing opportunity. If you can grow every dollar so that it doubles every seven years, you can turn $5,000 into $10,000. Inflation is still going to hurt, but it will hurt far less. The opportunity cost is the missed opportunity that time provides. The longer your time to invest and grow your investment, the more you will have to give to others and to take care of yourself and your family.
In the scriptures, Jesus told a parable of the talents. In Matthew 25, he commends the two who started with little and turned it into much for the Master. He rebukes the one who sat on what he was given, not realizing it was given to him to use wisely. The master told that servant, “You wicked and slothful servant! You knew that I reap where I have not sown and gather where I scattered no seed? Then you ought to have invested my money with the bankers, and at my coming I should have received what was my own with interest.” Matthew 25:26-27
We need to remember that every dollar we have belongs to the Master. Don’t waste the opportunities to invest, to give, and to return it to the Master.
All scripture passages are from the English Standard Version except as otherwise noted.
Know Your Flocks & Herds 