FB: A prime example

When a company's stock is trading at 114 times earnings, it is wise to take a step back and figure out why investors are willing to wait 114 years for earnings. Too often, investors forget that an investment in a company is actually ownership. Still, valuation aside, FB really made headlines this past week by purchasing "Whatsapp" for 19 Billion in cash and stock. In my opinion, I say kudos to facebook on such a bold transaction. Too many companies are letting cash sit stale on their balance sheets, too afraid to make moves. "Whatsapp" has an estimated billion users, many of whom are international. This exposure is huge for facebook. Facebook's presence internationally is weak. Still, where is the ROI going to come from? The best part of text messages is that there is no ads. As I am not a shareholder in FB, it is not my problem to answer this questions.

$12 Billion in stock plus $3 Billion in restricted stock for employees seems like a minor transaction according to their 8-K. But, how much did this really cost facebook? In my opinion, not much. The spdr XLY and XLK trade at 18 and 16 times past earnings. So, give FB a normal industry average PE of 17, and FB would have had to pay almost 7 times more than they did in equity. FB capitalized on their overvalued stock price -- I don't think anything is wrong with that. More companies should be using their overvalued stock prices as currency to fuel m&a deals rather than authorizing billions in repurchases of  their overvalued shares.

FB bought this company because this is what facebook does. FB prides themselves on their user base, this is where all of their "value" stems from. Whatsapp helps increase its international footprint and this could turn out to be a great deal for FB. But, it is unlikely we will find this out for at least 3 years. If FB can make this acquisition work, while growing earnings, their stock price will continue to soar. I believe a correction in the value will occur at some point in the future, but that goes without saying. FB is a company I would like to hold for a few years. Given its current price of 69 dollars, with a P/E of 114, and market all time highs I would be comfortable potentially buying on the dip. The company's support level has not been tested because investors clearly do not care about really investigating the value on this firm. When the euphoria around FB is gone, this will be a true test of its core values and management team.

First Solar

Recently, I began to search for a strong solar energy company. There is no doubt that eventually the demand for alternative energy will create a paradigm shift in the way energy is purchased throughout the world. Energy will always be  needed. Just like any company, the questions remain the same. Which companies have sustainable business models? Which companies are going to grow? Which companies are managed properly?

After reaching the financials of the 2012 FSLR annual report, it became very clear to me that FSLR is not a company I would want to invest in. Early in the AR the company touts its advancements in R&D, efficiency, and other technological innovations. Despite this, and a very long list of risk factors, I was alarmed.

First and foremost, FSLR's customers rely on bank loans to find financing for solar panels. As rates continue to rise, this will impact the sales of FSLR. But, this may not hurt FSLR as much as other solar companies as FSLR primarily sells to project developers which resell to end users. More alarming than a decline in sales is the unique risk to all solar companies: competitors, according to the AR, may be able to obtain sovereign capital, enabling competitors to operate at minimal or negative margins for an extended period of time. This debacle is a huge problem for investors in the solar industry, and underscores just how integrated politics and finance truly are.

Just to touch on an accounting issue of FSLR, long-term asset impairment, in my opinion should be listed as a risk factor. According to FSLR, "For long-lived assets, when impairment indicators are present, we compare undiscounted future cash flows, including the eventual disposition of the asset group at market value, to the asset group’s carrying value to, determine if the asset group is recoverable." Putting the accounting jargon aside, essentially what will happen is that the market value of the panels will drop when technology advances. The panels will no longer have as much value, and the company will have to take a hit on its income statement. Solar technology will advance and will have an impact on its market value of installed panels compared to expected cash flow.

In the company's defense, it has been able to produce improving results in 2013. Although the results are promising, you have to question their validity and transparency. The CEO of First Solar is none other than James Hughes, the former COO of Enron. There is no doubt in my mind that Mr. Hughes has a complete understanding of First Solar and the industry experience to make First Solar a leader in the industry. But, personally, I don't believe FSLR is the strongest company in the industry. I don't have enough faith in Mr. Hughes to bring FSLR to the top. Therefore, I will not invest in FSLR.

Buffet wiring the future

Berkshire Hathaway's subsidiary Business Wire has taken a direct stance in the fight against high frequency traders. As previously addressed, I am very much against HFT as it does not help market liquidity or stability. In a press release, it was announced HFT firms  will no longer have direct access to the feeds of Business Wire. This is a real issue for HFT firms as this is a huge arbitrage strategy; they get direct access to business announcements from business wire in order to save a few microseconds from the time it would take to get it from a new outlet such as Dow Jones or Bloomberg. These microseconds allow them to capitalize on information latency.

This will not hurt the bottom line for Berkshire Hathaway at all. It is clear this is more of a symbolic move and has been applauded by proponents for trading reform. Buffet and HFT are in a very different business. Buffet buys shares in companies that can survive, grow, and profit for generations. These investments do not need to be sold. HFT firms on the other hand simultaneously buy and sell securities in microseconds, clogging queues, and essentially front running. If you are an individual investor wishing to make money in the stock market, I would like to suggest being comfortable holding on to your shares for more than a few microseconds.

Buy companies that will not need to be sold.

Market Correction: Opportunity or Panic?

There is no doubt the market has gone into correction. It was understood that based on the 2013 performance at some point there was going to be some sort of correction, how big and when it was going to occur was the question. By May of 2013 alone, the market crushed expectations. But, increased tapering, valuations concerns, questionable manufacturing numbers, and lack of confidence in emerging markets has pulled the market into correction. For now, it looks like we have recovered and my bullish outlook on the year remains upbeat.

The taper in the US has been viewed as a negative; economics 101 tells us that an increase in lending rates will slow economic growth. While this is true, I have a different view on the situation. The Fed's balance sheet is at an all time high, I for one am glad to see them scale back their buying and force institutions to buy back treasuries. I do not have serious fears about inflation like some but this program has been unprecedented and it is yet to be determined what effect it will have in the long term. Although the CPI index has not been inflated, perhaps inflation can only be seen in the rapid increase of financial markets. The real economy and the financial economy are two very different things and have seen very different growth rates. Although the market has really been pushing, the S&P is still trading at 15 times twelve months earnings. Additionally, the taper signals that the FED sees growth in the economy, which there has been. This is a good thing. We are not in a rational market when the unemployment rate falls and the market falls because the FED may cut QE. Another promising sign are the spike in GDP numbers that have been largely thrown out by the street. At the same time, the FED is doing exactly what it has said it would do. Bernanke's unemployment target was 6.5%, it is currently at 6.6% and I have no doubt Janet Yellen has the same target. In some ways, it is nice to see a governmental institution sticking to its word.

With that said, reflecting on this recovery it still shocks me that there has not been any fiscal support at all. This is not a political blog but politics and finance are unbelievably intertwined. On the left, you have a President who ran on the premise of change, transparency, and increasing support to the poor. Although he had a huge win in the passage of the Affordable Care Act, how much change has he made? Underemployment is still inching down very slowly (thanks to the FED), student loan debt is at an all time high, and the real economy really has not recovered. Just last week Obama signed a farm bill that reduces food stamps -- was this what he meant by aid to the poor? Sure, financial markets are booming and US companies are reporting strong earnings but they are not hiring at a rate many would like to see. Why aren't they hiring? It is not because of increased taxes or compliance costs, it is because there is uncertainty about the future of the US economy. This stems directly from the current political climate. If the US itself is not investing in itself through education, infrastructure, and R&D, why should companies? Companies would rather buyback their own, often overvalued shares than invest in the real economy.

Congress cannot make it more any more clear they are divided. Anyone who has watched a Sunday morning talk show in the past six years can attest to this. The constant fighting between the two parties is literally painful. There has been no fiscal support to aid this recovery because congress cannot get its act together and pass anything. We have experienced a period with the least amount of bills passed ever. Sure, we have a budget now but it is not long term in structure and it only cuts $20 Billion from the deficit. Our representatives have not been able to give CEOs any reason to think that long term investments in the US will result in a respectable return on capital. There is no leadership for any party. Luckily for us growth in emerging markets has cooled off and the US stock market is pretty much the only game in town given rising interest rates.

For the year, I am still very bullish on the financial sector as well as utilities and manufacturing. Exposure to these sectors can be found cheaply through the spdr sector ETFs as well as some undervalued closed-end funds. I am still cautiously optimistic on the economy as the disconnect between the real economy and the financial economy is not found on cnbc.

2014 Picks

14 Stock Picks for 2014

AIG
PX
T
AIG
VZ
FDX
C
AMZN
AAPL
BCS
ADR
GS
STI
GOOG

Way of the world

Major Middle East Forces

Syrian Regime: Led by Bashar Al-Assad, and supported by Lebanon's Shiite Political Party Hezbollah. Syria's regime is dominated by alawites, a sect of shiite islam. Alawites were persecuted in the past by sunni muslims and this resentment still holds today.

Syrian Rebels: Composed of sunni muslims with the support of the United States of America and other Sunni Muslims.

Hezbollah: Formed after the Israeli invasion of Lebanon in 1982, they have dominant political power in Lebanon as well as an arsenal of weapons -- hezbollah will not give up its weapons as they believe they are necessary to protect the country from Israel. Hezbollah's weaponry is more advanced than that of Lebanon's army --  reports speculate the Lebanese Army is under control of hezbollah. Hezbollah has support from Iran, who helped rebuild neighborhoods in Lebanon after the 2006 Israel and Lebanon war. Hezbollah has been condemned as a terrorist organization by the U.S. despite being elected to power in Lebanon.

High Frequency Trading in the current environment

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High Frequency Trading in the Current Environment

In 2009, 73% of all US equity trading volume was not initiated, executed, or monitored by human traders.[1] Rather, it was performed by High Frequency Trading (HFT) firms that used advanced hardware and software to trade large volumes of stock in nanoseconds. HFT needs to act so quickly as the average bid-ask spread has moved from 1/8th of a dollar to an average of less than 2 cents in 2012.[2] These firms trade extraordinarily large volumes over the course of one trading day and have been able to make billions because of their efficient speed. They do not trade based on fundamentals or with any regard of what they are trading. These supercomputers use algorithms to control all trades and operate based on predictions of market signals that may influence extremely short term movements in the market,[3] which can extend insignificant patterns into something significant. These movements are extremely difficult to track due to the sheer speed and complexity of HFT. HFT firms sometimes even make money on the sell side and buy side of exchanges simultaneously, by buying and selling at the same time. Firms do this because there is no regulation in place that has a significant effect on the behavior of HFT. HFT costs are indirectly passed onto investors who have to then buy shares at an inflated price after HF traders increase the price.

These firms have been able to continue business due to their ability to hide under the umbrella of phantom “liquidity.” There is no question that the electronic exchanges in the U.S. have brought a remarkable opportunity for individuals to profit and businesses to raise capital and expand. However, with the opportunity provided by electronic exchanges, colossal challenges have followed into financial markets. Currently, the financial market is becoming dominated by HFT as the justification of liquidity has allowed HFT to grow far bigger than it should have been. The major firms range from small firms that are relatively unknown to major Wall Street firms such as GETCO and Goldman Sachs. These firms have been able to influence how exchanges operate to make huge profits from almost nothing. A vast amount of money is at stake with HFT. Nearly $2 Billion was spent in 2010 on trading infrastructure – high speed servers and fiber optic cables to increase the rate at which information could be transmitted.[4] This $2 Billion exemplifies what a drain of resources HFT has created in the global economy. 

HFT firms have spent millions to move their computers closer to the data centers of stock exchanges all over the world as digital information takes longer to reach some places than others. This technology has fueled a strategy known as latency arbitrage. It may take a few milliseconds more for trades on the Nasdaq’s servers in New Jersey to be crunched by America’s Clearing house for stock trades and reflected in the National Best Bid and Offer.[5] HFT uses a combination of hardware and software to see how much someone else is willing to buy or sell a given security for fractions of a second before the competition does. In the world of HFT, these fractions of seconds make all the difference when it comes to millions of dollars being made. This strategy means HFT trading firms can make money based on information that the competition essentially does not know yet. Latency arbitrage capital investments is not just being utilized in the U.S. from Chicago’s CME to the NYSE or NASDAQ, it is being utilized all over the world: London to Frankfrut, Sydney to Toyko and so forth. This has resulted in a technology arms race in hardware and software. HFT is no longer a distraction, it is a fundamental problem exacerbated by the poor business model of stock exchanges.

Exchange models allow firms to make money on the sell side and buy side of exchanges, by buying and selling at the same time. Firms do this due to a fundamental flaw of the exchanges that pays traders rebates to post shares to buy or sell[6]. The more postings firms can provide, the more they can collect from the rebates that are fractions of a penny. These quotes are not liquidity, they are quotes. These rebates are passed onto investors who have to then buy shares at an inflated price after HF traders increase the price. HFT firms only need to break even on trades due to these rebates, which increases the volume of trading. Markets are no longer nonprofit organizations owned by its trading members. Now, they’re businesses focused on making money, not funding the most efficient projects the economy has to offer. If HFT firms sought to help raise capital for businesses they would consider fundamental valuation techniques and make markets more orderly; not destroy confidence in the financial system as they have done on many occasions.

The flash crash has been well publicized in the media but its root cause has not received as much attention. The flash crash in May 2010 erased $862 billion in equity value within 20 minutes.[7] Individual investors who had stop orders in could have potentially been severely disrupted by such an unnecessary drop in market pricing. Individual Investors who were invested in large institutional funds also felt the wrath because of such a temporary rapid drop in equity valuation. The SEC and Commodity Futures Trading commission have not publically condemned HFT for the flash crash. Their report concluded that HFT didn’t “uniformly flee during the meltdown.” However, official reports suggested they helped fueled the uncontrolled selling.[8] According to John Bates, CTO of Progress Software, mini flash crashes happen all the time as a result of algorithms interacting with each other and forming an infinite loop. This is very concerning as HFT firms do not have the responsibility of being buyers of last resort.[9] Although HFT wasn’t the root cause for the Flash Crash, there are frequent examples of its responsibility for market dysfunction. When the AP Twitter account was hacked, the DJI fell 143 points[10] instantly, this is the opposite of reassuring. The NASDAQ is frequently being halted, and was halted for over 3 hours in August 2013. Knight Capital, a former HFT firm lost $440 Million in less than an hour due to a “software malfunction.”[11] The BATS Global Markets Exchange Inc. (Ironically, a leading HFT exchange) IPO flop was so damaging that an initial listing of $15 dropped to pennies on the day of its IPO due to technical issues, leading the company to withdraw its initial public offering of shares.[12] A firm that specializes in HFT can't pull off a successful IPO and that is concerning. These risks are real in IPOs. In BAT’S S-1 Filing the risks of HFT are limited to “regulatory changes” and “competition.”[13] 

Proponents of HFT justify this cancer by arguing that investors are not affected by everyday price swings. They believe HFT increases liquidity and actually benefits markets. While Investors should not be concerned with small price swings, they should be concerned because these small price swings can become very volatile and turn damaging when they have limit orders in. Additionally, they are constantly at a disadvantage due to latency arbitrage and pay more for stocks due to inflated prices by HFT. Investors do not benefit from HFT firm’s increased liquidity as there is no increase to liquidity itself. Any liquidity HFT adds to markets does not last as it can be instantly removed and HFT firms can exit all of their positions. HFT switches from actively buying and providing liquidity to actively selling and taking liquidity from markets in nanoseconds.[14] These actions are all based on algorithms that can take action based on anything from a change in simple moving averages to economic data. HFT does not help markets fund new projects, reduces confidence in the financial system, and drains resources from the economy. The average investor most likely does not know about high frequency trading, so it is true that they might not be affected by HFT in their personal financial life. But, it is true that average individual investors have their money in mutual funds that are managed by large financial firms who are greatly affected by the behaviors of HFT. The bottom line is that the downside presented by HFT far outweigh any type of benefit HFT firm’s bring to the markets.

In order to restore the health and order of financial markets there needs to be a cultural shift on Wall Street and a fundamental shift to the business models of the exchanges that make HFT so lucrative. A ‘60 minutes’ special and an overwhelming amount of information supporting an overhaul of HFT exemplify the insufficiency and potential future damage to financial markets. There are a number of possible solutions that could end HFT such as limiting the amount of rebates a firm can collect, regulating how long stocks are bought and sold, or eliminating the use of latency arbitrage. Regardless of the solution to the problem, the regulatory agencies need to advance HFT on their list of priorities in order to protect the public from to the corrosive behavior HFT brings to markets as well as the economy. No matter how many circuit breakers exchanges install, HFT will continue to act faster and outsmart anemic regulatory mandates.

[1] Michael McGowan, “The Rise of Computerized High Frequency Trading: Use and Controversy” (Law School Dissertation, Duke Law School, 2010)
[2] The Economist, The Fast and the Furious, http://www.economist.com/node/21547988/print (February 2012)
[3] Richard Finger, High Frequency Trading: Is it A Dark Force Against Ordinary Human Traders and Investors? http://www.forbes.com/sites/richardfinger/2013/09/30/high-frequency-trading-is-it-a-dark-force-
against-ordinary-human-traders-and-investors/ (September 2013)
[4] Jerry Adler, How Wall Street Got Addicted to light-speed Trading, www.wired.com/business/2012/08/ff_wallstreet_trading (August 2012)
[5] See footnote 3
[6] See footnote 3
[7] Nina Mehta, Trading Rebates on Exchanges Should End, ICE’s Sprecher Says, http://www.bloomberg.com/
news/2011-10-11/trading-rebates-on-exchanges-should-end-ice-s-sprecher-says.html
[8] See footnote 2 
[9] See footnote 3
[10] Heidi Moore, AP Twitter hacked and causes panic on Wall Street and sends Dow Plunging, http://the
guarding.com/business/2013/apr/23/ap-tweet-hack-wall-street-freefall (April 2013). 
[11] Francesco DeLuca, “High Frequency Trading,” Review of Banking & Financial Law Boston University 32; 62-74.
[12] Dan Beucke, Bats: The Epic Fail of the Worst IPO Ever, http://www.businessweek.com/articles/2012-03-23/
bats-all-folks-the-epic-fail-of-the-worst-ipo-ever (March 2012). 
[13] See Footnote 12
[14]Matt Levine, “High Frequency Traders Are a Little Too Slow” http://bloomberg.com/news/2013-11-05/ high-frequency-traders-are-a-little-too-slow (November 2013).