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Finance & Stock Groups Forum Index » Financial Planning » Financials in a fixed income account
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| Michael |
 Posted: Sat Jul 26, 2008 3:18 pm |
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My fixed income account is comprised of between 25% and 30% financial
issues (preferreds, bonds, a few funds). After taking a sizable hit, I
asked my advisor if we weren't overweight in that sector. He said that
with an income producing account a good portion of that account will
invariably consist of financials. Is this correct? Thanks in advance.
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| dapperdobbs |
| Posted: Sun Jul 27, 2008 4:15 am |
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On Jul 26, 10:15 am, Michael <gen...@verizon.net> wrote:
Quote: My fixed income account is comprised of between 25% and 30% financial
issues (preferreds, bonds, a few funds). After taking a sizable hit, I
asked my advisor if we weren't overweight in that sector. He said that
with an income producing account a good portion of that account will
invariably consist of financials. Is this correct? Thanks in advance.
Sounds like it depends on what definition you are using for
"financials". I think generally, "financials" refers to a very diverse
number of companies whose principal business consists of lending
money, whether for construction, equipment, or consumer loans. A bond
is not, as far as I understand, a "financial", but could be classed
that way if issued by a company whose business is, for example,
banking.
Traditionally, a fixed income portfolio would contain interest-bearing
intruments (such as bonds), or high yield preferred stocks - such as
you have. The idea is that bonds will not default, so the principal is
safe. Preferred stocks may be "cumulative preferred" - their dividend
is (given a priority) subordinate to interest, but senior to the
common stock, and if suspended, continues to accrue (cumulate) and
will be paid out when the dividend is restored. There is some
additional stability in preferred stock, due at least in part to the
higher dividend payout. But the principal in bonds and preferreds is
also subject to loss of purchasing power due to inflation. Thus when T-
Bills fall below the rate of inflation, they actually pay "negative
interest". Other classes traditionally found in income portfolios are
utilities, municipal bonds, and perhaps some CD's.
With interest rates at their current low levels, many dividends paid
by non-financial companies are higher than most interest rates. An
important factor not to be overlooked is that many companies have
steady earnings increases from year to year, and a history of
increasing their dividends. A screening program can give you high
dividend payouts, but there are all the factors of the company to be
very carefully considered before buying shares of the stock. Your time
frame is an important factor to consider - the longer it is, the more
time you have for dividend increases, and the less you have to worry
about overall market vagaries up and down. But you always have to look
very carefully at the underlying business of the company.
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| Michael |
| Posted: Tue Jul 29, 2008 12:00 am |
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Dapperdobbs, my sincere appreciation for one of the most complete and
concise answers I have ever received on this subject.
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| anoop |
| Posted: Tue Jul 29, 2008 3:56 am |
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On Jul 26, 5:15 pm, dapperdobbs <George...@hotmail.com> wrote:
Quote: With interest rates at their current low levels, many dividends paid
by non-financial companies are higher than most interest rates. An
important factor not to be overlooked is that many companies have
steady earnings increases from year to year, and a history of
increasing their dividends.
Keep in mind that the high dividend % currently being reported
may be misleading. Many stocks have fallen in anticipation of
reduced earnings making the past dividends look overly attractive.
Anoop
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| Guest |
| Posted: Wed Aug 13, 2008 1:13 am |
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Michael <gen...@verizon.net> wrote:
Quote: My fixed income account is comprised of between 25% and 30% financial
issues (preferreds, bonds, a few funds). After taking a sizable hit, I
asked my advisor if we weren't overweight in that sector. He said that
with an income producing account a good portion of that account will
invariably consist of financials. Is this correct?
First, to be very clear about what we mean by "financial issues" here,
most likely your account's decline was due to bank-issued preferred
stocks and/or bonds.
Second, I assume by "fixed income" you mean income that will not
adjust with inflation and so is pretty much the same dollar amount
year after year. If so, I would expect a "fixed income" account to
hold high grade corporate bonds; government bonds; and preferred
stocks. When it comes to preferred stocks, one can peruse
quantumonline.com to see what is typical. Use its screener (under
"income table"), and filter by company type. Banks and financials are
about 300 of 1200 preferreds. So I would say your advisor is being
accurate.
I am studying what has happened with banks this past year or so and
propose another question: Should we as investors expect managers of
our fixed income accounts to take more care? I think overall this
would be asking a little much. First, I propose the mission of a fixed
incom account's manager is to preserve income first and be less
concerned with the principal's fluctuations. Second, it seems to me
the decline in banking securities happened rather quickly; people,
even those in the business of investing, got caught off-guard. Third,
what would the manager buy in place of the sold bank securities?
Fourth, if the bank preferreds etc. started as pretty high grade,
chances are they have downgraded but not all the way to junk, meaning
your income should remain safe. Fifth, I would wager it's been over a
decade since bank preferreds and bonds have seen such a massive
downturn. Fact is that many banks' credit obligations were not
obvious.
To me, the only argument that might counter this is that banks are
inherently risky. Banks' common stock P/Es historically are well below
the P/E of the S&P. This is evidence of the risk. Should a fixed
income account manager therefore have fewer bank preferreds and bank
bonds? I would say no, because high grade preferred and bonds have
more safety built into them, as dapperdobbs describes.
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| Will Trice |
| Posted: Thu Aug 14, 2008 4:12 am |
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honda.lioness@gmail.com wrote:
Quote: To me, the only argument that might counter this is that banks are
inherently risky. Banks' common stock P/Es historically are well below
the P/E of the S&P. This is evidence of the risk.
The common shares of banks are obviously risky, as are all common
shares. And I think you're right that banks are riskier than the S&P in
general. But is their low historical P/E evidence of risk? Looking at
data I got from Value Line on 299 companies of various industries for
the ten year period ending with 2007, there's no correlation between the
average annual P/E ratios of companies and the annual standard deviation
of their stock price returns.
I know, I know... you don't necessarily equate 'risk' with 'standard
deviation.' But in a thread some time back about Graham's views on
diversification, you implied that P/E was positively correlated with
risk - whatever that definition of risk may be.
I would think that P/E would more likely be correlated with expected
growth rate? Or perhaps even market cap (inversely)? Others?
-Will
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| Guest |
| Posted: Fri Aug 15, 2008 12:20 am |
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Will Trice <n...@monitored.net> wrote:
Quote: I think you're right that banks are riskier than the S&P in
general. But is their low historical P/E evidence of risk? Looking at
data I got from Value Line on 299 companies of various industries for
the ten year period ending with 2007, there's no correlation between the
average annual P/E ratios of companies and the annual standard deviation
of their stock price returns.
Why do you consider banks risky? I have my reasons, per below, but I
am interested in others'.
I think we agree that the low P/Es the market normally assigns banks
is due to buyers perceiving banks as riskier. Yet using some perfectly
reasonable measures for the last ten years or so, the risk is absent.
(I have skimmed fundies on banks for awhile going back a decade, and
your finding is what I would expect.) I think the next question is:
Why do buyers perceive banks as risky?
My layperson's explanation to another layperson would suggest
consideration of things like: (1) Citigroup when its share price fell
by half from July to October of 1998; (2) the low ROA of banks?
probably all sort of implications from this arise here that might
justify lower P/Es; (3) awareness of the period c. 1991 when banks
were being taken over, cutting dividends, and seeing their share
prices declining significantly.
Let me stay away from more discussion on P/Es, since it gets into a
discussion of value and growth; large and small caps; etc., ultimately
some gray, subjective areas. For a few years now I have been seeking
an explanation of why historically the S&P 500 P/E has averaged 15.
Why is 15 "magic"? I have dug and dug and found nothing, though I do
have my own hypothesis.
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| Will Trice |
| Posted: Fri Aug 15, 2008 12:20 am |
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honda.lioness@gmail.com wrote:
Quote: Why do you consider banks risky?
In general, I don't consider banks risky per se (present credit troubles
excepted). What I mean is that I consider common stocks to have
volatile returns in general and that I consider them more volatile than
those of lower returning securities like bonds. And judging from the
KBW Banking Index, it looks like the returns of bank common stocks are
more volatile than the S&P 500. So I agree with you that banks are
probably riskier than the S&P in general.
But...
Quote: I think we agree that the low P/Es the market normally assigns banks
is due to buyers perceiving banks as riskier.
I actually don't agree with this. That was the point of my post that I
obviously hid in the weeds. Somewhat counter-intuitively I actually
expected stocks with higher volatility of returns to have higher P/E
ratios. When I checked the data, I was surprised to find no correlation
between volatility (standard deviation in this case) and P/E.
Quote: Let me stay away from more discussion on P/Es, since it gets into a
discussion of value and growth; large and small caps; etc., ultimately
some gray, subjective areas.
I agree, I think this is what led be to my first guess as I was equating
'growth' with 'high P/E' and 'growth' with 'more volatility', but this
isn't necessarily true I suppose.
Quote: For a few years now I have been seeking
an explanation of why historically the S&P 500 P/E has averaged 15.
Why is 15 "magic"?
An excellent question. It may be no more magic than the average height
of Montana women, i.e. it might just be a numerical artifact of our need
to take averages. On the other hand, perhaps there is a discoverable
reason...
-Will
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| Douglas Johnson |
| Posted: Fri Aug 15, 2008 12:20 am |
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honda.lioness@gmail.com wrote:
Quote: I think we agree that the low P/Es the market normally assigns banks
is due to buyers perceiving banks as riskier.
All a low P/E signals is that the market doesn't like the stock right now. There
could be all sorts of reasons for this. While perceived risk is one, it could
be that thinks the stock is:
1) Not sexy.
2) Not going to grow.
3) Likes something else better.
4) Doesn't understand it (I think this is a factor for banks, bank accounting is
weird.)
-- Doug
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| Guest |
| Posted: Fri Aug 15, 2008 12:20 am |
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Will Trice <n...@monitored.net> wrote:
Quote: judging from the
KBW Banking Index, it looks like the returns of bank common stocks are
more volatile than the S&P 500. So I agree with you that banks are
probably riskier than the S&P in general.
Well, as I tried to indicate in my last post, I thought different. My
portfolio picks have been largely based on earnings growth and
dividend stability over a decade, and banks did really well on these
counts from about 1997-2006. (My focus has also been on diversifying
for peace of mind, too, thank goodness.) Then again, with my stock
purchases, I only buy if, among other questions, I can say at the time
I will be comfortable holding the stock forever, through all sort of
price changes. I almost do not care about price volatility over a ten-
year period.
Either way, your finding above is interesting and suggests that buyers
are in fact rational, en masse, when it comes to pricing bank stocks.
Quote: When I checked the data, I was surprised to find no correlation
between volatility (standard deviation in this case) and P/E.
I wonder whether this is because P/E can vary so much from one stock
to another. E.g. small, new company X may have highly variable
earnings such that P/Es vary from 50 to 200, over the course of a
year, with the stock price staying the same all the while. It is stuck
with a high average P/E but no volatility over the year. Large, old
company Y may have a range of P/Es from 10 to 20, also with the stock
price staying the same. Both companies have the same volatility, but
their average P/Es are very different.
I remain somewhat curious about it all because Jeremy Siegel's _Stocks
for the Long Run_ puts much emphasis on growing one's portfolio by
buying low P/E stocks with decent, reliable dividends, said dividends
being reinvested. One could say the "old reliable stocks" offer the
best chance for portfolio growth because one can buy so much more of
them (they're cheap!) with the reinvested dividends. One gets that
compounding kicking in massively.
People talk about "growth stocks," inviting all kind of gosh-awful,
toxic, numerology-based "analyses." (The more math expertise, the
greater the chance of seduction and being duped? This ought to be a
modern rule of investing: stay away from whiz kids when seeking
financial advice.) Maybe people should talk about Siegel's perfectly
rational portfolio growth strategy instead.
My hypothesis on P/Es hovering around 15 is that those lucky few who
financed new companies through IPOs way back when were happy if the
company earnings in theory could pay them back after 15 years, which
would be something like one-quarter of a lifetime. A trend was set.
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| Guest |
| Posted: Fri Aug 15, 2008 12:20 am |
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Douglas Johnson <p...@classtech.com> wrote:
Quote: All a low P/E signals is that the market doesn't like the stock right now.
Historically bank stocks have been an outlier, on the low side, when
it comes to P/E. To me this says a lot more than bank stocks are not
the flavor of the day.
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| Guest |
| Posted: Fri Aug 15, 2008 1:33 am |
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Tad Borek <bore...@pacbell.net> wrote:
Quote: honda.lion...@gmail.com wrote:
I think we agree that the low P/Es the market normally assigns banks
is due to buyers perceiving banks as riskier.
The "right" trailing P/E hinges on earnings growth,
Do you think the following statement says the same?
"Historical differences between sector P/Es often hinge on historical
sector differences in expected earnings growth."
If so, sure. Though at the moment, I give more credence to the theory
that earnings by banks are more erratic, and so their stock price
volatility is higher. Like the steel, auto, and oil industries, IIRC.
Quote: Also - even more fundamental - why is
there inflation, and why 4%?
Why single digit inflation? Or why whatever number?
I bet the answers to this are very similar among economist minded
folks.
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| Tad Borek |
| Posted: Fri Aug 15, 2008 1:33 am |
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honda.lioness@gmail.com wrote:
Quote: I think we agree that the low P/Es the market normally assigns banks
is due to buyers perceiving banks as riskier.
The "right" trailing P/E hinges on earnings growth, or lack thereof
(bankruptcy being an extreme form of "negative earnings growth").
A stock or sector could have a low P/E because of a low earnings growth
rate. First, just intuitively...who would pay the same "P" for a dollar
of earnings that will stay there at $1 forever, vs. a dollar that will
be $1.50 within two years? Or, in finance jargon: highly simplified
Gordon model where earnings are paid as dividends says
P/E = 1/(r-g)
r is expected return demanded by investors
g is growth rate
assume competition for capital, r = constant
no growth means lower P/E
(it may not matter in the macro/model sense whether dividends are
actually paid - so says Modigliani-Miller theorem)
Quote: For a few years now I have been seeking
an explanation of why historically the S&P 500 P/E has averaged 15.
Why is 15 "magic"?
A simplistic view (mine) walks into it by starting with a 4% inflation
rate over the long run, adding a premium for "the inconvenience of not
having your money for while, and perhaps not getting it back," plus
another for investing in equities instead of nominal-return corporate
bonds. But why that has on average landed at an earnings yield of around
6.7% (1/15) is anybody's guess! Also - even more fundamental - why is
there inflation, and why 4%?
-Tad
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| Tad Borek |
| Posted: Fri Aug 15, 2008 7:00 pm |
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honda.lioness@gmail.com wrote:
Quote: The "right" trailing P/E hinges on earnings growth,
Do you think the following statement says the same?
"Historical differences between sector P/Es often hinge on historical
sector differences in expected earnings growth."
Yes, if by P/E you mean trailing P/E, and I think it's true whether it's
a stock, sector, asset class, etc. "Trailing" is important though
because there isn't the same justification for a high forward P/E -
which arguably never makes sense. One oddity to me about P/E studies
(whether of stock, sector, or asset class) is that overwhelmingly they
focus on trailing P/Es rather than forward P/Es. But a new owner at t=0
is not really interested in the prior earnings, of which he'll receive
no benefit. Instead the investment decision is (or should be) based
entirely on anticipated earnings. But there isn't much good data about
that, while it's easy to run studies based on current price and
historical EPS. How would one determine historical forward P/Es? Only
current IBES data about sell-side analyst earnings estimates is readily
available, not historical (not from sources I'm aware of). And sell-side
analyst earnings estimates are questionable source of the "E", anyway
given the "cheerleader" aspect to them. You'd need to know the earnings
estimate of everyone who was looking at the stock (including those who
decided not to purchase).
Quote: Also - even more fundamental - why is
there inflation, and why 4%?
Why single digit inflation? Or why whatever number?
I bet the answers to this are very similar among economist minded
folks.
Interestingly there are still quite a few theories about it, even though
it's been one of the most studied and written-about topics in economics.
-Tad
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| Elle |
| Posted: Fri Aug 15, 2008 7:00 pm |
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"Tad Borek" <borekfm@pacbell.net> wrote
Quote: honda.lioness@gmail.com wrote:
snipping much to meet guidelines and try to stay at least a
little consistent with the subject line
Quote: "Historical differences between sector P/Es often hinge
on historical
sector differences in expected earnings growth."
Yes, if by P/E you mean trailing P/E, and I think it's
true whether it's a stock, sector, asset class, etc.
Others and I were talking about how the banking sector's
historical P/E differs from, say, the S&P historical
average, hence my focus on the banking sector. Yes, I mean
trailing P/E.
Aside: It might be more accurate to speak of how the banking
sector's P/E historically lags that of the S&P 500 and other
sectors, rather than attest that banking P/Es always average
below 15. I have not had a chance to look at this fully.
Quote: But a new owner at t=0 is not really interested in the
prior earnings, of which he'll receive no benefit.
Aside: If memory serves, Ben Graham was adamant about using
only trailing P/Es. He was in the camp that felt, as you put
it, forward P/Es never make sense. He has elaborated on why
he feels this way, and I thought him persuasive.
Quote: Also - even more fundamental - why is
there inflation, and why 4%?
I meant to query: Do you mean why is there single digit
inflation? Or did you mean why does inflation set on X in
such-and-such country at such-and-such time? Places like
Israel had triple digit inflation from 1978 to at least the
mid-1980s, for example. So I do not follow why you chose 4%.
I still feel many have a good intuitive answer to what may
cause inflation. Either way, it is one of those economic
topics that I think is particularly fraught with human
psychology, anthropology, etc., so it's not a topic I care
to explore here. Inflation and deflation happen. Six months
ago I could buy a 2008 SUV for $30,000. Today I would pay
$28,000 for the same vehicle. Why? Well one big reason and
lots of smaller reasons.
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