My Quandry on BJ’s Restaurants

Regular readers will know that I’ve been buying up BJ’s Restaurants for sometime now.  I first bought at $40 or so, saw it climb to $60+, decided it was overpriced and sold off, making a nice profit.  I started buying again when it sank into the 30’s, and then made another, smaller profit this spring by writing covered calls on the position, which eventually resulted in the shares being called away.  To read that adventure, the initial post in the series can be found here.

I bought back in, little-by-little, on the way down from there and am now sitting on about a 10% loss.  I tried to buy a few more shares last week, only to see the stock rally away from my limit order of around $27.

BJ’s has a chain of casual dining pizza restaurants with microbrew beer.  I really like the stock for many reasons.  The company is very profitable.  They have no debt and a lot of money from operations, meaning that they can use cash from operations to grow and make investments rather than racking up large loans.  This says to me that they know how to run a business.  They also have plenty of room to expand, currently only having restaurants in less than 20 states.

This issue, however, is the ugly cloud called Obamacare that is hanging over the whole economy.  The healthcare law, formally known as the Affordable Care Act (ACA), was supposed to be in full force starting this January.  This would mean that employers with more than 50 fulltime employees would need to provide healthcare that meets the standards of the ACA (meaning the cost of the insurance would be higher) to their employees. All insurance plans offered to individuals would also need to meet these standards, meaning that a lot of the plans on the individual market would be cancelled, forcing individuals to go without insurance or pay $200-$500 a month more (or even more than that) for plans with higher limits and more services.  Even small businesses that had fewer than 50 fulltime employees would need to provide insurance that meets that new standards if they chose to continue to provide insurance.

The requirement for large employer plans to meet the new standards was delayed a year (probably illegally since the law was never changed by Congress, so this might change suddenly if anyone challenges the delay in court).  The requirement for individual plans remains in many states, however, as does the requirement that small employers offer plans that meet the higher standards, meaning they will need to pay a lot more per employee or, more likely, quit offering coverage.  This all means that 1) people are going to be paying a lot more of their income towards healthcare (or to pay the 2% of their income-tax if they go without insurance), particularly young, healthy individuals who spend little on healthcare now, 2) a lot of people are going to be placed on part-time status or laid off entirely since the cost to pay for their salary and healthcare cost will be more than they produce by working for the employer, and 3) salary growth will be slowed or salaries will even be cut, if the worker’s share of the health insurance payment grows, as employers deal with higher health insurance costs.

None of this looks good for the mid-priced casual dining segment who get a lot of their income from the disposable income of young people.  If suddenly all of the people in their 20’s and 30’s are spending 10% of their income to pay for the healthcare of those in their 60’s – 80’s, they might not have much money left over to go out to eat.  Even if they decide to go without insurance and pay the 2% tax, that owuld be $2000 per year out of the pockets of someone making $100,000, which might make those individuals on a mid-level income  LA decide to eat in more.  Restaurants like McDonald’s might do well as people scale back on their spending, and places like Ruth’s Crisp Steakhouse will probably do just fine since rich people and politicians (whose dining bill is picked up by lobbyists) will still go out for a ridiculously overpriced meals, but places like BJ’s might see a substantial drop in business.

I’ll probably therefore hold where I am and not build on my position in BJ’s.  I still like the business, but the effects of the ACA on the segment might be severe.  Hopefully as the estimated 80 million people lose their insurance next year when the large employer mandate kicks in, the outcry will be large enough to overturn the law.  All of this leads to uncertainty, however, which is what the stock market hates.  Expect a bumpy road ahead, even if things continue to go up for a while.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Now is Not the Time to Buy Bonds, Maybe

The conventional wisdom says that you should own your age in bonds.  If you are 20, you should have 20% of your investments in bonds.  If you’re sixty, it should be 60%.

The idea is that as people get older they need to get more conservative with their money, gradually shifting from uncertain growth investments to more certain income investments.  An ideal situation when you’re living on your savings is to have your bonds and dividend paying stocks paying enough interest to cover your expenses so you don’t need to sell stocks to raise cash.  Money just magically appears in your accounts as you need it.

The trouble is that we are not living in normal times.  To try to spur the economy, the Federal Reserve lowered interest rates essentially to zero.  When that didn’t work since no one had good enough credit to borrow money and businesses didn’t see any reason to expand with no one buying anything the Federal Reserve started buying buckets full of long-term bonds to bring down long-term rates.

This caused home mortgages to go down to unheard of levels.  No one was interested in buying a house, however, since so many people were upside-down in their mortgages.  People who could, however, refinanced their existing mortgages, reducing their payments and freeing up cash.  This has started to help the economy somewhat, but the recovery still isn’t much better than the recession.  Part of the reason is that unemployment benefits are so good that many people choose not to go back to work, meaning there are a lot of people not producing anything or moving up and increasing their income.

The good news for borrowers is that the economy has been so bad that interest rates have stayed low.  This has caused stock prices to go to new highs.  Bond prices also increased initially as rates were lowered, but have stayed in a trading range ever since.

Normally one would want to have a  substantial amount of savings in bonds later in life.  The trouble is currently that when rates do go up, either because the Federal Reserve raises rates to temper the economy or because inflation picks up because of all the easy money out there, bond prices will fall.  We could easily see declines of 10-20%, which would wipe out years’ worth of interest for bonds paying 3-5%.  Dividend paying stocks would be hit too unless the economy does start to recover and the underlying businesses start posting good profits.

The trouble is, sitting on the sideline waiting for this bond collapse that will occur eventually may leave an investor in cash waiting for years.  (These kind of things are easy to predict but very difficult to time.)  This could mean sitting in money market funds earning 0% when you could have been earning 3-5% for the next three years.  The internet bubble was similar in that it was obvious stocks were ripe for a fall back in 1997-1998, but the party continued on for a couple of years after that.

So, what to do?  It probably is best to have some bond exposure.  Sure, you’ll be looking at a reduction of 10-25% in price when interest rates rise, but if you hold long enough you’ll regain much of that loss.  Buying shorter term bonds would also be good, as would picking bonds which are below their redemption price (typically 100) per bond).

Spreading out into income investments would also help.  Buying dividend paying stocks would allow income both from dividends and price appreciation.  Stocks are also a good inflation hedge – if held long enough – since the price of the property of the company will increase with inflation and they will be able to pass along price hikes to their customers normally.

Another option is to get into real estate, either by buying rental properties or buying REITs.  These are also a good inflation hedge since the value of the real estate will increase with inflation.  There is some correlation with interest rates since investors will want a better return for their money when interest rates climb and higher rates make it harder for people to afford a loan, but in general bonds and real estate don’t move in lock-step, meaning you real estate portfolio may be up when bonds are down or vice-versa.

A final good source of income are Master Limited Partnerships (MLPs).  These typically own things like oil and gas pipelines and generate lots of cash.  Energy prices will also climb with inflation, making them a good inflation hedge.  The downside si that the tax treatment can be very confusing, even in an IRA.  It is well worth an hour with a CPA before buying into these to make sure you won’t be filing a dozen state income tax returns.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Beware the Jerk – How The Stock Market Trades on the Acceleration of the Economy

Ben Bernake, Chairman of the Federal Reserve,  was saying that by easing up on bond buying they would be easing off the accelerator rather than hitting the brakes on the economy.  Despite these assurances, the market has tanked, wiping out returns from June and May in two days.  The trouble is that the stock market trades on the acceleration of the economy rather than the velocity.  Changing interest rates may only effect earnings growth slightly, but this can have a big effect on the stock market which prices stocks based on expected future earnings.

In physics the rate of change in distance per unit time is velocity.  If you drive 50 miles in one hour, you have a velocity of fifty miles per hour.  The rate at which velocity changes is acceleration.  For example, something falling will go from zero feet per second to 32 feet per second over the period of a second, so the acceleration due to gravity is 32 feet per second per second, or 32 ft/s^2.  The rate at which the acceleration is changing is called “the jerk.”

A stock will be priced based on the expected future return of a stock.  This means that if earnings are expected to increase, the price will increase.  It is the rate of change, rather than the actual earnings, that causes the price to change.  The change in price occurs as soon as the earnings increase is expected and then generally will stay at the same price range with minor fluctuations due to trading and other factors so long as the earnings expectation remains the same.  Earnings are the rate at which money is produced, which is like the rate at which a distance is covered.  It is therefore like the velocity of money.

The rate of earnings growth is then like the change in velocity, or the acceleration.  A stock will be priced based on the rate of earnings growth.  If growth rate changes, the price will change as well.  A price change will occur rapidly when the jerk is non-zero – when the rate of growth of earnings changes. 

This is why we are seeing the stock market swoon despite Bernake’s assurances that they are just easing off the accelerator.  People know that interest rates will increase when that happens.  That will make money harder to get and make companies pay more to borrow money.  Both will cause earnings growth rates – acceleration – to slow.  The jerk is therefore negative, so the markets have reacted negatively.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.