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When going short goes badly wrong

News that the Federal Trade Commission is poking its nose into the company Herbalife probably had investor Bill Ackman jumping around on his desk, with his fists clenched and his eyes squeezed shut, going "Yesssssss!"

Ackman is a big-time investor who has made a billion-dollar bet (actually $1.2 billion) against Herbalife. He's like a gambler at a race track putting a huge chunk of money on a horse to not finish the race. Ackman's argument is that the horse (Herbalife) is such a busted up old nag that it will drop dead before it reaches the finish line. Herbalife, he says, is a pyramid scheme and a parasitic business model that simply can't sustain itself. The company, he argues, will eventually drop dead, and anyone who has invested in it will lose all their money.

Ackman's opponents say that he's more like a gambler who has made a huge bet, and is determined to make it pay by bad-mouthing the horse. Ackman, they say, has been publicly smearing the company for the last two years in order to drive the stock down.

Patrick Curtis, of WallSteet Oasis, puts it like this: "Ackman's money-making strategy is called short-selling.  He has effectively borrowed $1.2 billion worth of Herbalife shares and sold them. If the price of Herbalife shares fall, he can close the transaction by buying and returning the shares at a lower price and pocketing the difference.  For example, if the value of the Herbalife stock that Ackman sold dropped by $500 million (or about 40%), then he would be able to close out the position for $700 million and profit roughly $500 million (excluding fees and borrowing costs). "
 
Curtis says it's important to note that Ackman does not own the shares after the transaction is closed.  He never owned them and when he buys and returns, it's all done through an intermediary, such as a brokerage house or bank in one step.
 

Unfortunately, things haven't gone quite so smoothly. Instead of going down, the stock's price has risen. By more than 50 percent. Ackman is now, in trader parlance, "out of the money," which means if Ackman had to return the shares he owes today, he'd end up ...

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Mar 13, 2014

What is wealth? A tutorial

Mar 6, 2014
A lot of people think that wealth is money. But that's only half the story.
Posted In: wealth, explainer

Nice assets, Bill! Gates is the richest man in the world. Again.

Bill Gates is "The Richest Man in the World." Again.

In its latest list, Forbes pegs his net worth at $76 billion. Net worth is just another way of saying wealth, where wealth = assets - debt.

Debt is pretty simple – it’s what you owe. Assets, meanwhile, are what you own.

Assets can be a bit confusing, though, because sometimes debt can be an asset.

Confused? Here's a short video explaining what assets are.

So what are Bill Gates' assets?

The vast majority of Gates' money is invested. Through his Cascade Investment Fund, he's put money into both private and public companies  – about 17 percent is sunk into Microsoft.

It's hard to value those private companies, because they're not publicly traded, so you can't say what Gates' holdings are worth until he actually sells them, or they go public. The public companies, like Microsoft, can be valued, and that's where Gates has seen the biggest gains. And there's some cash, of course. Gates gets $250,000 each year for serving as a director on Microsoft's board. And there are the dividends that he earns on many of the public company shares that he owns. Maybe he uses that money for household expenses, or maybe he plows it back into his investment fund. Or maybe he just leaves it in the bank, and takes advantage of one of the easiest money makers in the world: compounding.


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Mar 3, 2014

The magic of compounding: An explainer

Feb 27, 2014
Compounding is one of the best tools out there to build wealth.
Posted In: compounding, interest

Why a digital King is crushing it in the casual gaming biz

King Digital Entertainment makes the popular and addictive "Candy Crush Saga" smartphone game. And Tuesday the company said it would parlay that success into an initial public offering -- of up to $500 million on the New York Stock Exchange. But if you thought "Candy Crush Saga" was the only bullet in King's revolver, think again:

  1. In the last decade, King has created 180 games.
  2. The company's most popular games, aside from "Candy Crush Saga," are "Pet Rescue Saga," "Farm Heroes Saga," "Papa Pear Saga" and, my own personal favorite, "Bubble Witch Saga."
  3. Together, those games account for 248 million daily game plays. ("Candy Crush Saga" accounts for 1,085 million daily game plays.)
  4. "Candy Crush Saga" has been the highest-grossing game app on iTunes, Facebook, and Google Play, but the company's other games have hit No. 5 on iTunes, No. 3 on Google Play, and No. 4 and No. 7 on Facebook.
  5. In December 2013, an average of 128 million daily active users played the company's games more than 1.2 billion times per day. That means if just 10 percent of users paid $1 a day to get to the next level of the game (or whatever), the company would have booked nearly $13 million a day.
  6. King made a $568 million profit in 2013, up from $8 million in 2012. That’s profit, not earnings. Peck on that, tweety bird.

 


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Feb 18, 2014

We're borrowing more. And yes, that's a problem

Numbers out today from the New York Fed show that we're once again veering into dangerous territory when it comes to borrowing.

It's not so much that we're borrowing more – although the numbers are a bit staggering – it's that the people that are borrowing, are much more likely to fail to make their interest payments or pay the money back.  

Here's the data: The New York Fed's fourth-quarter Household Debt and Credit Report says aggregate consumer debt increased by $241 billion in the quarter, the largest quarter-to-quarter increase since 2007. More importantly, between the fourth quarter of 2012 and the same period a year later, total household debt rose $180 billion, marking the first four-quarter increase in outstanding debt since 2008. And we all remember what happened that year.

Up until recently, overall debt has been falling. But it has turned around this quarter because young people and people with poor credit are borrowing more, by taking out mortgages and ramping up their credit card use. That's the first problem. The second problem is that those same kinds of borrowers are continuing a long-term trend of getting loans to buy cars and go to college.  As the New York Fed puts it:

"There’s been a tremendous amount of attention to the growth of student loans in recent years, and these charts [above] indicate some of the reason why. First, student loans grew the most of any debt product in both periods (in percentage terms). Second, the growth in educational debt, like that of auto loans, is concentrated among the lower and middle credit score groups."

In other words, we're borrowing more, which is juicing the economy. But the loans are risky, which means we may be storing up troubles for the future.


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Feb 18, 2014

How borrowing money can create wealth: Explainer

Feb 5, 2014
There are a million get-rich schemes out there, but here's one of the oldest: borrowing.
Posted In: borrowing, debt

Today's numbers: good news in disguise

Today we had a slew of numbers for December: personal spending; personal income; consumer confidence and  - the Fed's favorite - the core personal consumption expenditures price index.

Spending was down. Boo.

Prices were up. Boo.

Income was flat. No change there, then.

Consumer confidence was down, although not as badly as people had expected. Yay, I guess.

These indicators provide a pretty accurate picture of the economy right now. And they hang together in a way that numbers often do not. I mean, if prices go up, and I can't get a raise, I'm probably going to spend less money and you can bet I'm going to complain about it.

So this means the economy still sucks, right?

Well, maybe not. Spending was down very little, and in fact the number was better than economists had expected. So we're still buying stuff, which is important in our ridiculously consumption-focused economy (never mind we paid for all that shopping by dipping into the piggybank: savings are down and falling).

What about those price increases? Well, they were only slightly higher, and in line with expectations. And it's not necessarily a bad thing that we're seeing some inflation. Marketplace's David Gura recently quoted David Blanchflower, the Dartmouth College economist, saying at the moment, for the economy, a little bit of inflation is our friend, not our enemy. Or, as Matt Boesler put it over at BusinessInsider, inflation reports are the new jobs reports.

So this is going to sound weird – but pray for prices to keep rising. Just a wee bit.


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Jan 31, 2014

What investors love about the Treasury's new toy - it floats!

The U.S. Treasury rolls out a brand new toy today. Now, we're talking about the Treasury here, which means the toy is a kind of bond, but investors are excited for a couple of reasons. It's the first new product the Treasury has released in years, so there's a novelty appeal. And, unlike all of the rest of the Treasury's products, this toy floats!

Q. OK, you've got me intrigued. What is it?

The new product is a so-called "floating rate note," with a maturity of two years. A note is essentially the same thing as a bond, but under a different name. Any Treasury debt that has an "intermediate" maturity of 2-to-10 years gets the name "note."

Q. And why are we hearing about it now?

Treasury needs a floating rate because it wants to raise more money, and this kind of debt will attract a different kind of investor. Also, some investors are worried about buying too many Treasuries right now because Treasury bonds, notes, and bills come with fixed interest rates. And that means they lose value when inflation kicks in, or if interest rates go up (which they almost certainly will). A floating-rate note offsets those problems.

Q. I'm following. But all this stuff can be so complicated. Does this thing work?

Picture, for a moment, a peaceful bay in the Caribbean... Ah, yes.

Now watch the tide: it goes in and out, which means that in the center of the bay, the distance between the surface of the water and the sandy bottom beneath is constantly changing.

What's that floating in the middle of the bay? A pirate ship! With a real, live pirate!

The pirate is hanging out in the crow's nest, which is 250 feet above the surface of the water. But his elevation above the sea bottom changes with the tide.

He's floating, in other words -- at a fixed distance from the water, but a varying distance above the sea floor.

A floating-rate note works in the same way. The interest rate on the note is like the pirate in his crow's nest. It floats a fixed amount above a reference rate, which varies constantly. It goes up and down, just like the distance between the sea bottom and the water's surface as the tide goes in and out. The reference rate goes up? The interest rate rises a fixed rate above it. The reference rate goes down, and the interest rate lowers accordingly.

The reference rate can be anything that is based on a market rate. Sometimes it's the prime rate; sometimes it's the infamous LIBOR; sometimes it's the federal funds rate.

Floating rate notes are a great investment -- if you think interest rates are going to rise. Say you buy the note when it pays 2 percent above LIBOR. If LIBOR is 1 percent, you're making 3 percent. If LIBOR increases to 2 percent, suddenly you're making 4 percent. Awesome!

With interest rates at historic lows, interest rates are pretty much bound to rise. Good news for inv ...

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Jan 29, 2014

Why the trouble in emerging markets isn’t the end of the world

Yes, the U.S. stock market fell out of bed on Friday (and still looks bruised today) as the selloff in in emerging markets hit lemming-like proportions, but just because the Dow got dinged is no reason for us to panic.

So what happened in emerging markets last week?

Basically, investors decided to pull out a lot of the money that they had parked in those economies. They had bought a bunch of stock; last week, they decided to sell it.

Why was all that money in emerging markets in the first place?

There’s a rule of thumb in finance: Money always flows to the place where it will make the biggest return for the smallest risk. Emerging markets are usually seen as pretty risky, but because of the low growth, the low interest rate environment we’ve been in since the financial crisis, investors were having a hard time finding investments that would make money. So they got creative, and money flowed to places that investors usually fear to tread, such as junk bonds and emerging markets.

OK, so why sell now?

Well, money has been flowing out of emerging markets for quite a while now, but the outflows peaked last week for a couple of reasons. First: Reports that China’s economy may be weakening. Concerns about the country’s debt levels had the bulls pulling in their horns, because China is such a big trade partner with many emerging nations. Then, there’s speculation about U.S. Federal Reserve reducing its bond-buying program: The program has been such a stimulant to emerging markets that investors worry that if it is reduced too far too fast, it could stunt those economies’ growth. Investors worry that the end of the program means a stronger dollar (which hurts countries reliant on external financing), and higher interest rates (which will make it more attractive to invest in places other than emerging markets).  

Where did all the money go?

It’s hard to say. It certainly didn’t flow into the U.S. stock market, as we saw. Instead, investors looked as though they sought refuge, probably opting to hold cash and buying U.S. Treasuries, which did see a lift last week.

How can you be so complacent about the fact that these economies are melting down?

OK, I don’t mean to be complacent: This is bad news for these economies, and market volatility is never a good thing, for anyone. But the affected economies are not exactly “melting down” at this point (well, maybe Argentina). They are seeing some pullback in investment, which is not good for their growth, and they will experience some short term pain, but it doesn’t necessarily follow that the US will suffer terribly as well. For one thing, their problems do not appear to pose a systemic risk, in the way that the Asian Fi ...

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Jan 27, 2014

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