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Market Buzz - Basic Principles to Help Protect Your Portfolio from Accounting Fraud & Financial Trickery PDF Print E-mail
Written by Ryan Irvine: Keystone Financial   
Monday, 21 April 2014 17:55

Screen Shot 2014-04-21 at 5.57.13 PMWhen we think of investor fraud, many of us will automatically conger images of infamous stories such as Enron and WorldCom. More recently, we have seen several examples on our own TSX and TSX Venture exchanges of managers inflating or even outright falsifying performance and assets at the expense of unsuspecting investors. The latest example comes from the once highly-touted, Poseidon Concepts, who just Thursday reported that $95 million to $106 million of the $148.1 million in revenue for the nine months ended September 30th should not have been recorded as revenue. Poseidon which had hit an all-time high of $16.87 in the first quarter of 2012 was cease traded today at just $0.27. Whether this particular example was one of outright fraud or just gross incompetence is questionable but it is a classic example of how disastrous these scenarios can be for investors. While fraud can be very difficult to identify in foresight, if we adhere to a few fundamental rules, we can substantially reduce our susceptibility to the dangers of financial trickery and mismanagement of fiduciary duty.

Follow the Cash Flow

We have long been proponents of limiting investments to profitable companies. But when people hear the word profit, they automatically think of net earnings. The problem is that net earnings are an accounting figure and can be subject to manipulation. Cash flow on the other hand, is less subject to misstatement. Often we will see companies that report a history of net profit on the income statement but routinely fail to generate cash flow on the cash flow statement. A significant and prolonged differential between accounting profit and cash flow is an indication of poor earnings quality. While this does not necessarily indicate outright fraud it should be viewed with skepticism.

Invest In What You Understand

The greatest investor of all time, Mr. Warren Buffet, routinely discusses his adherence to the “simple and understandable business” tenant as fundamental and to his investment strategy. He will not invest in any company that he does not fully understand. At times (notably during the dotcom bubble) he has been criticized for missing opportunities, but in the long run his focused discipline has made fools of his critics. More than just the business, it is also important to understand the financial statements. Highly complex financials with nebulous accounting items make it easier for unscrupulous managers to hide facts or inflate figures.

Don’t Overexposure Yourself to Speculative Regions

In the recent past, we have seen fraudulent activities and scandals uncovered in companies whose base of operations are in emerging markets – notably China. There are two issues at work here. One is that in emerging markets, the regulatory framework and oversight has not had as long to develop as it has in the developed world. Secondly, when a company’s operations are located entirely in emerging market, it makes it more difficult for our regulators to monitor them effectively. We are not trying to say that fraudulent activities are exclusive to emerging markets – they absolutely are not. But we do believe that structurally there is a greater chance that fraud can be developed and concealed at a larger magnitude and longer amount of time in the emerging world. For this reason, we strongly suggest that investors confine the majority of their activities to developed regions.

Read the Footnotes

Many investors, and even analysts, confine their analysis strictly to the financial statements (income statement, balance sheet, and cash flow statement) and ignore the financial footnotes. However, the financial footnotes, which are typically provided after the financial statements, provide a wide range of information and clues about the assumptions and policies used by management (e.g. revenue recognition, depreciation and amortization policy, treatment of derivatives, off balance sheet items, financial covenants, etc). Understanding the information beneath the headline numbers makes those numbers more meaningful and allows the investor to develop a better comparison amongst companies in the same industry. It is also a little known fact that if a management team is trying to hide a piece of information then they will probably put it in the middle or at the end of a long document. Remember… if these notes are impossible to understand then maybe you should question whether or not this is a company you want to invest in.

Diversify your Stock Holdings

For most typical investors, diversification may be the best defense against fraud. The fact of the matter is that fraud does exist in the world of investing and it can be extremely difficult to uncover. By spreading your capital amongst a group of quality companies that adhere to these principles you substantially reduce your susceptibility to both fraud and poor financial performance. This is not to say that we think investors should over diversify into dozens of companies. Such a strategy could make your portfolio unmanageable. But we do strongly suggest that you hold enough companies so that your overall success does not hinge on one or two individual stocks – no matter how good they may look. 

KeyStone’s Latest Reports Section






2nd Most Viewed Article of the Week - How I Intend to Survive the Meltdown of America PDF Print E-mail
Written by Louis James   
Saturday, 19 April 2014 07:17

It is with a troubled heart that I look at the continued fighting in eastern Ukraine. I worry about my friends and students in the country who may well be in physical danger soon, if the conflict escalates. As an investment analyst, it’s the financial war the Russians seem quite willing to wage that has my attention.

It should have yours as well.

In our just-released documentary, Meltdown America, one of the experts noted that the Kremlin had already made moves to dethrone the US dollar as the world’s reserve currency before the renewed East-West tensions of this year. Putin has openly threatened what amounts to economic warfare as a response to sanctions placed on Russia after its Crimea grab.

Now bullets are flying—can Putin’s financial ICBM be far behind?

Mind you, the US and global economies are on such shaky ground, they could come crashing down without any help from Gospodin Putin.

One of the things that really struck me while watching Meltdown America was the way the writing was clearly visible on the wall in past cases of financial collapse and hyperinflation—but no one wanted to believe it.

That’s the way I see the US today. Life seems so normal and there’s so much wealth even in poorer regions, it’s hard to believe the cracks in the foundation could really bring down everything built on it. And that’s exactly why the cracks never get fixed; people don’t want to see them, and politicians do everything possible to deny they exist. So they widen and deepen until the collapse becomes inevitable—and I believe we have already passed the point of no return.

It’s just a matter of time now.

Gloomy thoughts indeed, but I’m not here to depress anyone. Hopefully, I can help deliver a wake-up call. Perhaps even more useful, I can tell you what I’m doing about it.

Of course, precious metals and the associated stocks are a key part of my strategy. As Doug Casey likes to say, I buy gold for prudence and gold stocks for profit. If I’m right about the economic trouble ahead, gold will protect me, and my gold stock picks will make me a fortune.

But Doug also says that our biggest risk today is not market risk; it’s political risk. He has moved to rural Argentina to get out of harm’s way. I’ve moved to Puerto Rico, a US territory that is rapidly becoming the only tax haven that matters for US taxpayers.

Million-Dollar Condos for Half Price

As I type here in my new home office, I glance up and see waves of Caribbean blue crashing on the palm-lined beach. Surfers are out in force. Scattered clouds add to the already amazing variety of colors in the ocean. I wonder if I will have time to go for a swim before dinner—and I’m amazed yet again to think that it was a shot at lower taxes that brought me here to Puerto Rico.

It seems almost unnatural for me to be able to enjoy so much beauty while saving money, but that’s exactly what I’m doing.

the view

The view from my new home office.

You see, the economy here never really recovered from the crash of 2008. This is very bad news for long-suffering Puerto Ricans trying to make ends meet. When I first came here with my wife to check the place out, locals kept asking us why we were thinking of moving here; jobs are scarce, and something of an exodus is taking place in the opposite direction (Puerto Ricans are US citizens and can travel and work freely anywhere in the US).

But I wasn’t coming to Puerto Rico to sell hot dogs. My income doesn’t depend on the local economy, so its woes are an obvious opportunity for a contrarian speculator like me.

Take the most simple and basic asset class one can invest in as a Puerto Rico play: real estate. The market has been so devastated that million-dollar condos are selling for half price. When we closed on our new place, the seller came up short, and we had other options, so we weren’t willing to pay more. The real estate agents involved were so eager to keep the deal from falling through, they kicked in with their own money to help the seller out.

Personally, I’m not a big fan of gated communities, but for people who are concerned about possible social unrest in the future, it’s good to know that you can buy properties in some of the most posh and secure communities on the island with no money down.

Now, as much as I like a contrarian bargain, and as much as my wife loves the tropical weather, what really brought us here were the new tax incentives the government of Puerto Rico enacted to make the island more attractive to investors and employers.

The critical point here is that Puerto Ricans are exempt from US federal income taxes, even though they are US citizens. They pay Puerto Rican taxes, of course, and those have generally been similar to US taxes, so the island has never been seen as a tax haven before. That all changed in 2012, when Puerto Rico passed Acts 20 and 22.

Act 22

Act 22 is basically a 100% capital-gains tax holiday designed to attract investors to come live in Puerto Rico. Exactly what is included or excluded is beyond the scope of this article, but for me, the important thing is that it covers the stocks I already owned when I moved here on January 1, 2014. Given that the market bottomed at almost the same time, I have no gains to be taxed on for 2013, and will not be taxed for the gains I make going forward—all the way to 2036.

This alone was worth the move to Puerto Rico, in my opinion.

Happily, the application process was simple. My wife downloaded the form and filled it out. I signed it, and a couple weeks later, we got an official tax holiday decree in the mail—no questions asked. I had to accept the conditions of the decree in front of a notary and send in an acceptance form with a $50 filing fee, and that was it. Didn’t even have to hire a lawyer.

This tax break is not available to current residents of Puerto Rico—it’s designed to attract wealthy people to come live on the island, after all—but it’s available to all others who move here, including but not limited to US taxpayers.

Act 20

Act 20 is a tax break on corporate earnings designed to incent job creation in Puerto Rico. The idea is to persuade US employers who might set up call centers in India, or create other similar jobs abroad, to do so closer to home, by offering them a 4% corporate earnings tax rate.

My fellow Casey Research editor Alex Daley has moved to Puerto Rico as well, and we’ve formed a company here that exports writing and analytical services to Casey Research in Vermont. This is the basis of our application for Act 20 tax benefits, which has not been approved yet, but which we understand is close.

If we get our Act 20 decree approved, we’ll still have to pay regular income taxes on our base salaries, but the lower tax rate applied to our corporate income will result in a drastically lower total income tax rate for us as individuals.

I’ll be sure to let readers know when we get our Act 20 decree approved.

All 100% Legal

The beauty of this is that Puerto Rico’s tax breaks are not shady tax dodges set up by entities of questionable legality or trustworthiness, but perfectly legal tax incentives within the US.

Act 20 and Act 22 benefits are available to non-US persons, but they are especially important to US taxpayers because, unlike almost every other country in the world, the US taxes its serfs citizens whether they live in the US or abroad.

In other words, while a Canadian can get out of paying Canadian income taxes by moving out of Canada, a US person cannot escape US taxes by moving to Argentina, or anywhere else—anywhere besides Puerto Rico.

It’s like expatriation without having to leave the US, truly a unique situation.

And it’s a win-win situation; people like us bring much-needed money, ideas, and energy to the island, while getting to keep more of what our crisis-investing strategy nets us. We create jobs, rather than take them. We are part of the solution here, and we’ve been made very welcome.

Is It Safe?

So that’s why I’m here. Whether or not my Act 20 status gets approved, I’m so happy about my Act 22 decree that I’m convinced we did the right thing moving here.

When I tell people what I’ve done and why, most get immediately excited by the idea—and then they balk. The first question they ask is usually: What about crime?

Puerto Rico isn’t a large island, and a good chunk of its three million inhabitants are clustered in and around the capital city of San Juan. Of course there is crime here, as there is in any large city. There are places I would not walk alone at night—just as there are in New York City.

Mexico City, Buenos Aires, La Paz… the capital of any other Latin American country or Caribbean country I’ve been to is much larger, more polluted, and more dangerous than San Juan. In my subjective view, San Juan, with its old Spanish fortifications and amazing beaches, is more beautiful. And you can drink the water here.

Sure, it might be cleaner and safer in Palm Beach, Florida—but it’s a lot more expensive there, it has less charm, and there’s no Act 20 nor 22. It’s a matter of priorities.

When I say this, most people remain skeptical; they read about the economic problems Puerto Rico has and the financial trouble the government is in, and they wonder if things could get worse.

Of course they can—but if Doug is right about The Greater Depression about to envelop the whole world, things are going to get worse everywhere.

Here at least, people are already used to massive unemployment. It won’t come as a shock; it’s never left since 2008.

Another way of looking at it is that since tropical storms hit the island from time to time (southern Florida is much more prone to major hurricanes than Puerto Rico, but they do happen), people here are more prepared for disasters than in many other parts of the US. The better apartment buildings and hotels have their own electricity generators. Nobody can freeze to death here, anyway, and fruit trees grow all over the island.

There’s a lot more I could say, but the bottom line is that I think Puerto Rico is a much better place to ride out a global financial storm than Miami, or Anchorage, or almost any city in between. A self-sustaining farm in rural Alabama might be better, but that’s not the sort of place I want to live.

I Like It Here

That last is an important point: if I have to hunker down to ride out an economic storm, it should be in a place where I like being.

Puerto Rico is beautiful and bountiful year-round. I speak Spanish, but most people in San Juan are bilingual, so that’s not really an issue. Our new flat is blocks from the best schools, shops, and restaurants in town—and even the hospital.

I open the window and the fresh air coming off the ocean carries the sound of waves, sometimes laughing children. There’s more noise pollution during the day, but at night, the city calms down, and we can hear the famous Puerto Rican coquí frogs, which my daughter calls “happy frogs.” Ten floors up, the ocean breeze is cool enough that we have yet to turn on the air conditioning.

The beaches are fantastic, and the clear water makes for great diving. I’ve never been a surfer, but the waves here are famous too, so I’m thinking of trying it out. There’s no end of other things to try out, and the neighboring islands have their own charms to offer as well.

Granted, my wife and I try to be smart about what we do and where we go, but we’ve never felt unsafe here—well, apart from the crazy drivers.

We like it here. We’re happy. For tax reasons, for quality of life, and with the potential meltdown of America in mind, we’re glad we made the move.

Find Out More

Doug Casey’s International Man Editor Nick Giambruno, Alex Daley, and I have coauthored a special report on Puerto Rico’s stunning new tax advantages. The report gets into all the details I didn’t have time or space for here. We cover all the specifics of what, why, and how. The report includes links to the forms you need, as well as recommended resources, from lawyers to realtors.

Whether you’re thinking about expatriating or you’re just tired of paying high taxes, I think Puerto Rico is a place you should consider. I know of no better resource to help you get started than our special report.

For your own health, wealth, and enjoyment, I encourage you to get your copy today.

The article How I Intend to Survive the Meltdown of America was originally published
5 Wall Street Insider Tips To Multiply Your Dividends PDF Print E-mail
Written by Michael Vodicka - Dividend Opportunities   
Thursday, 17 April 2014 07:04

imagesIn all my years in the market, I've never heard of such an incredible track record.

The IPO prospectus from high-frequency trading firm Virtu Financial reveals that in the past four years, the company has lost money in exactly one of 1,238 trading sessions.

J.P. Morgan didn't have a single losing day in 2013. Bank of America notched a perfect performance of its own in the first quarter of 2013.

Clearly, Wall Street trades and invests its own money a lot differently than the "buy and hold" strategy it preaches to its clients.

One of the best-kept secrets they use is selling options.

Does that sound scary? Intimidating?

If it does, there's a very good reason for that: That's exactly how Wall Street wants it.

Wall Street works very hard to keep one of its most powerful income strategies out of the hands of regular investors.

Because what most investors don't realize is that selling puts isn't just one of the most conservative options strategies... it's one of the lowest-risk investment strategies in the entire market -- more conservative than owning individual stocks and bonds or even mutual funds and ETFs.

The conservative strategy of selling options is driven by a fact you might find shocking: About 80% of options expire worthless. That means whoever sold those options gets to keep the full premium collected as income from their sale 4 out of 5 times.

And these aren't small premiums. They're annualized yields of 36%... 47%.... even 87% from well-known, trusted companies like Microsoft (Nasdaq: MSFT) and Verizon (NYSE: VZ).

Despite Wall Street's best efforts, well-informed investors are embracing selling options as an important source of portfolio income. In fact, this is what we do every week in my premium newsletter service, Income Multiplier.

But deciding to sell options is only half the battle. Learning how insiders increase their returns and win ratios is the other. That's why I'm sharing these 5 insider tips that provide a basic framework for understanding how Wall Street insiders increase the probability of winning trades.

1. Only sell options on stocks you want to own.
Selling a put offers two potential outcomes.

The first is that the options expire worthless and the put seller keeps the entire premium generated from the sale. This is a powerful income strategy and the most desirable outcome when selling an option because we keep this premium as pure profit.

The second potential outcome is that shares of the underlying stock fall below the strike price on the date the option expires. This obligates the put seller to take ownership of the shares.

Although that's a low-probability outcome, it's the reason why it's so important to sell options only on stocks you actually want to own. In the event that the put seller is put shares, you want to own a great company with plenty of long-term potential that will quickly rebound from a temporary pullback.

2. Avoid long-dated expirations.
All options contracts have an expiration date. Some options expire every week; other options expire after several years. Options that are dated far into the future have a higher premium value because a longer time allows significant price swings or unexpected events to occur. That could be a macroeconomic event (like a recession) or a company-specific event, such as earnings falling short of expectations.

Conversely, options that expire in just a few weeks or a month are much less susceptible to price fluctuations. Think of this like a baseball player hitting a bunch of singles and doubles as opposed to an occasional home run with lots of strikeouts.

3. Sell puts more than 5% out of the money.
Every options contract carries a probability of expiring worthless. Some options contracts have a 90% probability of expiring worthless; others have a 50% probability. It all depends on the variables of each individual contract.

One of the biggest factors impacting the probability of a worthless expiration is an option's strike price. Options with strike prices that are far away from the underlying stock's current share price have a lower probability of assignment than those with strike prices that are close to current prices.

Selling puts with strike prices more than 5% away from the current share price greatly increases the chances that the puts you sell will expire worthless.

4. Diversify.
Regular stock investors should always diversify their portfolios. Holding stocks from different sectors and regions of the world is a great way to reduce volatility and short-term price risk. Stocks from different sectors and industries tend to have a lower correlation with each other.

That same concept of diversification holds true for selling options. As an options seller, it's important to avoid highly concentrated positions in sectors, stocks or themes with a high correlation. This reduces the probability of one single event triggering assignments on multiple open put positions.

5. Don't increase the size of positions too quickly.
This is the No. 1 mistake made by new options traders. It's also a familiar theme across any asset class. A novice investor experiences great results early in the game with a new investment strategy. Gaining confidence, the investor begins to quickly ramp up the size of their position, increasing risk significantly. When the size of the investor's trades has grown out of proportion to the value of the account, one small miscue can have serious implications.

This is a recipe for disaster. The value of any individual put-selling position should be calculated as a percentage of overall account value. That makes actual results and the growth of an account the primary drivers of position size as opposed to a bout of short-term confidence driven by a bull market.

The unprecedented track records that Wall Street trading firms are racking up are due in large part to successful strategies like these.

But I think it's time that regular investors got in on the wealth-building opportunities that these traders are so set on hiding from the public.

In my premium newsletter Income Multiplier, I'm showing readers my research each and every time I sell a put option, and we're seeing annual yields on our trades that make regular dividends look meager by comparison. As I mentioned earlier, we're talking 36%... 47%... even 87%. To learn more about how easy it can be to multiply your income, I'd like to invite you to watch a special presentation I've prepared. Simply follow this link to learn more.

Good investing,

Michael Vodicka
Chief Investment Strategist
Income Multiplier

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