Tip: When Engaging in Insider Trading, Be Discreet!

Evidently a Hong Kong couple thought the rest of the world was asleep. Listen to what they did before their brokerage accounts were frozen, preventing them from pocketing an estimated $8.2 million. Tell me if you think their broker, Merrill Lynch (MER), might catch on that something was a bit suspicious.

In early April the couple's account was worth $1.2 million, consisting of mostly fixed income and commodity investments, along with a small position in Intel (INTC) stock. All of the sudden, they wire $10 million into their account and borrow $5 million on margin to buy 415,000 shares of Dow Jones (DJ) for an average price of $35.14 per share.

Just days later Dow Jones gets a $60 cash offer from News Corp (NWS) and the couple tries to sell all $23 million worth, netting a profit of $8 million. How on earth do people really think Merrill Lynch isn't going to notice this? Regulators often do investigations after M&A deals are announced to try and uncover illegal activity, but this case was handed to them on a silver platter.

It will be interesting to see what happens to these people. I hope they get the book thrown at them. Perhaps a copy of the insider trading laws would be a good start.

Full Disclosure: Long Intel $10 2009 LEAPs at the time of writing

Dow Winning Streak Longest in 80 Years

It has truly been a breathtaking run, with the Dow Jones Industrial Average rising in 24 of 27 sessions, the longest streak since eight decades ago in 1927. Unfortunately, Tuesday's four point drop snapped the streak. How should investors play this? Many are stuck between two prevailing ideas, either ride the momentum to ensure not missing it, or wait for a pullback and buy on the dip. The problem is, there aren't any dips. We got a 7 percent correction a couple months ago but it was so short-lived that many didn't have time to get back on the train before it left the station again.

I am sitting on an above-average amount of cash right now, due to an overbought market that I am uninterested in chasing, coupled with a seasonal inflow of deposits. Since I'm a value investor, not a momentum trader, I am content with sitting on cash and waiting for an excellent opportunity. With the broad market rallying so strongly, such a dip might only occur in select names, as opposed to a widespread sell-off that makes many stocks compelling.

Why not just get my money in when short term momentum is strong? There are far fewer bargains now than there were six months or a year ago. Although I might miss some upside in the short term, due to above-average cash positions during a long winning streak, I still believe that buying dips and not rallies will prove to be more profitable when we look back a year from now.

The result could be lagging returns in coming days and weeks, but when we get another pullback and I have the ammunition to jump at true bargains, those purchases will more than likely make up the lost ground and plenty more over the intermediate to longer term.

I'm Not Holding My Breath for a Dell-RadioShack Deal

I get a kick out of some of the ridiculous deals that are rumored on the Street. Did anyone really think Sears Holdings (SHLD) would buy Anheuser Busch (BUD)? The latest story comes to us from Business Week, speculating that Dell (DELL) could buy RadioShack (RSH) in an attempt to reinvigorate its business after Hewlett Packard (HPQ) has kicked their butt for a while now.

How does this rumor get published? There is no evidence whatsoever that Dell would even consider buying an electronics retailer. Did RadioShack shares really jump 6% Monday on this story? It's insane. Remember the Gateway Country store concept? Huge bust. That was nearly as bad as waltzing into large corporations trying to sell computers in cow boxes.

The current market environment is very conducive to spreading M&A rumors. After all, the sheer volume of deals right now is astounding. That said, don't put stock into the stories that don't really make any sense. If you are looking to sell some stock, use these temporary bumps to sell into the rumors if you don't think they have merit. A client of mine did that with BUD when merger rumors surfaced, and it proved to be the top in the stock.

I didn't sell any RSH Monday into the rally, but that is because I like the stock for other reasons, not based on a silly buyout rumor. If anyone was going to buy RSH, you'd think it would be Sears, not Dell.

Full Disclosure: Long shares of RadioShack and Sears Holdings at time of writing

Renting versus Buying a House - A Contrarian View

I'm often posed with the question, "Given that interest rates are low, why shouldn't I buy a house instead of throwing money away by renting?" In recent years, buying a home has been all the rage. With interest rates around 6% for a 30-year fixed mortgage and the housing market booming, I've been amazed at how many people who have no real need for a house (young singles) have bought one.

As someone in the investment management business, whenever I am asked my opinion about buying a house, I look at it from two perspectives. The first one ignores the financial aspect (assuming the buyer can afford the home) because if you are getting married and starting a family, there are reasons to buy a house that have little to do with return on investment or anything like that. However, for those single people out there who don't have a true need for a house of their own, I suggest looking at the possible purchase as an investment and running the numbers accordingly.

I have made many spreadsheets for people to determine if buying a house makes sense financially. In the vast majority of cases it does not, as you can usually earn a higher return investing in a bank CD (let alone the stock market) than you can on a house, even after considering the benefits (mortgage interest deduction) and the costs (insurance, maintenance, taxes). The exceptions are cases where you rent out spare bedrooms and that cash flow covers a large chunk of your mortgage-related expense.

As a result, it is baffling to me when people will choose to take money out of their high yield savings accounts, investment accounts, and even their IRA or 401(k) plans in order to fund a house purchase. The common reason given is "renting is just throwing money away." While this sounds logical (your rent check isn't going toward the purchase of any asset), you have to look at it from a return on investment point of view.

A Smart Money article published last Wednesday entitled "Why Rent? To Get Richer" outlines the case for renting very well. I suggest those of you faced with the "rent versus buy" dilemma give it a read.

Full Disclosure: No position in a house at the time of writing

Gordon Gekko Coming Back?

The movie Wall Street starring Michael Douglas as a greedy corporate raider in the 1980's is a classic and although two decades old, it appears the film will be making a comeback. According to a New York Times source, Gordon Gekko is back. Edward Pressman, the producer of the original film, has signed on to make a sequel entitled Money Never Sleeps. Other movies have tried to duplicate Wall Street's success, Boiler Room comes to mind, but none have really been able to do so. Sequels are rarely as good as the original, but this project is definitely something that has the potential to be a pretty solid film.

Microsoft and Yahoo! Have Little to Lose in Tying the Knot

There are plenty of reasons why the rumored deal that would have Microsoft (MSFT) acquiring Yahoo! (YHOO) for $50 billion is not a good idea. In general, large tech deals rarely work. The history of failures is very long; Compaq-HP, AOL-Time Warner, Symantec-Veritas to name a few. Company cultures in Silicon Valley are typically very hard to mesh. Going from evil competitor to lifelong companion doesn't happen overnight too easily. In fact, for AOL Time Warner it never worked. The two sides hated each other from the start and the result was, according to many, the biggest failed merger of all time.

Add to that Microsoft's preference against big deals and an outright merger of the two companies seems pretty unlikely. Not to mention a price of $50 billion is outrageous and would be extremely dilutive. However, given where they both are right now, I can't help but think that there would be nothing to lose. Sure, the odds are high that the deal would never bear the kind of fruit that the optimists would hope for. But that doesn't mean it is a bad idea.

From Microsoft's perspective, they are probably shocked that despite having a near monopoly on the computer desktop, they still have yet to become an integral part of the user's online experience. Windows and Office represent nearly all their profit. An inability to smoothly integrate their desktop applications and online applications is a huge failure on their part. Instead, people are using Google (GOOG) and other software to manage their online activities and search for content they need. You can certainly argue that just adding Yahoo services won't necessarily change that, but perhaps the two sides working together can be more successful at turning Internet Explorer users into money-making customers.

From the Yahoo angle, they are obviously trying hard to regain some of the market share they have lost to Google. Combining with Microsoft would give them more reach and added capability to try and regain their relevancy. The potential of a Microsoft-Yahoo! team is obviously overwhelming.

Given the history of failed tech mergers and difficulty integrating vastly competitive corporate cultures, there are certainly reasons to believe that Microsoft and Yahoo! together would be no more adept at boosting their online presence than the two firms were able to accomplish alone. That said, I have to think that they have very little to lose by giving it a try. The worst case scenario, in my mind, would be no progress. And who knows, just because something is difficult doesn't mean it is impossible.

Talks of any kind are clearly in the early stages, so it's way too early to speculate on a deal happening, despite the move in Yahoo stock today. At this point I'd put the odds of a deal at no better than 50/50 but if I were advising them, I would make sure they thought long and hard about it. If they just dismiss it as joining with the enemy, which appears to be how talks between the two sides have gone in the past, it could be a missed opportunity to eat into Google's lead.

Full Disclosure: Long Google and short Yahoo! at the time of writing

Could the Bancroft Family Reject a 67% Premium for Dow Jones?

One of the things I look for when picking stocks is high insider ownership. The logic goes that you want people running the company you own to have their interests aligned with yours. Who is more likely to act in the interests of shareholders, someone with a guaranteed salary and bonus or someone with a large stake in the company and performance-based compensation?

However, few companies do fact have high insider ownership, so finding examples that fit the bill can be difficult. If a CEO gets options that are priced below market and vest immediately, he or she will likely sell them right away and not see any meaningful ownership maintained for the long term.

In the case of media company Dow Jones (DJ), you have very high insider ownership (the Bancroft family controls 64% of the voting rights), so you might think they have shareholders' interests at heart. However, we get news that News Corp (NWS) has offered $60 per share for DJ, a premium of 67 percent, and yet reports have surfaced that the Bancrofts may be prepared to vote against the deal.

How on earth can the Bancrofts reject a $60 cash offer when their stock is trading at $36 per share? Isn't that a huge disservice to DJ shareholders? Don't they have a fiduciary responsibility to take the deal? Legally, probably not. They can vote their shares any way they want. Other shareholders should have been well aware that the family has been against a buyout for years, and should have taken that information into account when they made the choice to invest in the company.

Although the Bancrofts have every right to reject the offer, they should do the right thing for their other shareholders. They should take the company private. If you want to keep the company in your family, as it has been for more than 100 years, that's fine and very understandable. However, when you are part of a public market, you do have a responsibility to your fellow shareholders. It might be legal, but it is absolutely unfair to DJ investors if you reject a $60 offer for shares that the market says are only worth $36 each.

The "low-ball offer" defense won't work here. If you want to make financially irrational decisions, then take the firm private and run it any way you want. If you want to open the company up to outside investors, then make sure you treat your shareholders with respect. You own the stock, so it's your choice which road to go down, but it's unfair to try and have your cake and eat it too. People invest in public companies to make money. If you make it impossible for them to do so, then you shouldn't be in the public marketplace in the first place.

Full Disclosure: No position in any of the companies mentioned

Finding the Next Starbucks - Part 3 - Compound Interest

"Compound interest is the eight wonder of the world." - Albert Einstein

The above quote leads off chapter two of Michael Moe's book, "Finding the Next Starbucks: How to Identify and Invest in the Hot Stocks of Tomorrow." Although we learn about compound interest and the Rule of 72 in our high school math class, sometimes it takes some financial related calculations later in life to really drive the point home, enough so that it will have an effect on our saving and investment habits during adulthood.

Moe uses two compound interest examples that are worth repeating here. Although both cases are impossible to be recreated in the real world today, the dramatic numbers should at least intrigue people enough to run the numbers on their own individual financial plans. The results will still most likely be surprising for many of you.

Example #1

Purchase price for Manhattan Island in 1626 by Dutchman Peter Minuit: $24

Value today if invested at 5.0% annual rate of return: $2.7 billion

Value today if invested at 7.5% annual rate of return: $20.7 trillion

Value today if invested at 10.0% annual rate of return: $128.7 quadrillion

Example #2

You have landed a consulting job for the month of January. Your temporary employer has given you the option of earning $10,000 per week or earning $0.01 on the first day and having your daily pay double each day thereafter for the remainder of the month. Which payment plan should you choose?

Earn $10,000 per week for the month = $40,000

Earn $0.01 on first day, double every day = $21.5 million

While these examples are meant to be fantasy, not reality, compound interest is still a very important concept to consider when you are contemplating your saving and investing plans.

This post is the third in a multi-part series discussing the book Finding the Next Starbucks. You may read Parts 1 and 2 in the series below:

Finding the Next Starbucks - Part 1

Finding the Next Starbucks - Part 2