Harry Newton - 8:30 AM Tuesday, December 2, 2003: The sales charge tells you a lot about the nature of the business and the motivation of the promoter. I'm looking at a new real estate syndication deal I received yesterday from Brookwood. The upfront sales commission is 9%. That means if I give them $100,000, I only get $91,000 of real estate. And that doesn't include the annual property management fees of up to 5% of the revenues, plus some other fees I don't understand. It seemed to my commission-weary pocketbook like a bit much. But my friend in real estate told me the Wells group -- the largest real estate syndicators in the country -- have routinely charged as much as 17%.
Once you see numbers this high, you begin to look at your interests versus those of the promoter and wonder if they're at all aligned. Clearly his "business" is the up-front sales commission. His motivation is here and now. His business is promoting deals, irrespective of their cost. He has a serious incentive to pay too much for the building -- which Wells often has done, according to industry gossip. His returns are immediate. In contrast, yours are long-term. You want decent returns for many years. What incentive does he have to manage your money well for the long-term. The obvious answer: Very little.
These days, with Wall Street's greed stratospheric, you have to look at the fees before you even look at the deal. And you'd better learn all the words for sales commissions. For example, mutual funds call them loads. Buy $100,000 in a mutual fund with a front-end load, you might easily lose 5% in sales charge (called load) and end up with only $95,000 in stocks. Loads may be up-front or back-end or along the way. Some funds charge up front. Some charge nothing up front, but charge you if leave the fund or its family of funds in under seven years. Mutual funds often have many "classes" of shares they sell you -- all of which charge huge sales commissions. The difference is when you get hit -- up front, in the middle, at the end, etc. But you typically get hit.
The problem with many "investments" is that the paperwork you get is often unclear on what all the fees may be. My rules are threefold:
1. Check the fees first.
2. If I still want in, I'll negotiate the fees. Everyone cuts sales commissions -- if you ask.
3. I'll check what management is investing alongside me.
My wife believes that she gets what she paid for, i.e. the more she paid, the better it is. All the studies show this doesn't apply to investments. Mutual funds that charge more don't perform better. Hedge funds that charge even more than mutual funds don't perform better than mutual funds. High sales commission real estate has performed far worse than low sales commission real estate.
Gretchen Morgenson took at swing at mutual fund fees in this Sunday's New York Times. She wrote, "Now that investors realize that their interests do not always come first with their mutual fund managers, perhaps they will focus on the sky-high fees they have been forking over for years. It has not been easy for investors to fathom exactly what they are paying in fund fees. In fund prospectuses, the fees charged to investors are stated as a percentage of assets. At around 1 percent a year, these costs look positively benign.
In dollar terms, however, the fees are staggering. And when the managers receiving them turn in a woeful performance, as has been the case recently more often than not, the fees represent an enormous and troubling transfer of wealth from hard-working individuals (i.e. you and me) to some seriously fat cats.
So how much did investors pay to stock and bond fund managers in the most recent 12 months? More than $35.2 billion, according to Max Rottersman, president of FundExpenses.com, a research firm that analyzes fund costs for institutional clients. That represents 0.86 percent of assets in these funds. ... And the total does not include sales charges on broker-sold funds.
Mr. Rottersman breaks the fees into four groups. The largest is adviser fees, which totaled $21 billion or 0.52 percent of assets. Other fees, including the self-serving 12b-1 charges fund companies use to attract new money, totaled $9.2 billion, or 0.23 percent of assets. Shareholder servicing fees added $5.6 billion, or 0.14 percent, and custodian fees brought in $537 million, or 0.01 percent.
So, apart from being a ridiculous sum to pay for subpar performance and chicanery, what is $35.2 billion? It is roughly equivalent to the gross domestic product of Ecuador. It is $3 billion more than what American consumers spent on major household appliances last year. What else does $35.2 billion buy? It would pay for the nation's entire food stamp program this year, as well as all the child nutrition programs run by the government.
The numbers at specific funds are equally astounding. Over the three fiscal years ending in March 2003, for example, investors in the Fidelity Magellan fund, which has not been implicated in any scandals, have paid management fees of $1.6 billion. Yet in each of those years the fund lost money: it was down 24 percent in fiscal 2001, and it lost 0.76 percent in 2002 and almost 25 percent in 2003. (The stock market has recovered since March, when the fund's fiscal year ends, and it is now up 18 percent for the year to date.) Over 10 years, Magellan investors have paid $4 billion in management fees, Mr. Rottersman said. Yet the fund has lagged behind the Standard & Poor's 500-stock index through that period. ...
"The public needs to understand the enormity of these numbers," Mr. Rottersman said. "When you're paying all this money to mutual fund companies, you're working for them; they're not working for you."
The extreme risk of low-price, low cap, speculation: "The Force" sometimes doesn't last long. In yesterday's column, I gloat that on Wednesday I bought a stock called 8x8 Inc. (EGHT). By the end of the day, the thing had risen 33% above what I paid. By Friday's close, I was up a cool 48%. Clear proof of my financial genius.
Poof, end of genius. On Monday, the New York Post runs a negative story and 8x8 plummets. I sell instantly. In hindsight, I should have sold Friday. I was busy, or lazy, or both. Fortunately I sold it above what I paid. I still made a profit, but less than had I sold on Friday. The lesson is threefold:
1. Things come out of left field. It's good to take a little profit along the way.
2. When things do come out, get out fast. The stock will likely continue falling as the word of the disaster gets around.
3. Don't get back in quickly. Once The Force is gone from a stock, it's unlikely to return for a long while.
Out of curiosity, here's yesterday's article from the New York Post. It adds logic and analysis to where only momentum and "The Force" existed beforehand:
December 1, 2003 -- HERE at Curmudgeonly Arms, where news from beyond the moat arrives seasonally at best, the castle's crippled manservant, Yorick, recently dragged his club-footed and withered left leg up the stairs to the writing garret in the north tower.
Placing a crumpled news article on the desk, he retreated from the chamber in his hunched-over and groveling way, muttering, "Heh, heh, another victim, sire." Of course, as he always does when angling for a laugh, the man missed the top step (that Yorick!) and went tumbling head over heels down the tower's winding and windowless staircase.
Alas, poor Yorick, I paid him no mind, absorbed as I already was in the reading matter he had brought me, for it suggested an exciting new way for investors to lose money in the current, frothy stock market.
The idea: Buy shares in a obscure and struggling California outfit called 8x8 Inc. - which plans to take on corporate giants like Verizon, AT&T and many of America's largest cable companies simultaneously by selling "all you can eat" phone calls over the Internet. Viewed from the north tower of C.A., 8x8 Inc. seems to be emerging less as a real business than as a gambler's bet that the company will be taken over by a larger rival before the money runs out and the business collapses.
Meanwhile, investors have been going nuts over the stock. Back in February, the shares were selling for a mere 17 cents, and were still trading for barely 50 cents as recently as August. Yet by Friday they were changing hands at prices as high as $8.06 before ending the day at $7.52.
At that price, the shares have gained 4,323 percent so far this year, making 8x8 Inc. far and away the hottest Nasdaq stock of 2003, sporting a market value of $232 million for a business with just 53 employees and top-line revenues of less than $10 million per year.
In most cases, the market value of a company like 8x8 Inc. amounts to a statistical fiction. That is because of the way the market value of a company is calculated - by multiplying the price of its stock in the open market by the total number of shares issued and outstanding.
Since trading in these companies typically amounts to just a few thousand shares a day, whereas the total shares outstanding could run to the tens of millions, it makes no sense to claim that the quoted market price reflects what one would get if all the company's shares were offered for sale.
But 8x8 is different. The company may not be worth much more than the cash on its balance sheet - about 30 cents per share at latest look. But plenty of investors think otherwise, with the result that real money is pouring into the stock and millions of shares are changing hands daily.
On Friday, trading volume in 8x8 reached a record of nearly 23.5 million shares, or 75 percent of the company's total shares outstanding, making it the second-most active stock on Nasdaq, behind Microsoft.
The stock is hot because the tech sector itself is hot, with the Nasdaq composite rising 52 percent in value since its trough of last February, vs. a gain of 32 percent for the blue chip Dow industrials since the average touched its own 2003 bottom a month later.
Such frothy markets invariably breed "concept stocks" that investors begin chasing in hopes of catching the next market leader. This is how investors wound up with stocks in bagel companies - and companies in the plastic tampons business and the backrub business and what-have-you - during the last bull market.
Now, the "voice over broadband" business has become the tech sector's hot new "concept," and 8x8 has emerged as the sector's Pet Rock.
According to one recent article, getting the service up and running takes "less than five minutes" and is so simple to accomplish that even my grandmother could do it.
According to the company's Web site, you start by sending away for a "DTA 310 handset-to-Ethernet desktop terminal adapter." (That's where my grandmother bows out.) Next, you hook up one end to your phone, and the other end to your "home router or gateway." And that's where I bow out. (Did you see that word "router"? That's the Anglicized variant of the French verb routié, which means "to ruin your whole weekend.")
Finally, you switch your phone service from ATT (or Verizon or whatever), and start making those unlimited phone calls to anywhere in North America for $19.95 per month (or to anywhere on earth for $49.95).
But wait. What if you make all those connections just as you're supposed to - from the thingamajigger to the whatchamacallit, and finally to the routié - and then pick up the phone to place that first blow-your-mind phone call over the Internet, and there's no dial tone? How are you going to call tech support?
In reality, "voice over broadband" isn't a business any more than "faxing" is a business. It's just an activity that can take place over an existing communications network. In fact, if any money at all can be made from "voice over broadband," the cable companies that already operate the networks are in the best position to try; they at least already know who their customers actually are, and how to reach them most effectively and inexpensively.
A number of cable companies are getting into the game already. Cablevision Corp., which has one of its big fat black wires running right through a wall of Curmudgeonly Arms, now offers an unlimited calling plan for voice-over-broadband service at $34.95 per month, and other cable companies are looking at similar deals.
What's more, it is ridiculous to think that the phone companies are just going to watch their customers disappear. If residential subscribers begin migrating to cable-based telephone services, the phone companies will do as they've been doing all along for years now and simply keep cutting prices to cling to their market shares. And in a race to the bottom, 8x8 cannot win.
THE company has had an auditor's "going concern" warning on its financials for the last year, and is currently raising money through stock-and-warrant private placements - a desperation move if there ever was one.
One need look no further than the company's latest quarterly financial report, for the three-month period ended Sept. 30, to see the problem. Nearly 90 percent of this company's revenues come not from the voice-over-broadband gimmick at all but from supplying chips and software to the videoconferencing market - a business that is apparently not doing well. The 10Q says that most of the revenues for the segment are coming from non-recurring licensing deals.
In reality, revenues from the voice-over-broadband business totaled a mere $214,000 in the September quarter, resulting in a negative gross margin of 45 percent. Throw in the rest of the corporate overhead allocable to the segment and the business generated four dollars of losses for every one dollar of revenue.
There's also a puzzling little item in footnote No. 5, which discloses that the company's chairman, a fellow named Joe Parkinson who in an earlier lifetime was a founder of Micron Technologies Inc., gets to day-trade $1 million worth of the company's cash - apparently to help beef up the balance sheet.
Yet the company's cash flow statement shows negative cash flow of $802,000 from "short term investments" and "trading activity" over the last six months, so maybe Joe's talents as chairman lie elsewhere than day trading.
In any case, 8x8 Inc. may be this year's hottest stock on the Nasdaq, but I doubt that any investors holding the shares this time next year will be laughing very much. And speaking of laughs, is that poor Yorick I hear moaning at the bottom of the stairwell? Let's hope the Rottweilers don't mistake him for a Democrat."
The economy is roaring back. Good News for the stockmarket: Manufacturing in November showed the most robust activity in two decades, lifting employment in the sector higher than expected, reported yesterday's Wall Street Journal.
"The Institute for Supply Management, a private research firm, said Monday that its index of manufacturing activity rose to 62.8 last month from 57 in October. Providing solid evidence of an improving manufacturing jobs picture, the ISM employment index climbed to 51 from 47.7. The last time the employment gauge was above 50 was September 2000. Readings of at least 50 point to strong growth in the industrial sector, which has lagged behind other sectors as the economy digs out of the recession that started in 2001. Economists had expected the industrial index would rise to 59, according to a survey by Dow Jones Newswires and CNBC.
Calling the survey results "astonishing," Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd., said the latest reading is consistent with year-over-year growth in gross domestic product of about 7%. He added that the employment survey suggests "the three-year run of industrial job losses will soon end." Meanwhile, construction spending increased 0.9% in October as still low mortgage rates drove residential home building to unprecedented levels. Big gains were registered in public projects as federal and state governments have ramped up spending.
Overall construction spending rose to a seasonally adjusted annual rate of $922 billion, the highest level on record, from an upwardly revised $913.5 billion in September, the Commerce Department said Monday. Private residential construction spending rose 2.2% to a record $484.1 billion. .. "
Success in the book business. The DaVinci Code book has sold 4.3 million copies in the United States alone -- all in hard cover. This is phenomenal. It could become the largest-selling novel ever. The record is held by is The Bridges of Madison County. But DaVinci Code may top Bridges. Estimates for DaVinci are for 6-7 million copies in the U.S. alone. The movie rights on DaVinci Code were sold for around $10 million. I figure the author, Dan Brown, stands to make $40 million in royalties from the U.S. alone. Yes, you can get rich writing the Great American Novel.
Erase all the bad evidence. They're advertising a piece of software called Total Cleaner that makes it difficult for your boss or your spouse to figure out where you've been. I'm not ashamed of where I've been. But it's interesting to see what Total Cleaner does -- which you can do manually:
+ Erases Secret Windows Files
+ Erases Windows Temp Directories
+ Erases Recent File List
+ Erases Recycle Bins
+ Erases Browser Cookies
+ Erases Favorites list
+ Erases Browser history
+ Erases Run File History
+ Erases User Selectable Directories
+ Erases History Logs
+ Erases AOL Go-To History
+ Erases AOL History
+ Shreds Files so they can't be undeleted
Impeccable Logic:
Shapiro walks into work one day at nine, half an hour late.
His boss is furious. "You should have been here at eight-thirty."
"Why?" says Shapiro. "What happened at eight-thirty?"
Rothschild is traveling through Minsk and stops for breakfast at a small cafe. When he is finished, the waiter hands him the bill.
"Twenty rubles for two eggs," shouts Rothschild, "That's impossible. Are eggs so rare in these parts?"
"No," replies the waiter. "But Rothschilds are."
Harry Newton
I make my daily column (Monday through Fridays) freely available for three reasons: First, writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I'm hoping some of you will send me your investing concerns. To email me, Click here mailto:Harry_Newton@TechnologyInvestor.com
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