TRANSCRIPT: Navigating Today’s Volatile and Unpredictable Market w/ Hedge Fund Trader, Kevin Logan

Announcer: It’s time for Marc Lichtenfeld’s Oxford Club Radio, the hardest-hitting half hour about you and your money. And now, here’s Marc Lichtenfeld.

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Marc Lichtenfeld: Welcome to Marc Lichtenfeld’s Oxford Club Radio. I’m Marc Lichtenfeld. We have a big show for you today. Today is our 200th show. We’ve been on the air for almost four years. Amazing. And this is show No. 200. So thank you to everyone who’s been listening with us. If you’ve been with us since the beginning, I would love to hear from you. So shoot me an email. Go to OxfordClubRadio.com, click on “contact,” where you can tweet at me on StocksNBoxing. And thanks to everyone who has participated, all the guests – Curtis Daniels, who runs our board, Colleen Hill, Alex Moschina, everybody who’s helped with the show over the last 200 episodes. It’s been a hell of a ride so far.

Today we have another great show. We’re going to talk with our first guest that we ever had on the show, Kevin Logan, who’s a principal with Occasio Partners hedge fund out in San Francisco, and a guy who’s been trading the markets for 20 years, really knowledgeable.

We’re going to be talking a little bit about how the market doesn’t seem to be responding to what’s happening out in the rest of the world. We’re just kind of stuck in this very narrow range, slowly grinding higher. And it feels like a very, very different market than what we’re used to. And so we’re going to talk about what that all means and what it means for the future. Is this something that’s going to continue, or could the wheels come off when there is a change? So we’ll talk with Kevin about that.

One real quick statistic before we move on: Friday was the 89th trading day in a row without a 1% drop in the market. That is amazing. That is a really mind-boggling statistic. So we’re going to talk with Kevin about all that and what it all means. That’s coming up in a bit.

We’re also going to get into a question that a reader of Wealthy Retirement asked me, and Wealthy Retirement is one of the websites I write for. He had a question about payout ratios and whether a dividend is safe. So we’re going to talk about that because that’s a really important concept for dividend investors, knowing whether your dividend is safe.

And lastly what I want to get into is a story that broke on Friday, and it’s a Florida man. And anytime a story starts with “Florida man,” you know it’s going to be a good one. Because all the crazy stories come out of Florida.

So a Florida man has been charged with making over 10 explosive devices that he was planning to put on shelves of Target stores along the East Coast. And the reason may surprise you. The reason he was going to try to have explosions go off at Target wasn’t because of some deep hatred that he had of Target. It wasn’t to try to kill and maim as many people as possible. In fact, he told someone that the person who eventually turned him in that these wouldn’t kill anybody. They were too small. But they could hurt somebody. They could “take off a hand,” as he put it. But they weren’t going to kill somebody. So it wasn’t going to cause massive destruction and mayhem.

The reason he was going to put these explosives in a Target was because if these bombs went off, he thought the price of Target shares would come down and he’d be able to buy the stock more cheaply. I kid you not. That was his reason for attempting to put bombs in Target stores. And then his rationale was that the stock would come down, he’d buy it more cheaply, but this was a minor incident, and then the stock would rebound.

So a couple of things here for this sophisticated trader here that jumped to my mind. First of all, as I tweeted on my Twitter account at StocksNBoxing, I totally get it. It’s tough to find value in these markets today. I mean, it’s hard to find a cheap stock. So I know where he’s coming from. But in all seriousness, Target stock is already down 25% in the past year. So maybe he could have gotten it a little cheaper but it’s pretty cheap already. So I don’t know. I don’t think this guy is the next Buffett or Soros as far as his financial analysis.

The other thing too is why wouldn’t you just buy some puts, rather than buy the stock? I guess maybe he wanted the dividend… he wanted to get in the stock cheap, get the dividend, hold it for the long term. I guess he’s a long-term value investor. So you can’t fault him for that. But maybe his methods were a little unorthodox, we should say. But just a crazy story.

It does kind of emphasize the fact that in today’s market, if you want value, you do have to find some beaten-up stocks. Especially dividend payers, there’s not a lot of value out there. You’ve got to find some stocks that have a little hair on them. I mean some of the names that I’ve recommended in The Oxford Income Letter are things like Gap, Mattel, Omega Health Investors, all these stocks you have to be patient with. You have to be ready to expect a turnaround and be content to sit there and collect a decent yield. I mean, you don’t buy these stocks without getting some kind of a payoff in the immediate term.

So you buy the stocks to collect a sizable yield in the anticipation that they will turn around. And you need to have a reason to believe that it will turn around, and not just because 10 small bombs went off in the store and so things will return back to normal. You need to have a better reason than that. That’s usually not a good basis for your thesis on why you’re buying a stock, let’s put it that way.

But in all seriousness, it’s tough to find value these days, and you do need to be patient with your value stocks today. If you’re getting into new stocks today, these are long-term projects. You’re not going to buy a stock, mostly likely at a 10 P/E, and see it go up to a 15 P/E within the year unless there’s a major catalyst. But generally you’re talking turnaround stories that take a year, two, even three years to happen. So if you are investing in a value stock and you are anticipating some kind of a big turnaround in a company, make sure you’re getting paid for that. Make sure you’re getting a 3%, 4%, 5% yield in order to wait that out and see this company turn around.

All right, when we come back we’re going to talk with Kevin Logan, principle at Occasio Partners. This is Oxford Club Radio, I’m Marc Lichtenfeld. Stay tuned.

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Announcer: And now back to Marc Lichtenfeld’s Oxford Club Radio.

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Marc Lichtenfeld: Welcome back to Marc Lichtenfeld’s Oxford Club Radio. I’m Marc Lichtenfeld. We are knee-deep into show No. 200, and I thought what better way to celebrate show No. 200 than with bringing on our very first guest, way back when, in 2013: Kevin Logan, who’s principal with Occasio Partners. Kevin, thanks for joining us. I’ll bet you didn’t realize you were our first guest, and you’ve been on several times and here we are at show No. 200.

Kevin Logan: I did not know that, and congratulations on 200 shows. That’s great.

Marc Lichtenfeld: Thank you very much. And so yeah, I wanted to bring you back on since you helped us get things started way back when. And we’ve talked over the years… you’re one of the best traders I know. You’ve been in the markets for 20 years. And one of the things that jumped out at me – and you were actually the one who pointed it out to me yesterday – was that as of Friday, we’re at 89 days without a 1% pullback in the S&P 500, which is an amazing statistic.

And then you added a comment, saying, “You’re telling me that’s human emotion?” meaning that is human emotion, greed and fear, still a factor in the market? Or is it all the algorithmic trading? So what’s your take on this? Do individual investors, or even institutional investors who are not using algorithms, do they have an impact on the market anymore?

 Kevin Logan: It’s starting to feel that way. I think I’ve heard a stat that 80% of the volume is program trading these days. And it all goes in the computerized trading, which I think is just taking away the human emotion of the markets. I mean, a great example is what you’ve just stated: 89 days without a 1% pullback? I mean, that’s unheard of, especially considering the political landscape and what’s going on overseas and all the different earnings we’ve had out in the past six weeks, and now to have a 1% pullback for almost three months? I mean, it’s just unheard of.

 So the only way I can point to the rationale is that the human emotion’s been taken out and literally it’s just computers trading against each other all day. And it sure seems that way when you study the tape all day like I do.

Marc Lichtenfeld: So what does that mean for the future if the vast majority of trading is these computer programs? How does an individual investor think about the markets going forward, and could something turn on a dime? Could these algorithms start selling and make it very, very difficult for investors?

Kevin Logan: I would think so. I think another factor is the huge popularity of ETFs, which have become super popular for not just retail, but also institutional. I think that goes back to the computer trading-type situations. And I think more and more retail is getting involved in the ETF. There’s so many of them now that I think the future for the retailers is what we’re seeing right now: They’re just going to be, you know, auto-programed into ETFs and build a big basket, and then hopefully the market takes care of them.

But the problem is if these ETFs ever get big redemption calls or whatnot, I think you can see a real dislocation in the market because I don’t think we’re prepared for something of that manner yet.

Marc Lichtenfeld: Do you think it would be something like a flash crash or something longer lasting?

 Kevin Logan: I mean, it’s hard to say. If I had to guess, basically the guess would be more of a flash crash-type situation like we’ve seen. I just think, you know, like everyone says, all software has a bug somewhere, and all we need is this small little bug in all these computerized trading programs that causes something to go wrong, and all of a sudden you get this real crazy move. That doesn’t mean the market’s going to crash and the economy is going to go to zero, it just means that with all these computerized programs basically fighting each other all day there is room someday for a pretty large error, in my opinion, at some point. But that could be five years away; it could be five days away. That’s pretty hard to guess.

Marc Lichtenfeld: So is that something that you prepare for at all? I mean, do you have – I’m just throwing around an example – like deep, out-of-the-money puts just as an insurance policy, basically, on this type of event? Or is it something you’re not especially worried about in the near term?

Kevin Logan: I mean to buy puts and just wait for something bad to happen I think is a pretty easy way to lose a lot of money, unless you get really lucky on your timing in it. And that is luck. So no, to answer your question, there was nothing I have planned. You keep your eye out and you keep your eyes open to see some interesting moves, especially watching the VIX, which is the fear index. I watch that very closely to see if there’s any kind of big spike that might be telling you that something unusual is happening.

 But no, I mean believe me, anybody who’s been buying puts for the past three months has lost money on the S&P for sure. So I’m not sure that’s a great strategy.

Marc Lichtenfeld: We’re talking with Kevin Logan. He’s principal with Occasio Partners.

You mentioned the VIX, which is a measure of volatility. And the VIX is at extremely low levels, which seems like a real disconnect with what’s going on in Washington, as you alluded to earlier. What do you think is going on here? Is the market not appreciating the volatility in Washington? Or is the market perhaps signaling as a forward-looking mechanism that perhaps things aren’t as bad as they may appear, or not as volatile as they appear in Washington?

 Kevin Logan: I think right now the market’s focusing more on fundamentals. Some good earnings have been coming out, low interest rates, accommodative Fed policy. I think they’re, for whatever reason, ignoring the political craziness going on right now in the White House and whatnot. And that’s not a view of politics. I mean, I think everyone would agree we’re seeing a period of politics like we’ve never seen before in terms of language and tweeting and bizarre press conferences and whatnot. And you would think that, again, this goes back to the human emotion, that the humans would be looking at that and going, “Oh my God. This is crazy. We have to do something here.” But the markets have totally ignored our current politics. And I just find that very interesting. And I think that goes back to how we’re just almost 100% computerized trading and the humans aren’t even involved anymore, which sounds crazy, but it sure feels that way.

Marc Lichtenfeld: So can humans make money in a trading environment that’s dominated by algos?

Kevin Logan: Yes, it’s just harder. I mean – and this is my opinion – it’s a lot harder because you look at the basics and you look at some – like you see oil dropping harder or you see the VIX maybe spike a little bit and you think, “Okay, that’s going to affect the markets. That’s going to affect the S&P. That’s going to affect oil stocks.” And it doesn’t. The correlations have seemingly gone away, which in terms of trading makes it very hard. But it doesn’t mean it’s impossible, just that you have to adapt and find some ways to make money. It’s doable, it’s just harder.

Marc Lichtenfeld: I want to ask you about a comment that President Trump made the other day. He tweeted, “Stock market hits new highs with longest winning streak in decades. Great level of confidence and optimism, even before tax plan rollout.” To me, that smacked of something that is said at a top. Did it concern you at all?

 Kevin Logan: Yeah, I mean I found it interesting, considering how much the market moved up under President Obama. And then he’s in office for I think a month and he’s kind of claiming how rich the market is. But no, I mean it’s interesting for sure, and the market has gone down since then very slightly, but it would be pretty ironic and somewhat funny if you’re a trader – at least if that was the market short term. But I guess we’ll see about that.

Marc Lichtenfeld: We only have a very short time left, but I did want to ask you if there are any sectors that you particularly like right now or don’t like.

Kevin Logan: The fiber optics sector is exploding. It’s made a nice move. And I think it’s a cheap buy down here, but you’re looking this morning –Networks is up, gee, 19% on blowout earnings. Sierra Wireless has been blowing out its earnings. So you’re really seeing some really strong momentum in that sector. I think the future for there is pretty strong, although there’s already been some pretty big moves in the names.

Marc Lichtenfeld: All right, so we’re going to leave it there. We thank you very much for being our first guest and our 200th guest. Kevin Logan, principal with Occasio Partners.

 Kevin Logan: Thank you, Marc.

Marc Lichtenfeld: All right, we’ll talk to you soon. When we come back, we’re going to talk about how to make sure your dividends are safe with a very well-known ratio, but I look at it a little bit differently. This is Oxford Club Radio, I’m Marc Lichtenfeld. Stay with us.

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Announcer: And now back to Marc Lichtenfeld’s Oxford Club Radio.

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Marc Lichtenfeld: Welcome back to Marc Lichtenfeld’s Oxford Club Radio, show No. 200. I’m Marc Lichtenfeld. So I want to talk about something that is still very confusing to a lot of people, and it was brought to my attention this week when I wrote an article for Wealthy Retirement. And I write on Wealthy Retirement every week. It’s WealthyRetirement.com. It’s absolutely free. Feel free to sign up if you’re not signed up already. Again, absolutely free.

So there’s a column that I write on Wednesdays called The Safety Net, which is where I analyze a stock that is submitted by our readers for their dividend safety. I’m analyzing the safety of the dividend. And one of the key things that I use is the payout ratio. And the payout ratio is typically the percentage of earnings that are paid out in dividends. So if a company made $100 million and it paid out $60 million in dividends, the payout ratio would be 60%. So that’s the concept.

And as logic would have it, you don’t want a company paying more in dividends than it’s earning, because then it has to get the money somewhere else. It either has to dip into cash on hand, it has to raise money. You want the dividend to be self-funded by how much money the company’s making. So that’s the basics of the payout ratio. It’s a very simple concept.

But I put a little twist on it. Back when I was an analyst on the sales side and was studying for the exam… and I knew how to read financial statements, and the three main financial statements are the income statement, the balance sheet and the statement of cash flows.

I had never really spent a lot of time on the statement of cash flows and I had one of those “a-ha” moments when I was studying the statements of cash flows for this exam, this licensing exam. And it just kind of all made sense to me, and I was thinking, “This is the statement that’s the most important financial statement for a company. It’s not earnings. I’ve talked about this before on the show, and I’ve written about it, but there’s still a lot of confusion for some people.

Earnings have all kinds of non-cash expenses in them. So for example, let’s say a company makes $100 million but it has $10 million in depreciation. Okay, depreciation is a non-cash expense. It doesn’t actually cost you any money. No money went out the door in depreciation.

So if a company earned $100 million but had $10 million in depreciation. Well, now earnings are down to $90 million. Now let’s say it has another $10 million in stock-based compensation. So it didn’t actually give any cash to anybody, no cash went out the door but it gave its employees shares of stock. So another $10 million in stock-based compensation. Well now that’s $80 million in earnings because you had $100 million in earnings minus $10 million for depreciation, $10 million for stock-based compensation. You’re down to $80 million in earnings.

So if a company had dividends of $60 million and its earnings were $80 million, the payout ratio would be 75%. But that earnings does not represent the cash that the company earned because, again, you have these non-cash items. Also there are adjustments made for accounts receivables and accounts payables. So what the cash flow statement says, what it determines is how much cash the company brought in the door in that quarter or in that year. That’s what counts.

Because when a company makes a sale… let’s say that it sells a widget on December 15 and that bill is payable within 30 days. That sale is chalked up as a sale as if money came in the door, and it trickled all the way down to the earnings. But it didn’t receive any money. It did not get a dime for that sale. It got paid, say, 30 days, later, January 15, the next quarter, the next year. So the cash flow statement will reflect that. The cash flow statement in the first year will reflect that the cash did not come in the door, and that it did in the second year.

So when I look at the payout ratio, I base it off of cash flow, not earnings. And that’s different from the way most people look at it. And the reason this whole thing came up was because on Wealthy Retirement I was looking at a company called Apollo Commercial Real Estate Finance and I said the payout ratio was 65%. And then people did their own homework on the stock and they said, “Well, Morningstar and Yahoo Finance say it’s 130%.” And they were right if you’re looking at earnings, which is what Yahoo and Morningstar and most mainstream sites and most analysts look at because it’s a very simple concept: how much money did the company earn and how much did it pay out in dividends.

But if you want to understand if the company really brought in enough cash to pay that dividend then you need to look at the cash flow number. And it’s not a difficult number to determine. Instead of looking at earnings, just go to the cash flow statement, which again, Morningstar and Yahoo Finance, all these mainstream sites do have the financial statements for most companies. Just go to cash flow and if you want to make it really simple, cash flow from operations, and use that number versus dividends. Or if you want to really kind of dig into it, then you look at cash flow operations minus capital expenditures, which is the equation for free cash flow, and that’s kind of like the bottom line number for how much cash the business generated. So that’s what I look at.

And that’s why there’s confusion when sometimes I will publish a payout ratio that’s very different from what you see on the websites because I want to know… I don’t care what depreciation was and I don’t care what stock-based compensation was and if a company brought in a sale on December 15 but didn’t bring in the cash, that doesn’t help me determine whether the company can pay the dividend because that cash didn’t come in in December and yet it’s paying out the dividend in December. And sometimes, you know what? Sometimes bills don’t get paid. Or sometimes items get returned. Or sometimes companies stuff the channel, which is borderline fraud and sometimes crossing the line for fraud. Well, they will get a bunch of sales, get somebody a customer or a wholesaler, get a bunch of sales so they can chalk up a big number to hit their earnings targets. And then either the wholesaler just sits with them for a while or sends it back and then, again, no cash would come in as a result.

So the cash flow is the best way to look at a company, in my opinion, for a whole bunch of reasons, including determining if any hanky-panky is going on with the earnings, any kind of fraud – a cash flow statement will be the first place where you can detect it, where if you see earnings consistently going in one direction and cash flow going the other, something isn’t right. So that’s why I look at cash flow and it helps me determine – and most importantly, from my work as the Chief Income Strategist – can a company afford to pay its dividend with cash? I don’t care about the earnings, I don’t care about all that stuff. I want to know if enough cash is coming in the door that it can then afford to send it out to its shareholders.

So that’s why I’m such a big, big proponent of cash flow. I talk about it all the time because I think it’s a really important concept to understand for investors and I think not enough people pay attention to it because earnings are so simple. Earnings are easily understandable. Cash flow is not that difficult, but it’s an important concept and earnings  get the headlines. Earnings get the mainstream. When I analyze a company for anything, dividends or not, I’m looking at cash flow.

All right, that will do it for us. My thanks to Kevin Logan, Curtis Daniels, Colleen Hill, all of you for listening. Until next week, I hope your longs go up and your shorts go down. I’m Marc Lichtenfeld.

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