How to invest in stocks for beginners: Begin investing within 30 days

There are two ways to invest in the stock market. The first way is to invest in getting the average market return of 7%, just following the S&P 500. The second way is to invest in individual stocks to outperform the S&P 500 index.
***If you have specific inquiries or anything in my post that I can help clarify, please feel free to comment or email me (TomNguyen@agarwoodcapital.com).

1. Decide if you want to put in the time to beat the stock market average returns (Week 1)

Passive investing- The goal of passive investing is to achieve average stock market returns. The average return over the last 100 years in the stock market estimates at 7% – 8%. To start passive investing, you want to buy a mutual fund or ETF representing the S&P 500. Robo-advisors or standard investment advisors provide these mutual funds and ETF.

Robo-Advisor Services
  • For Passive investors, you only need to go with low and cheap online services (i.e., Vanguard and Fidelity), Robo-advisors (i.e., Wealthfront and Betterment), or anything that has management costs below 1% of your total asset value.
    • A note about indexes: The S&P 500 represents the largest 500 companies; therefore, it’s often used as a proxy benchmark for the US stock market performance. Other indexes represent niche industries or smaller size samples. For example, the Dow Jones (DJI) isn’t a great representation of the overall stock market because it includes only 30 US companies, so it’s just a small cross-section of the thousands of companies in the market. This is the reason why the S&P 500 is used as the standard benchmark instead of other indexes.

Active investing- The goal of active investing is to pick stocks and beat the stock market average, which is the S&P 500. Active investment requires putting in the time to research and analyze both individual stocks and the overall market. In becoming an active investor (or the DIY approach as I like to call it) you will want to learn key aspects to analyze a stock and strategies to end your year above the stock market average.  

  1. Learning about an industry, company, and competitors
  2. Learning about investment strategies can outperform the average return 
  3. Learning how to read and create financial statements

If becoming an active investor is the path you want, then continue reading.

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2. Start by reading about industries and companies that’re the most familiar to you. (Week 2)

Determine a business industry that is easy for you to comprehend. The easiest industries to learn are from your profession or products you regularly purchase.

For example, an apparel company usually has simple operations. Apparel companies make clothes that offer branding value with unique design distinctions. The apparel industry is a multi-billion-dollar investment opportunity, but it is a very competitive industry. Apparel retailers can offer their goods in physical and/or digital distribution channels: take note of these differences. For example, one of my favorite apparel business is Under Armour. 

At the beginning of your active investment journey, learn general facts, and find interesting tidbits on your chosen business. Ask critical questions because if you don’t have enough confidence in your research, it could cost you your entire life savings. But don’t worry, this should be a fun process! It’s like finding the perfect ingredients for a recipe so that you have an enticing outcome! Read everything you can on the company’s merchandise, management, and business risk. It may be tempting, but for now, let’s hold off on the financial statement. We should uncover the basics about the company first. Once you have learned about the company, the financial results will make much more sense. 

Here are some initial questions I might ask about Under Armour:

  • Why is Under Amour (UA) a better investment than its competitors?
  • What makes UA better than other apparel businesses?
    • Does UA have any patents on their clothes and shoes?
  • Who manufactures UA clothes? 
    • Is there a contract or partnership from the manufacturer? 
    • Why was this manufacturer selected?  
  • Who are UA shipping partners?
    • Is UA shipping partner contract?
  • Does UA have its own stores? Why does UA have its own stores?
    • How many stores does UA have?
    • How many retail partnerships do they have? 
  • Did Under Armour ship their apparel from a warehouse, and from which warehouse?
    • How did UA decide to pick this warehouse?
    • Where were the clothes made?
  • Who designs UA’s clothes?
    • What is the designing strategy, do they create athleisure clothes or not? 
    • Who’s the design team leader, how long did they work at the firm? Do they have experience at other firms?

Notice that I did not list any financial or math-related questions. The point of this exercise is to get familiar with the industry and business. As you are learning, there will be more financial jargon and it will get more confusing. Do not be discouraged. If it is confusing, you are learning.

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3. Learn about investment strategies (Week 3)

While there are many investment strategies, the best strategy to get an above-average market return is to buy undervalued companies called value investing.

The value investing strategy provides a strong foundation for an investor to learn about other investment strategies. Value investing is a popular strategy that created many billionaire investors, to name a few, notably Warren Buffet, Seth Klarman, and Bill Ackman.

What exactly is value investing?

Value investing identifies companies with a current market price that is less than their intrinsic worth, which means the stock or company is “undervalued.”   

How do I determine the value of a stock and know if a stock is undervalued?

The discounted cash flow – this method provides the net present value by estimating the company’s future profitability to help determine the company’s values. The discounted cash flow will help provide a range of value to the entire business. 

Another way to find undervalued stocks is by using the valuation ratio. A valuation ratio shows the relationship between a company’s market value or its equity and some fundamental financial metric (e.g., earnings). The point of a valuation ratio shows the price you pay for some stream of earnings, revenue, or cash flow (or other financial metrics).

  • Price/Earnings – The historical average of the S&P 500 index P/E is 15, therefore anything under 15 could be considered undervalued relative to the historical average of the S&P 500 index. 
  • Price/Book – Price is the stock’s current market price. Book value represents what the total asset of the company is worth. So, if the price of a company is worth $100M, and the book value is worth $110M, you will see a P/B= .90 ($100M/$110M).

Not all undervalued stocks are suitable investments. Some companies may reflect undervalued but aren’t performant and stay that way. We call these value traps. A value trap will have a valuation that appears cheap, but it has risks and troubles that will cause the company to continue declining.

Understand why stocks become undervalued

  • Missed expectations and lower guidance: Shares can plunge if the company provides quarterly and annual reports that misses target earnings or provides guidance below Wall Street estimates. 
  • Market crashes and corrections: If the entire market drops, it’s a great time to look for undervalued stocks.
  • Bad news: Just like when a stock misses an analysts’ expectations, bad news can cause a knee-jerk reaction from shareholders, sending shares plunging more than they should.

Cyclical fluctuations: Certain sectors tend to perform better at different stages of the economic cycle. Industries that are out of favor are the right places to look for bargains. Again, not all out of favor sectors will ever return to normal business operations. Think about how often restaurants and the retail industry go out of business.

Tesla stock priced at $200 could be a value stock as Apple is a value stock. Investors underestimated the technology and complexity of Tesla, comparing Tesla to other traditional auto companies. Similarly, it is much like how investors compared Apple’s iPhone to the BlackBerry Rim. Investors underestimated the software, ecosystem, and design of the iPhone initially. If you could buy a $100 bill for $70, wouldn’t you jump at the chance to do so? While value investing is a little more complicated than that, this is the general concept behind finding undervalued stocks that are perfect for your portfolio. Value Investing is not the only investment strategy, but it is the most straightforward and yet the most challenging strategy to master.


4. Learn how to read financial statements and how to create one from scratch (Week 4)

Financial statements will be disconcerting to learn. If math isn’t one of your strongest skills, it will be considerably more difficult. But, most of the investment math is simple algebra. If you cannot interpret a financial statement well, don’t rush to buy stocks. Start a stock account or paper trading account with only the amount that you can afford to lose, but still assert the same spending habits that you would with a larger account. The amount of money you need to buy an individual stock depends on your investment experience and skills. 

How do you know when you are fundamentally ready to invest? 

  • Q: Can you identify seasonality in a financial statement?
  • Q: What happens to cash flow if customers are paying with credit cards instead of cash?
  • Q: How much profit does a company have to pay off its current debt obligations? 
  • Q: Can you teach someone how to read a financial statement

 

 

The Music Will Stop for GameStop

Why is there a used video game industryThe arrival and growth of the used game stores such as GameStop (GME) in the 1990s to early 2000s.
After baseball cards, the next popular collectible was used, rare, and collectible video games. The new era of internet technology helped produced video games frequently and created a robust secondary marketplace for used video games. There were many new game releases all the time which meant that customers who finished a game would be willing to trade their games for a new or used game. The reason that I brought up baseball cards in relation to the used video game industry is that both of these industries are missing official marketplaces. This results in customers being unsure if what they’re buying or selling is price efficient.

(If you want to read more about Funoland history and how it became Gamestop go here: FuncoLand History: The Company Behind Used Video Games written by Ernie Smith)

As a teen, my favorite store was FuncoLand. FuncoLand was a used video game and technology store that was named second place in Forbes’s list of the fastest growing companies in 1998. FuncoLand was the best place to buy both new and used video games. Additionally, FuncoLand had a handful of consoles in their stores so you could play the demos. In the early 2000s, FunoLand merged with EB Games to become GameStop.

1. 2010 to Present– The GameStop business model will continue to decline because of decreasing consoles unit sales, weak pricing power, increasing digital downloads, and used games becoming less valuable. In the recent 10 years, many retailers fought for survival but eventually failed. Specialized private equity (PE) groups operated in the retail industry like surgeons, but still failed to revive retail stores. The days are getting darker for retail firms and PE firms have recognized that risking their capital is not worth saving the retail industry. Many retail giants such as Bonwit Tellers, Incredible Universe, and Kids “R” Us have disappeared, liquidated, or greatly reduced in size. Millennial customers love their 90s nostalgia moments, but they are not going to shop at GameStop because it is expensive, inconvenient, unethical, inauthentic. All niche communities are built on authenticity. Unfortunately, when GameStop changed its name and business model, GameStop’s authenticity was lost in the merger too.

Management is speculating that New Game consoles would recover sales in 2020. In the most recent 2019 quarter, GME’s CEO, George Sherman, was surprised by the steep sales decline. There is a surplus of GameStop stores and both new games and used games are so much cheaper everywhere else. Bullish investors believe GameStop can automatically recover sales through the new gaming console cycle. But over half of GameStop console market opportunities vanished between 2008 and 2020. In 2008, total consoles sales were 90 Million. Consoles were sold worldwide in 2008 unlike in 2020, but regardless, the totaled estimated consoles sold for 2020 were estimated to be 30M to 40M.

Overview

The Global Unit Sales of Current Generation Video Game Console in million units (2008 to 2017)Infogram.

  • Used games are less valuable each year and Download games are more popular each year. Used games remain a substantial income for GameStop, but its sales in that category have fallen every year since 2011. In 2019, Sony sold over half of its game sales came through downloads. Microsoft, Nintendo, and Google have invested heavily in online gaming.

Playstation 4 was released on Nov 15, 2013. GME stock from Nov 2013 to Nov 2017 is -67%

  • GameStop’s supply chain and marketing tactics are some of the worst in the retail industry: GameStop does not offer free shipping unless the total purchase is over $50. GameStop’s top competitors are upgrading their business with robotics, software, and logistics innovation.
  • Corporate culture is toxic, and the business execution is mediocre: The gaming culture is really aware of GameStop’s misleading business practices. What will make GameStop more successful than their competitors? I’m still searching for answers. If anyone told me they found Santa Clause on the North Pole, I would trust you before I ever believe in GameStop’s management plan.
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  • Weak pricing power: New and popular games from competitors are typically discounted 10% less than Gamestop prices. Also,competitors an additional 5% off for customers who make purchases with the retailers’ branded credit cards. Also, used games are cheaper on eBay, Facebook, and Craigslist.
    • GameStop cannot compete against cheaper alternatives: Major retailers are taking losses with their gaming discounts, with the promise that it builds brand loyalty and customers will buy other higher-margin products to make up for it. Competitors are beating GameStop through pricing, convenience, and superior Omni channels. GameStop knows it cannot compete on price, so it makes up creative membership deals that will mislead customers into buying overpriced used games.
    • Used cheap games are recession-proof, not expensive used games: Consumers will buy the cheapest alternatives in a recession, not overpay for discretionary goods. In an economic system where customers could use an extra buck, they would prefer to make $10 on eBay than to lose $10 at GameStop. GameStop’s trade-in value doesn’t make economic sense to most consumers.  GameStop will always offer a lower trade-in price, and then force the customers with their credit to buy merchandise that’s typically 10%+ as expensive as Walmart, eBay, or Amazon.
    • Low trade-in value: Customers can always get a better value from online retailers such as eBay, Facebook, or Craigslist. There are multiple ways to sell and buy games online that are more convenient and have considerably better prices.  The cost of shipping video games is really affordable, and you will still make more money selling games on eBay than you would at GameStop.
  • It’s not convenient to drive to a game store. It’s easy to find popular games from large retail spots when customers can drop by for other items. If customers are looking to buy video games, they aren’t usually rushing to store for them. The supply of used video games is plentiful and it’s fairly easy to find popular game titles from other, more convenient marketplaces.
  • Lack of Customer Service & Knowledge – GameStop has unrealistic sales goal and use the forceful sales tactic. GameStop’s innovation is making membership points misleading and confusing.

2. History of Poor Capital Allocation – Low ROIC, no investment in business and waste of share buybacks.

  • Aggressive share buyback won’t work: Since 2010, GameStop has had a Capital Allocation Strategy that wasted over $400 Million in Share Repurchase. This number doesn’t take into account the recent $120M shares buybacks from 2019. A company should simply buy back shares if it has ample funds to take care of the operations and the stock is selling at a large discount on a conservative calculated intrinsic value.  GameStop will run out of cash by the remainder of the year, and it will depend on revolving high-interest credit to pay for their operations.
  • Liquidity Fallacy: If customers don’t shop at GME, then cash flow doesn’t matter. Surly, Michael Burry understands liquidity and cash flow, he’s one of the few investors that bet on the Real Estate liquidity crisis. But Burry and many other investors failed to see the cultural currency in the gaming community. Clients are the most important currency on GME’s balance sheet, not USD. Much like how Eddie Lambert said Sear’s had enough liquidity to carry through a turnaround strategy, but customers were not shopping at Sears. Price-cutting can quickly stabilize a financial statement, cutting too much cost will deteriorate the customer’s shopping experience. There are over 10,000 companies in the world, but Burry chose GameStop as one of his TOP ideas. I was initially shocked at his decision to buy GameStop, but I wasn’t totally surprised. Many investors believe their skills and knowledge are transferable in an everchanging industry.
  • Fallen ROIC since 2014: GameStop’s ROIC has fallen every year since 2014. It had not made any significant investment in their business in the last four years.
Historical 10 year ROIC of GME

3. Proposing unproven Strategies – gaming events, retro games, and merchandise will not replace the loss of used games revenue.

  • Store gaming events are not proven strategies: Management has not provided information that shows gaming store events could create profitability. Most GameStop stores are simply too small for hosting gaming events. GameStop had a press release about their gaming events in Spring 2019, and it has been quiet ever since.  GameStop probably has already failed its first gaming event attempt. The best gaming hosts in the industry are only mildly successful.
  • Increasing retro and rare game sales will not stabilize revenue: Rare games sell on eBay at a much lower price than GameStop trade-in value. Collectible games will slow down the turnover inventory and they will take up shelf space from other, newer products.

Shifting sales to nongaming merchandise will turn GameStop into another commodity store: GameStop owns the ThinkGeek store that sells nongaming merchandise and its sales are going down too. GameStop eliminated the position of Chief Operating Officer (COO) and in recent months has begun to switch some of its business models toward collectibles and trading merchandise. In other words, GameStop is basically converting its store into another failing business: its sister brand ThinkGeek. GameStop’s best non-selling items are Bubbleheads that are made by Funko.  Gimmicky products like Bobbleheads are the beanie baby 2.0… Bobbleheads have high-net income margins, but it doesn’t add any value to GameStop. GameStop may get some foot traffic from Bobbleheads, socks, T-shirts, and other random merchandise, but total sales are simply not good enough to offset their declining game sales. In the early 90s, trading card stores attempted to switch from baseball cards to other popular merchandise, but eventually, the hobby store industry disappeared.

Gamestop is hoping for Collectibles to turnaround the company

Valuation Verdict:
GME at its best would be worth $5/Share, assuming a small decline of -2% revenue CAGR and an average 3% EBITDA Margin.  Bullish investors estimate GameStop valuation between $6 to $10, but it doesn’t require complex math to explain GameStop’s valuation. Analysts are overcompensating on complex valuation because they believe used video games can be a sustainable business model. The next 12 months will be critical for GameStop to improve its revenue or else the stock price will take a nose dive. 

GameStop has less than one year to prove to investors that they can stabilize and improve sales. GameStop currently holds $290 million in cash and $419.4 million in debt. GameStop has had many years to turn around the company, but they have just burned through cash to buy back a company that offers customer zero value. Buybacks are great if the company is greatly undervalued and if it receives enough funds to support both business operations and buybacks. In GameStop’s case, it only has adequate money to pay down debt or buy back shares.

GME will drop to $3 again and become a penny stock in the next two years. Private Equity dry powder is at an all-time decade high, and there is still no offer for GameStop. Based on the last 4 quarters, GME is projected to lose a minimal of $160M to $200M in 2020.

Conclusion:

The existence of GameStop came from the void of the used game market. The industry has evolved and that used game void is available through multiple channels that offer cheaper prices and better value.

A new generation of game consoles is arriving later this year, buying GameStop sometime to hold out. The question remains, how much longer can GameStop’s business model remain relevant in a fast-growing digital distribution era? Get ready to say Rest In Peace, as GameStop will join its non-innovative retail family members in bankruptcy shortly.

Can’t stop, won’t stop, Gamestop selling drops ’cause it, it gets down baby, it gets down baby

The GameStop, gameflop, and StockDrop

Where was Under Armour in 2001?

Before Under Armour became a famous sports brand worn by professional athletes, it was a small business founded in 1996 in my home state, Maryland. Kevin Plank, founder of Under Armour designed shirts to help cool down an athletes body during training. Under Armour clothing was available through a regional mid-size sport’s retail chain called Modells. Modells were also one of the first major retail chains to carry their brand.

I still remembered the moment UA apparel caught my attention in Modells. As soon as you enter Modells, Under Armour was the solitary thing you could look at because it was visible in front. It was situated on the button on the front left entrance and Nike was located near the front right entrance of the store. UA had this skin tight shirt on display that looks hi-tech and innovative. UA shirt was like no other clothing apparel that I have ever come across, the material felt light and smooth. I decided to buy a $40 shirt in 2001 that was worth my entire paycheck for mowing two lawns.

Purchasing an expensive shirt wasn’t the best financial decision, but I felt cool for being the first kid in my neighborhood to have an Under Armour shirt. I did not know anything about Under Armour business model yet, but I knew their shirt pulled in my skinny teen body felt like I transform into a superhero. I felt proud wearing UA gear and shouting “we must protect this house” during basketball games and gym workouts. I was attracted to the brand because the unique logo and the marketing motto “Protect this House”.

The UA business model started out, targeting the male demographic customers. UA is much more than a one trick pony company that sold skin tight shirts. They rapidly expanded their business in over 2,500 retail stores near the end of 2002, and shortly less than a year later it started offering Women’s apparel. In 2005, UA went IPO to expand their brand domestically and introduce more products.

15 years after, I am still wearing the UA shirt to basketball games, this time with a real superhero “Batman Embalm” that cost me over $50 dollars.    I bought more UA apparel and a few pairs of their place, but I am not the only kid anymore to purchase UA gear. There are children all over the world wearing UA and Adults in the gym are challenging my status quo as a superhero with their own UA superhero shirts.

UA grew tremendously and became competitive enough to challenge the sporting apparel industry leaders like Adidas and Nike. Its IPO gained over 800%, turning from a market size of ~ $770 Million to the current valuation of ~$8Billion! In that respect is no doubt, UA became a successful business and a household brand. Early UA investors have tons of earning money over the last decade. UA continues to expand to multiple clothing apparel lines and even introduce hi-tech sport electronics.

The business environment was very challenging in the early 2000s.    On Jan 2002, Kmart became the largest retailer in American history at that time to file for Chapter 11 bankruptcy. By the summer of 2002, US Airways, shared Kmart’s faith and declared Bankruptcy. Many trade names from the early 2000s have disappeared and became irrelevant. Today, many investors and shoppers recognize the UA brand. UA offer products for nearly every major sport and is a world-wide brand. While Under Armour has been wildly successful so far, they are really small compared against Adidas and Nike. Stay Tuned for my next BLOG on learning what is keeping Under Armour, UNDER PRESSURE!