Cloud Hosting is The Architecture of Cloud Computing Techniques

Cloud Hosting Technique

Cloud Hosting is The Architecture of Cloud Computing Techniques

Cloud Hosting is The Architecture of Cloud Computing Techniques

provides the hosting services in the form of a single virtual machine and is implemented through the use of cloud computing and cloud architecture. It dynamically distributes data and processes across the small servers of the system for processing. The cloud hosting system is divided into many virtual machines. The services offered by a loud hosting service provider are located at its premises and these can be accessed by using client software.

The cloud hosting allows the users to get their applications up and running much faster and enables the quick readjustment of virtual resources to meet the dynamic demands like increased data rate, traffic size and storage requirements. The users can assess the cloud using different client devices like desktops, laptops, tablets and phones. Some of the user devices require real time cloud computing for running their applications, while others can interact with a cloud application via web browsers. Some cloud applications only support specific client software dedicated for these applications. Some legacy applications are also supported through screen sharing technology. The internet giants such as Google and Amazon are using this state of art hosting technology successfully for their servers.

Cloud hosting can be offered in three different modes i.e. infrastructure as a service(IaaS) , platform as a service(PaaS) and software as a service(SaaS). The basic mode IaaS , offers the services in the form of physical or virtual machines ( computers & other processing devices), raw/block storage , firewalls , load balancing mechanism and networks .The IaaS mode services provider supply these resources from a large deployed pool of resources in data centers andthis also include provisioning of local area networks and  IP addresses. The PaaS mode cloud hosting services provider offers a cloud computing platform  that include an operating system, programming execution environment, database and server. The PaaS application software can be developed and run on a cloud platform and does not involve cost and complexity of buying and managing the hardware and software layers. The (SaaS) mode cloud hosting services provider  install and operate application software in the cloud and cloud users access the software from cloud clients and the cloud platform in this case is not managed by the clients. Clouds hosting can be physically deployed in the form of public cloud, personal cloud, hybrid cloud and community cloud.

Cloud hosting has greatly reduced the website operational cost. In older versions of servers, the clients used to pay for a specific bandwidth irrespective of the traffic on that server. The cloud hosting has tackled this problem through the skillful use of variable costing method, where the cost will increase with the traffic and as the load/traffic reduces the cost will be automatically decreases.

The cloud hosting has a great advantage in terms of its security, as it operates in isolated environment and only the host has the access to it. One of the biggest advantages of cloud hosting is that the cloud platform manageability, maintenance and upgrades can be easily and remotely accomplished, as it does not require any physical/hardware maintenance repair and replacement.

Now Is The Time To Buy These 2 Undervalued, High-Yield Stocks

Source: imgflip

The goal of my high-yield retirement portfolio is to build a highly diversified mix of companies in all sectors and industries, including those with very strong growth characteristics. Industrial REITs fit that bill well, thanks to the strong tailwinds created by an expanding US economy.

Source: Monmouth Investor Presentation

In addition the rise of e-commerce is fueling rapid demand growth for warehousing space for distribution centers, further putting the wind in the sails of industrial REITs such as STAG Industrial (STAG), and Monmouth Real Estate Investment Corp. (MNR).

Let’s take a closer look at why these two high-yielding REITs represent a great mix of generous, secure, and growing income potential that might be just what your diversified dividend portfolio is looking for. That’s especially true at today’s attractive prices, made possible by the current REIT bear market.

In addition, learn what risks these REITs face in the coming years. And more importantly whether or not these could derail their enticing investment cases.

STAG Industrial: Fast Growing Niche Empire

STAG Industrial got its start in 2003 when STAG Capital partners was formed to own free-standing and single tenant warehouses and light industrial facilities. It IPOd as a publicly-traded REIT in 2011 and ever since has been on an impressive growth streak (goal of 25% portfolio growth each year).

Source: STAG earnings supplement

Today STAG owns 356 properties in 37 states, in over 60 cities, and leases its buildings to 312 tenants. The REIT is highly diversified in terms of geography, industry, and tenant. In fact, the single largest occupant representing just 2.6% of rent. And keep in mind that this tenant, the General Services Administration, is a federal agency, and thus represents a highly reliable income source.

Source: STAG earnings supplement

What sets STAG apart from most of its rivals is that it long ago concluded that Wall Street’s perceptions about the industrial sector were wrong. Specifically that the secondary market (cities with 25 million to 200 million of rentable areas) were being mispriced.

This was out of a belief that primary and super primary markets (big cities) have higher and more stable occupancy rates over economic cycles. This is why it was thought that they maintain stronger pricing power during economic downturns.

Source: STAG investor presentation

However, during the last recession (far more severe than most) this didn’t prove to be the case. In fact, occupancy rates for secondary markets held up better than primary markets, and rental rates fell less severely.

Management believes this is because in smaller cities there is less competitive industrial real estate. This means that tenants have less pricing power because of higher switching costs. In other words, secondary markets are more of a “sellers’ market.”

In addition, because most investment dollars have been focused on primary and super primary markets in recent years, there is less competition for acquiring new properties. Thus, STAG can buy quality properties for less, resulting in higher cap rates (cash yields), and achieve more profitable growth.

The key to STAG’s long-term investment thesis is management’s ability to strike a fine balance between very fast growth, but also remain disciplined in what it buys. This is possible thanks to its deep and experienced bench. For example, CEO Benjamin Butcher, who has been with STAG Capital since 2003, has 24 years of commercial real estate investment experience.

This explains why STAG is so selective about its purchases, usually only buying about 1% of properties it considers each year.

STAG 2016 Acquisition Selectivity

Source: STAG investor presentation

In 2017, the REIT closed on a record 53 property acquisitions, with an average lease term of 7.5 years and a cap rate of 7.4% (1.9% above industry average).

This helped drive very strong growth in revenue and core FFO/share.

Metric

2017 Growth (Except Payout Ratio)

Core FFO

34.6%

AFFO

28.7%

Shares Outstanding

27.0%

Core FFO/Share

7.0%

AFFO/Share

1.3%

Dividend

1.3%

AFFO Payout Ratio

81%

Source: STAG earnings release

However, that didn’t translate into better bottom line results. Owing to the older nature of its buildings and a lack of economies of scale, its adjusted funds from operation (REIT equivalent of free cash flow and what funds the dividend) grew slower than its core FFO. Also due to the large number of shares issued to fund its growth last year, AFFO/share growth was mostly flat. This explains the tepid dividend growth in 2017.

The good news is that in 2018, management expects to rely less on equity markets because the share price has taken a hit recently due to rising rate concerns. Instead, it plans to fund its growth plans with modest amounts of cheap debt.

Source: STAG earnings supplement

Fortunately, management has been disciplined with its use of debt in the past. When shares were high it used equity to grow, allowing it to achieve a below average leverage ratio.

Today the REIT is safely capable of borrowing more and in fact, management intends to take leverage from 5.0 to about 5.5 in 2018. But this won’t risk breaching its debt covenants, which the REIT is nowhere near violating. The strong balance sheet is why STAG is rated BBB by Fitch, and enjoys access to very low-cost borrowing (average interest rate 3.5%).

This means that going forward, STAG should be able to achieve stronger AFFO/share growth, and raise its payout at a quicker pace. Currently, analysts estimate this to be about 5% over the long term.

To help drive that growth is STAG’s impressive $1.9 billion growth pipeline, consisting of 144 properties that total 32.4 million square feet. This is notable because right now STAG only owns 20 million square feet of leasable space. This means that the properties it plans to buy are larger, and likely to generate more rent per building than its existing property base.

Source: STAG investor presentation

And that $1.9 billion growth pipeline is just a drop in the bucket when it comes to STAG’s growth potential. Management estimates that STAG has 1% market share in the $250 billion industrial property markets it’s targeting. Or to put another way, STAG has potentially decades of strong growth ahead of it.

Monmouth Real Estate: A Fast-Growing Dividend Aristocrat With A Bright Future

Monmouth is one of the oldest REITs in the world, having been founded in 1968. Over that time it’s built up a property portfolio of 109 properties in 30 states. Almost all of its rent (85%) is from strong investment grade blue chips such as: FedEx (FDX), International Paper (IP), Coca-Cola (KO), and United Technologies (UTX).

Source: Monmouth Investor Presentation

While its property base is very small, it’s also the highest quality in the industry. That’s because Monmouth’s portfolio has: the youngest buildings (less maintenance cost, higher rents), the longest leases, and the highest occupancy.

Source: Monmouth Investor Presentation

This means that MNR’s rent roll (leases expiring in the next three years) is also the smallest, which gives it excellent cash flow predictability. Combined with a below average payout ratio (77% vs. industry average 83%) this makes this REIT’s dividend highly secure.

Source: Monmouth Investor Presentation

In 2017, Monmouth had a record year of growth, thanks to $287 million in new property acquisitions. All of these were effectively brand new facilities, with 10 to 15-year leases. This boosted its property count by 10%, and led to massive growth in its top and bottom line.

Metric

Fiscal Q1 2018 Growth

Revenue

21.2%

FFO

23.8%

AFFO

27.3%

Shares Outstanding

9.7%

AFFO/Share

15.8%

Dividend

6.3%

AFFO Payout Ratio

77.3%

Source: Monmouth Earnings Release

Note that Monmouth, despite its tiny size, was able to show signs of strong operational leverage, meaning that AFFO grew faster than revenue. This is a sign that management runs a tight and efficient ship, despite lacking the economies of scale of its larger peers. It’s also due in part to the very young nature of its buildings, which have very low maintenance costs.

Strong growth is nothing new to Monmouth, which has been growing at a quick pace for years.

Source: Monmouth Investor Presentation

This has helped it to generate some of the industry’s best total returns.

Source: Monmouth Investor Presentation

Monmouth has a $135 million growth pipeline to drive growth in 2018. When combined with the long-term industry tailwinds, including the continued exponential growth of e-Commerce, MNR is expected to remain one of the fastest growing industrial REITs in America.

Source: Monmouth Investor Presentation

Industrial REIT FFO/Share Growth Projections

Source: Brad Thomas

This bodes well for its future dividend growth prospects, which combined with a generous yield, mean that it could easily prove to be a market beater.

Dividend Profiles Point To Excellent Total Return Potential

Stock

Yield

AFFO Payout Ratio

Projected 10-Year Dividend Growth

10-Year Potential Annual Total Return

STAG Industrial

6.0%

81%

4% to 5%

10% to 11%

Monmouth Real Estate

4.8%

77%

6% to 7%

10.8% to 11.8%

S&P 500

1.8%

50%

6.2%

8.0%

Sources: earnings releases, FastGraphs, Multpl.com, CSImarketing

The primary reason for owning any REIT is the dividend. This is why I look at every stock’s dividend profile, which consists of: yield, payout safety, and long-term growth potential.

Both STAG and Monmouth offer attractive current yields, especially compared to the market’s paltry payout. More importantly, those dividends are well covered by AFFO.

Now there’s more to dividend safety than just a good payout ratio. The balance sheet is also important, because too much debt cannot just put a dividend at risk, but also decrease a REIT’s growth potential.

REIT

Debt/Adjusted EBITDA

Interest Coverage Ratio

Fixed-Charge Coverage Ratio

Credit Rating

STAG Industrial

5.0

5.5

4.3

BBB (Fitch)

Monmouth Real Estate

6.2

3.9

2.4

NR

Industry Average

6.0

3.6

NA

NA

Sources: Gurufocus, earnings supplements

Here we see that Monmouth has the weaker balance sheet, though not one that should put the dividend at risk. Its leverage ratio is only just above the industry average. However, I would prefer if the fixed-charge coverage ratio (EBITDA minus unfunded capital expenditures and distributions divided by total debt service costs), were higher.

That being said, Monmouth’s access to low cost capital doesn’t seem to be impaired. For example, in the last quarter it was able to refinance its very long duration (11.5 year) fixed debt down to an average rate of 4.2%. This indicates the bond markets have confidence in: management’s long-term abilities, its very strong counter parties, and its long leases.

Meanwhile STAG industrial enjoys a leverage ratio right at the bottom of management’s long-term 5.0 to 6.0 target. And thanks to its very strong fixed charge coverage ratio it sports a strong BBB credit rating that allows it to borrow very cheaply and generate one of the highest interest coverage ratios in the industry.

All told I (and most analysts) expect STAG and MNR to be capable of strong long-term dividend growth. That’s courtesy of their small sizes and very long growth runways (industrial real estate is a $1 trillion market). Specifically that means 4% to 5% payout growth for STAG, and 6% to 7% for MNR, over the next decade.

Combined with their current yields, that should allow both REITs to easily beat the returns generated by the overheated S&P 500.

Valuations: Worth Buying Today

Chart

STAG Total Return Price data by YCharts

Ever since tax reform passed fears of an overheating economy stoking rising inflation have sent long-term interest rates up sharply. This has battered REITs, including STAG and MNR.

However, where some see this as a reason to stay away, I view it as a potentially good buying opportunity.

REIT

2018 P/AFFO

Historical P/AFFO

Yield

Historical Yield

STAG Industrial

13.3

14.5

6.0%

5.7%

Monmouth Real Estate

15.8

19.3

4.8%

6.4%

Sources: FastGraphs, Gurufocus

There are numerous ways to value a REIT, both in terms of historical valuation metrics, and forward looking ones. Today STAG and MNR are both trading at historically low price/AFFO (REIT equivalent of a PE ratio).

In addition STAG is trading slightly higher than its historical (since IPO) median yield. Monmouth, however, is not. But that doesn’t mean it’s not a good buy. Remember that over the long-term a dividend stock’s total return will usually follow the formula yield + dividend growth. So this is where a forward looking discounted dividend model comes in handy.

That’s because we can estimate the fair value of a dividend stock by the net present value of its future payouts.

REIT

Forward Dividend

Projected 10-Year Dividend Growth

Projected Dividend Growth Years 11-20

Fair Value Estimate

Dividend Growth Baked In

Margin Of Safety

STAG Industrial

$1.42

3% (conservative case)

2%

$25.40

0.7%

7%

4% (likely case)

3%

$26.81

12%

5% (bullish case, analyst consensus)

4%

$28.37

17%

Monmouth Real Estate

$0.68

5% (conservative case)

4%

$15.24

2.4%

8%

6% (likely case)

5%

$16.08

13%

7% (bullish case, analyst consensus)

6%

$17.01

17%

Sources: FastGraphs, Gurufocus

Since 1871 a low cost S&P 500 ETF (if it existed) would have generated a 9.1% total return, net of expenses. Since this is the default investment option for most investors (and what most people benchmark off), I consider this the opportunity cost of money, and a good discount rate.

Now of course there is a lot of uncertainty with any forward looking valuation model, especially one that uses a 20 year time frame. This requires smoothed out growth assumptions that aim to isolate long-term growth potential based on an industry’s fundamentals, and the capabilities of its management team.

This is why I use a range of conservative to bullish growth cases to try to estimate the intrinsic value of a dividend stock. In this case, based on the most likely growth scenarios, I estimate that STAG and MNR are 12%, and 13% undervalued, respectively.

This means that the market is assuming lower dividend growth than what they are likely to generate. Or to put another way, both REITs have a low bar to clear, and thus the opportunity to outperform. This seems to confirm my earlier estimates of their market beating total return potentials, and makes both stocks a good buy right now.

Risks To Consider

There are two kinds of risks to consider with industrial REITs. The first are company specific.

For example, two things potentially concern me about STAG Industrial. These are why I consider it a medium risk stock (5% max position size in my portfolio). First, the REIT’s historical focus on shorter-duration leases in secondary markets (and with older buildings) have caused it to see far lower retention rates than many of its peers.

Now in fairness to STAG this has largely been by design. That’s because the long economic expansion has meant that overall industrial rental rates have been climbing. This means that all industrial REITs have pretty strong pricing power, and thus have more incentive to not offer price breaks to retain older tenants.

For example, according to Monmouth CEO Michael Landy, the average asking price (per square foot) went up 5.3% in 2017. And while STAG has a lower quality portfolio ($4.09 per square foot vs. $5.96 for Monmouth), the point is that current retention rates are low for a reason. And in 2018 STAG does expect retention to climb to about 75%, as it focuses more on longer-term leases, and more primary market properties.

In other words, STAG is likely preparing itself for the next recession, by trying to increase its cash flow stability. That’s a smart long-term move since STAG hasn’t publicly been through a recession, and STAG Capital has been through just one. This means that the “secondary market occupancy and rent will hold up better than primary” theory hasn’t been fully tested yet across multiple downturns. At least not enough for me to call it a low risk dividend stock.

With an AFFO payout ratio of 81% STAG doesn’t seem like its dividend might be put in peril during the next downturn. However, its lower quality portfolio does mean that management might want to create a larger safety buffer before raising the dividend at the 4% to 5% that it’s likely capable of.

Basically this means that STAG Industrial shareholders may end up waiting several more years, and potentially until after the next recession, before they see more than token dividend increases.

As for Monmouth, there are two potential concerns I have. First, it has a very high concentration of its rent coming from just one company, FedEx.

Recently Amazon (NASDAQ:AMZN) announced it was launching its own competing delivery service. The good news is that JPMorgan (JPM) expects this to hurt the USPS far more than FedEx. This means that Monmouth’s most important tenant isn’t likely to fail anytime soon.

In addition in the last quarter the REIT acquired a 300,000-square foot distribution center in Oklahoma City leased for 10 years to Amazon. This indicates that even if Amazon ends up disrupting package delivery, (which is far from certain), Monmouth should be able to adapt as it has successfully done since 1968. After all, plenty of tenants have failed over that time period.

Still given its rental concentration, such a worst case scenario would likely take a few years to overcome in a slow growth turnaround period. During which we might see Monmouth return to previous nasty habit of several years with no dividend growth.

Source: Simply Safe Dividends

The other worry I have about Monmouth is the slightly over-leveraged balance sheet. The industrial REIT industry is facing a potentially challenging year or two. That’s thanks to rising interest rates and falling cap rates on new properties.

Source: Monmouth Investor Presentation

Monmouth’s relatively higher debt levels are not dangerous as of now. But they might limit its future borrowing ability, making it more dependent on fickle (and currently bearish) equity markets to fund its growth.

The problem here is that industrial property cap rates have been declining for years due to rising property values. If they fall too low it can be harder for all industrial REITs to grow profitably. That’s especially true for smaller ones that lack massive scale and large access to cheap growth capital.

Industrial Property Cap Rates

Source: Monmouth Investor Presentation

As you can see, cap rates for industrial properties are cyclical, rising and falling with the economic environment. During recessions, when vacancies rise and the industry struggles, cap rates increase. This makes it easier for REITs to invest profitably.

The second longest US economic expansion in history, (which will hit 10 years in June of 2019), has also seen interest rates near zero for much of the decade. This has led to rising property values and declining cash yields.

For example, back in 2010 STAG Capital was able to acquire properties for cap rates as high as 9.2%. By 2016 that had fallen to 7.9%, by 2017 7.4%, and now in 2018 management is guiding for 7.0%. And keep in mind these are mostly secondary markets, which have lower prices and higher cap rates.

Monmouth on the other hand, has historically targeted prime market properties, specifically: brand new buildings, with the strongest tenants, and the longest leases. While this gives it the best property portfolio in the industry, it also means the REIT has to pay more for growth. For example, in 2017 the average cap rate for its 10 acquired properties was 5.9%.

The concern here is that because they are small REITs, STAG and MNR might lack the scale to keep their cost of capital low enough. At least low enough to generate the kinds of strong gross cash yields on investment (cash yield on new property minus cost of capital) to fuel their projected growth rates.

STAG Industrial

Estimated Cash Cost Of Capital

4.7%

2018 Cap Rate

7.0%

Approximate Gross Cash Yield On New Investment

2.3%

Sources: earnings releases, FastGraphs, Gurufocus, management guidance

In 2017 STAG’s higher share price allowed it to enjoy a lower cost of equity. When combined with higher cap rates this generated a gross cash yield on acquisitions of about 3.0%. That is expected to decline to 2.3% this year, due to a lower share price, and management’s focus on more prime market properties with longer lease durations (which cost more to buy).

Monmouth Real Estate

Estimated Cash Cost Of Capital

4.3%

2017 Cap Rate

5.9%

Approximate Gross Cash Yield On New Investment

1.6%

Sources: earnings releases, FastGraphs, Gurufocus, management guidance

And while Monmouth enjoys a slightly lower cost of capital due to its slightly higher share premium, the gross cash yield on new properties was rather low in 2017.

The good news is that according to STAG higher long-term rates will EVENTUALLY drive cap rates up, thus preventing a liquidity growth trap in which industrial REITs are unable to grow profitably.

However, this might not be for several months or even a year or more. It depends on the rate at which long-term rates rise, as well as numerous other factors.

But there are reasons for optimism. Monmouth says that in their latest quarter (Q1 of Fiscal 2018) they were able to acquire two new properties for $52.1 million. These were leased to FedEx and Amazon for 15 and 10 years, respectively. The cap rate on these buildings was 6.1%, 0.2% higher than last year. This potentially indicates that perhaps the prices for top grade industrial properties may be near its top and set to start falling relatively soon.

Still we can’t forget that there are two parts to the profitability formula, cap rates, but also cost of capital. STAG and Monmouth have enjoyed the lowest interest rates in history, which has allowed even small REITs like these to still borrow very cheaply. For example STAG’s average borrowing costs are 3.5% while Monmouth’s longer duration bonds, (average of 11.5 years), have an average interest rate of just 4.2%.

With long-term rates now rising it’s unlikely that either REIT can expect to see borrowing costs fall any lower, but rather start drifting higher. This could largely offset any near-term increase in cap rates caused by higher interest rates.

So if cap rates move up a bit, and borrowing costs move up by the same amount, doesn’t that mean that the profitability of new properties will remain the same? Not necessarily, at least not in the short to medium-term.

This is because REITs have been incorrectly used as a “bond proxy” by yield-starved income investors for so long, the sector is currently highly rate sensitive. This means that when 10-year yields rise, so do REIT yields, indicating falling share prices, and thus higher costs of equity.

Source: Hoya Capital Real Estate

The amount of sensitivity is determined in part by the duration of a REIT’s leases. This is because the longer the lease, the more inflation sensitive a REIT’s cash flows are thought to be. In reality, rental escalators usually have inflation baked into their formula. But in the short term, perception is reality, at least on Wall Street.

The good news is that industrial REITs have below average rate sensitivity, at least compared to other kinds of REITs. However, Monmouth’s very long lease durations mean that its sensitivity may be the highest among its peers.

This indicates that, at least until industrial cap rates start moving higher, and REIT rate sensitivity declines, (it’s cyclical and mean reverting), both STAG and Monmouth might see slower than expected growth.

For example, STAG industrial is guiding for about $450 million in net acquisitions in 2018, down from $545 million in 2017. For a REIT with a goal of growing its portfolio 25% a year, this slowdown is a potentially troubling sign. Management says that the slower growth will be mainly from growing dispositions as lower cap rates mean it can recycle capital very profitably, (12% unlevered returns on property sales in 2017).

Monmouth too is likely to not repeat 2017’s record year of growth, because its current growth pipeline is just $135 million. That’s compared to $287 million in acquisitions last year.

The good news is that over the long term, interest rates don’t actually hurt: REIT growth, dividend safety or total returns. In fact, because rates usually rise during times of economic prosperity, REIT fundamentals tend to do best in a rising rate environment. And both STAG and Monmouth have long histories (since 2003 and 1968, respectively) of growing during all manner of economic and interest rate environments. Thus, I have full confidence that these quality management teams will be able to keep growing and generating: generous, secure, and rising dividends over time.

But until the market starts focusing on those positive economic, industry, and individual REIT fundamentals, investors need to brace for a potentially painful year. Both in terms of share price, and potentially slower than expected growth rates for these REITs.

Bottom Line: These 2 Undervalued, Fast-Growing Industrial REITs Make Potentially Great Long-Term Buys At Today’s Prices

Don’t get me wrong, I’m not calling a bottom for REITs. For all we know, the sector might end up lagging the broader market for the next year or more, due to rising rate concerns.

What I do know is that industrial REITs like STAG and Monmouth have a bright future, and strong long-term total return potential. I have full confidence in their skilled management teams to continue adapting to various challenges, as they have successfully done in the past.

Which means that at today’s prices, long term, high-yield income growth investors are likely to do well adding these two stocks to their diversified income portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Nvidia: After The Fall

Pronounced Drop And Volatility

After radical swings in the stock price of Nvidia Corp. (NASDAQ:NVDA), which included a rapid 18% drop, investors can examine the causes of this volatility to form a view of prospects for the stock over coming months. This author believes that more growth may be expected in the price of Nvidia shares.

Investors saw a pronounced drop in Nvidia before an outstanding full-year’s earnings report. Thereafter the stock entered a very volatile range. That volatility continues and is to date more than double that of the weeks before the marked fall, and is greater than at any time in more than a year.

For example, on February 21 Nvidia fell more than $10.00 (4.00%) as the stock exemplifies high beta. To compare with its competitors, Nvidia registers a beta of 1.87, while Advanced Micro Devices, Inc. (NASDAQ:AMD) shows 1.58, and Intel Corp. (NASDAQ:INTC) has a beta of 1.41. Whenever beta becomes elevated, that is a time for investors to exercise increased vigilance as it may presage transitions, trend reversals and fake-outs.

Heightened Volatility Persists

In light of continuing volatility persisting after announcement of earnings outperformance, understanding the cause of the drop and its volatile aftermath should aid investors in reconciling these contradictions to determine the future direction of the stock.

Between January 21, 2018 and February 6, Nvidia fell precipitously by $45.27 (18.16%) to lose in just four trading days what it had taken nearly one month to gain. During such rapid market moves, valuation offers no protection. Then on February 8 the company announced that 2018 financial year profit grew by 83%, revenue climbed nearly 41%, and gross margin grew by 110 basis points. This outperformance has now taken the stock beyond previous highs, yet heightened volatility persists and may trouble holders.

Chart
NVDA data by YCharts

The 18.16% fall in price was caused mainly by technical market factors, not fundamental considerations particular to Nvidia. Approximately 85% of the total volume of stock market trades are based on algorithmic or quant criteria, and consequently by virtue of that sheer volume of technical trading, markets often rise and fall around technical trigger points.

Market Correlations

Underscoring this prominence of technical considerations is the correlation that the fall in Nvidia stock had with the drop in both the semiconductor sector as a whole and in the entire stock market. Compare the similarity in the charts below of both the semiconductor sector and the S&P 500 with that of Nvidia above.

As regards the overall stock market, a significant technical element on this occasion was the volume of short volatility trades using instruments tied to volatility indexes like the VIX. As a result of the power of market correlation, the downdraft in the stock market as a whole depressed stock prices in the semiconductor sector and pulled Nvidia down.

Chart
SOXX data by YCharts
Chart
SPY data by YCharts

This view of the attribution of the market pullback to technical factors was also stated by fellow Seeking Alpha contributor, Mohamed El-Erien:

It is driven by technicals, not fundamentals. The ongoing market correction doesn’t reflect a worsening of economic and corporate fundamentals. Rather, it is being driven by technical factors, including the unwinding of “short-volatility” trades . . . the testing of relatively new products and a shift in investor conditioning away from the “buy-the-dip” paradigm.

Demand May Weaken

Continuing volatility in Nvidia’s stock is in significant part due to concerns in some quarters regarding Nvidia’s exposure to cryptocurrency demand, as there are factors at play which may cause that demand to weaken in the foreseeable future. Cryptos generate approximately 10% of the company’s revenue, compared to approximately 3% of revenue for rival Advanced Micro Devices, Inc. (NASDAQ:AMD).

The future evolution of cryptocurrencies, especially Ethereum, threatens to render mining less profitable as it diminishes the block reward and reduces the difficulty of algorithms. In areas characterized by high energy costs, the profitability of mining is also waning. A mooted move to proof of stake settlement would reduce the need for mining.

To be considered additionally, Nvidia’s switch from in-car entertainment systems to AI driving systems is demonstrating lower than anticipated cash flow from the automotive segment. In the fourth quarter, automotive income grew 3% year-on-year, while falling 8% sequentially. However, 1Q19 automotive revenue is projected to climb above 1Q18 levels.

First Driving Processor

This market promises much increased revenue from approximately 2020 when mass market car manufacturers are expected to launch their first wave of autonomous vehicles. Nvidia is to launch the world’s first autonomous driving processor, named Drive Xavier, constructed with more than 9 billion transistors in the first quarter of 2019. Nvidia’s road to a sizable share of the autonomous driving market will be based on its alliances with Volkswagen, Uber, Mercedes-Benz, Baidu Inc. (NASDAQ:BIDU) and China’s ZF among others.

While there are valid concerns as discussed above, it may be expected that Nvidia’s increasing revenue derived from the cloud enterprise segment with their Volta chips, with capital expenditure in this market rising annually at a rate of 20-30%, will more than compensate for any reductions in cryptocurrency or auto market revenue. To underscore this point, Nvidia’s sequential growth in data center revenue exceeds 20%. A further growth area for Nvidia promising markedly increased earnings is that of AI inference applications and the IoT as these markets, presently in their infancy, evolve exponentially.

Nvidia’s financial base is healthy and growing, forming a foundation for projecting a continuing rise in share price. Sales growth in financial year 2018 was 40.58% year-on-year. The cost of sales in the same period grew at a slower rate than sales revenue, while EBITDA in 2018 was $3.41 billion compared to $2.16 billion in 2017. Total assets rose to $11.24 billion in 2018 from $9.84 billion in 2017, and total liabilities fell from $4.08 billion to $3.77 billion in the same period.

The drag on net income of Nvidia’s transition away from in-car entertainment towards AI driving systems, with their inherent cash flow lag, has been minimal with net income rising in 2018 to $3.05 billion from $1.67 billion in 2017. Free cash flow rose in 2018 to $2.91 billion from $1.5 billion the previous year.

Conclusion

After a jolting fall in share price, which can largely be attributed to technical factors, the full year’s earnings report has led Nvidia stock into a very volatile period with heightened beta relative to its peers. However, this phase promises to resolve into a continued upward trend as a result of growing demand in the enterprise segment. Concerns about a downturn in cryptocurrency revenue or lag time in realizing a higher volume of auto revenue are unlikely to halt that uptrend.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

How to Use the Power of Your Personal Brand to Skyrocket Your Business

In his new book, The Rise of the YoupreneurChris Ducker argues that the key to building a sustainable, future-proof business lies within your own experience, interests, and personality. Ultimately, finding success boils down to unleashing the power of your personal brand (what he calls, being a “Youpreneur”).

It sounds simple, but taking the leap to becoming a “youpreneur” takes vulnerability and authenticity.

I know the tactics Ducker suggests in his new book work, because they are the same strategies I used to pivot from my career as a TV news reporter to an entrepreneur. I didn’t know it at the time, but leveraging a strong personal brand and loyal fan-base is what helped me to build a successful business, with zero experience.

Here are my top four takeaways from Ducker’s book, if you want to leverage your personal brand for business success.

1. Be Original

While it may feel like there are no new ideas in business, Ducker suggests you can avoid the copycat marketing that is so prevalent these days, by building a business centered around you.

Anybody can have the same business model, the same services, or the same pricing. But nobody has your exact personality and experiences.

While you might be able to “get by” for a while modeling your business after another, ultimately, being successful boils down to being different and memorable. The easiest way to do it? Infuse your personal brand into your business.

As Ducker says, being different from your competitors beats being “better” every time.

2. Share Stories

You don’t have to look far for the most powerful marketing tool in your business: your own stories of what you have done and what you can do for other people.

Ducker shares that in order to use your stories to attract the right people to your business (and repel the wrong ones), you need to identify your true strengths and weaknesses and use these to captivate your audience.

It makes sense. People like doing business with other people. Major brands spend millions to develop characters or spokespeople that their customers can relate to. The benefit to the “youpreneur” business model is that you already have the spokesperson (you) and the stories to go with it.

Spend time identifying which stories your audience can relate to and leverage those in your marketing.

3. Create Content

Ducker recommends taking one piece of content and re-purposing it on multiple platforms.

This is something I call the “content compound effect.” It’s where you take one piece of content, let’s say a video interview, and you turn it into a blog post, a podcast, and a media pitch. You can develop a webinar around it or offer a live workshop on the topic.

I started doing this in business out of necessity- I just didn’t have the time to create original content on a dozen different platforms. Turns out, it’s a pretty effective marketing hack. If you’re going to spend time creating content, you might as well get the most return out of it as possible. Re-purpose your content for different platforms and you’ll reach more people as a result. 

4. Be an Expert

Ducker shares how he experienced a major shift in business when he decided to put himself front and center by hosting a podcast, blogging, and doing more public speaking.

It’s easier said than done, but for those willing to do it, the rewards are significant.

I’ve worked with many entrepreneurs who are too humble or overwhelmed to take center stage as an expert in their industry. The ones that are willing to take the leap and share their expertise in media interviews, training workshops, and public speaking, benefit from reaching a larger audience and making a bigger impact. 

While Ducker lays out a full strategy to becoming a Youpreneur in his book, I don’t think  it has to be all or nothing. Pick a couple tactics and start small. Begin infusing more of your personal brand into your content or your web copy. Make some media pitches and do a couple podcast interviews. Start peeling back the layers of your business to reveal the authentic, original brand of you and you’ll begin to experience the benefits of being a Youpreneur. 

6 Keys to Attracting and Nurturing Breakthrough Innovators on Your Own Team

Breakthrough innovation is the dream of every entrepreneur, but it’s still a scarce commodity. Selecting and nurturing people who are likely to help you in this regard is an even more elusive capability, and one that every angel investor, like myself, wishes he could get a lock on.

In fact, every manager and business owner needs this skill just to survive with today’s pace of change. 

We all wish we were the next Steve Jobs, or Elon Musk, or Thomas Edison. If we’re not, then at least we would like to recognize them when they come through the door, or better yet, create a few like them in our own organization.

I wish I understood what makes some people so spectacularly innovative, producing triumph after triumph, while the rest of us merely get by.

I’ve seen a lot of speculation on this challenge over the years, but I was recently impressed with the insights in a new book, Quirky, by Melissa A. Schilling.

From her position as professor at NYU Stern, and recognition as one of the world’s leading experts on innovation, she takes a deep dive into the lives and foibles of eight well-known innovators, including the ones mentioned.

One of her encouraging conclusions is that we all have potential in this regard, which can be brought out naturally by life circumstances and special circumstances, or nurtured by the people and culture around us.

I’ll paraphrase her key recommendations for capitalizing on this potential, for use on yourself and members of your team:

1. Incentivize people to challenge norms and accepted constraints.

Everyone wants to fit in, but most of us have felt a sense of being an outsider, which needs to be nurtured rather than crushed. In business, that means never saying or implying “that’s not the way things are done around here.”

It also means giving people opportunities in areas they have interest, but no track record. Elon Musk, for example, had no experience or training as a rocket scientist when he came up with the idea of reusing rockets, and the innovative idea for SpaceX

2. Give people time to think beyond current job assignments.

When you are looking for breakthroughs, you need time to think outside the box without fear of consequences. Make it clear, as they do at Google, that you are expected to spend some “20 percent time” outside your current job assignment.

The payoff value of a person working alone on side projects, tapping into intrinsic motivation, has been the source of several of Google’s most famous products, including Gmail. 

3. Reinforce people’s belief in their ability to succeed.

One of the most powerful ways to increase creativity, at both the individual and organizational level, is to encourage people to take risks by lowering the price of failure, and even celebrating bold-but-intelligent failures.

Also, creating near-term project milestones, with plenty of opportunities to celebrate early progress, is extremely valuable to reinforce people’s belief in their ability.

4. Inspire ambitions by setting grand goals and purpose.

Driving business goals that have a social component that people can embrace as improving quality of life provides intrinsic motivation to increase creativity and effort in their activities. Steve Jobs was obsessed with revolutionizing personal expression, more than making a computer.

5. Tap into people’s natural interests and favorite activities.

In business, this is called finding the flow. It requires both self-awareness on what you like to do, and a willingness on the part of your manager to personalize work assignments. With most jobs, there are many ways to get to results, so let your employees tell you what steps and tools they prefer.

Thomas Edison loved to solve problems and he designed his own experiments. Thus he was happy to persevere, despite 10,000 of his light bulb filament material tests that didn’t work. 

6. Increase focus on technological and intellectual resources.

With today’s pervasive access to the Internet, with powerful search tools from Google, WolframAlpha, and many others, the Library of Congress is at everyone’s fingertips. They just need the inspiration, time, and training to capitalize on these tools, and the new devices that arrive every day.

Schilling and I do agree that you have to start with people who possess substantial intellect, so the conventional indicators of skill and accomplishments cannot be ignored.

In addition, it’s important to find partners and team members with a high need for achievement, a passionate idealism, and faith in their ability to overcome obstacles, often seen as a level of quirkiness.

We are talking here about finding and nurturing people who can literally help you change the world, because that’s what breakthrough innovation is all about. If your business and personal goals don’t measure up to that standard today, maybe your first focus should be on rethinking your own objectives.

The bar for staying competitive in business keeps going up.

Broke Out Of This Jailhouse REIT

It’s one thing when jails are successful in housing and rehabilitating prisoners, but when those jails themselves become dysfunctional, something has to give. We were originally very positive on the concept of private prison ownership, knowing that the government couldn’t handle or didn’t want to handle the workload. But with its own set of issues and challenges, we are throwing in the towel on this Jailhouse REIT.

CoreCivic Inc. (CXW) (formerly Corrections Corporation of America) is a real estate investment trust company specializing in correctional, detention, and residential reentry facilities and prison operations. It also makes certain healthcare, food, work and recreational programs available to offenders as well as providing a variety of rehabilitation and educational programs like basic education, faith-based services, life skills and employment training, and substance abuse treatment – programs that intend to help reduce recidivism and prepare offenders for their successful reentry into the society upon their release.

It earns revenue on an inmate per-day based on actual or minimum guaranteed occupancy levels. In 2016, the company recorded $1.9 billion revenue. It has 13,755 employees and is the largest player in the correctional facilities industry with 34% market share. It owns 57% of all privately owned correctional and detention capacity.

Source: CoreCivic Investor Presentation

If Planning To Visit

As of September 30, 2017, CoreCivic owned 79 real estate assets and manages 7 additional facilities owned by its government partners. It owns 44 correctional facilities with 64,064 bed capacity and manages 7 facilities with total bed capacity of 8,769 beds. It leases 2 correctional facilities with 4,960 beds capacity and leases 7 residential centers with a total of 1,047 beds capacity to other operators and leases another 3 properties with total area of 30,000 sq. ft. to the federal government. It also operates 23 residential reenter centers with total capacity of 4,792 beds.

Aside from its principal executive offices in Nashville, TN, it also owns two corporate office buildings.

Source: CoreCivic Investor Presentation

Customers/Key Buyers

CoreCivic’s customers consist of federal and state correctional and detention authorities. Its key federal customers include the Federal Bureau of Prisons (BOP), the United States Marshals Service (USMS), and U.S. Immigration and Customs Enforcement (ICE).

Contracts from federal correctional and detention authorities account for about 51% of the company’s revenue whereas contracts from state customers account for about 42% of its revenue. Most of these contracts contain clauses allowing the government agency to end the contract at any time without cause. Moreover, these contracts are also subject to annual or biannual legislative appropriation of funds.

Aside from diversifying within federal, state, and local agencies, the risks of ending a contract prematurely is that CoreCivic has staggered contract expirations with most of its customers having multiple contracts. In the past, BOP has tended to let contracts end rather than end them prematurely as it is dependent on private prisons to house low-security inmates – typically undocumented male immigrants.

We knew about the concentration of government dependence when we invested in the stock but have become increasingly concerned with both the lack of inmate growth (see below) and the potential for government decisions that could adversely affect revenues – particularly in a highly polarized political environment that frankly, we find unpredictable.

Source: CoreCivic Investor Presentation

Recent Trends

Because the majority of the company’s revenue come from the federal government, its contracts are susceptible to annual or biannual appropriations, and having short terms of just three to five years, CoreCivic could be largely affected by an impending government shutdown. At present, immigration policy is one of the major issues wherein the Republicans and Democrats have opposing stances. For example, from January 19th to the 22nd, the U.S. entered a government shutdown after the two parties failed to come to an agreement about the funds allocated to immigration issues like the Deferred Action for Childhood Arrivals (DACA).

With the U.S. Immigration and Customs Enforcement being one of the major customers of CoreCivic, the company is directly affected by these shutdowns.

During a shutdown, the government will not be able to pass any short-term spending bills that allow budget allocations to be released to various agencies. Companies like CXW receive fixed monthly payments so the BOP may not be able to release funds or pay CoreCivic for a short period of time, depending on when and how long the shutdown occurs – resulting in cash flow and working capital challenges. Luckily, the government shutdown did not last very long, but the potential for a similar risk in the future is still relevant.

Another trend that is likely to affect CoreCivic’s business is the continuous decline in the number of prisoners. The number of prisoners under state and federal jurisdiction has declined by 7% from 2009 when the U.S. prison population peaked (See the table below). Federal prison makes up 13% of the total U.S. prison population and contributed 34% of the decline in the total prison population in 2016.

Source: U.S. Department of Justice

Accordingly, prisoners being held in private prisons have declined. According to Pew Research, after a period of steady growth, the number of inmates being held in private prisons has declined since 2012 and continues to represent a small share of the nation’s total prison population. We’re not confident this trend will reverse.

Another reason for the declining population in private prisons is the growing government commitment to progressive criminal justice, particularly to nonviolent offenders – low-security prisoners who are catered by private prisons. For example, the recommended mandatory minimum sentencing for nonviolent drug traffickers has been reduced. These progressive trends are likely to lead to further decreases in inmate populations.

Source: Pew Research

In August 18, 2016, the DOJ also issued a memorandum to the BOP directing that as each contract with privately operated prisons expires, BOP should either decline to renew contacts or substantially reduce scope in line with the BOP’s inmate population.

However, despite the said memorandum, BOP did exercise a two-year renewal option for CoreCivic’s McRae Correctional Facility. Moreover, in February 2017, the Department of Justice also reversed the memorandum to phase out private prison. It argues that this policy will impair the government’s ability to meet the future demands of the federal prison system. This decision saves the private prison industry from the risk of being phased out in the near future but may only push that decision out a few years. The uncertainty worries us.

To make matters worse, a class action lawsuit (Grae v. Corrections Corporation of America et al.) was filed against CoreCivic’s current and former offices in the United District Court for the Middle District of Tennessee. The lawsuit alleges that from February 27, 2012 to August 17, 2017, the company made misleading or false information and public statement regarding its operations, programs, and cost-efficiency factors to inflate its stock price. CoreCivic insists that these accusations are without merit but it still puts CXW and private prisons in a negative light.

Lastly, CoreCivic has also been receiving criticisms about its services. Complaints were received from Trousdale Turner Correctional Center in Hartsville after allegedly failing to address the concerns of prisoners and their families, including the healthcare needs to diabetic inmates. The scabies outbreak in its Metro-Davidson County Detention Facility is also cited as an example of its negligence to protect the wellbeing of prisoners. These lawsuits do not help CoreCivic’s image especially after it has laid off 500 employees after losing three jail contracts in Rusk, Jack, and Willacy counties.

Outlook

According to IBISWorld, the correctional facilities industry revenue is expected to grow minimally at an annual rate of 0.1% to reach $5.3 billion from 2017 to 2022, but industry profit is not expected to rise significantly. The trend in the number of prisoners will slow down the growth of the industry despite the overcrowding problem in the state prisons, which may or may not compensate for decreased demand for its services at the federal level.

Overall, we do not view the company’s prospects favorably in light of industry trends, governmental risks, and reputational image that can affect fundamentals and create unwanted headline risk. For this reason, we are selling CXW out of the REIT Portfolio.

America is the land of the second chance – and when the gates of the prison open, the path ahead should lead to a better life. – George Bush

Disclaimer: Please note, this article is meant to identify an idea for further research and analysis and should not be taken as a recommendation to invest. It is intended only to provide information to interested parties. Readers should carefully consider their own investment objectives, risk tolerance, time horizon, tax situation, liquidity needs, and concentration levels, or contact their advisor to determine if any ideas presented here are appropriate for their unique circumstances.

  • Past performance is not an indicator of future performance.
  • Investing in any security has risks and readers should ensure they understand these risks before investing.
  • Real Estate Investment Trusts are subject to decreases in value, adverse economic conditions, overbuilding, competition, fluctuations in rental income, and fluctuations in property taxes and operating expenses.
  • This post is illustrative and educational and is not a specific offer of products or services.
  • Information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein, nor is the author compensated by any of the products mentioned.
  • Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the topics or subjects discussed.
  • Information presented is not believed to be exhaustive nor are all the risks associated with the topic of each article explicitly mentioned. Readers are cautioned to perform their own analysis or seek the advice of their financial advisor before making any investment decisions based on this information.
  • Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice and you are encouraged to consult your own lawyer, accountant, or other advisor before making any financial decision.
  • All expressions of opinion reflect the judgment of the author, which does not assume any duty to update any of the information
  • Any positive comments made by others should not be construed as an endorsement of the author’s abilities to act as an investment advisor.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Beware of Pranksters Crashing Apple iPhones Using Twitter

If you’re an Apple iPhone user who also enjoys Twitter, listen up.

Pranksters on the social media service have been sharing a character from the Indian Telugu language that causes iPhones to crash, according to Mashable. The offending users have been putting the character into their Twitter usernames and tweets and encouraging people to share them with their friends. If the character lands in a user’s Twitter feed, it will cause the social app to crash. The app will continue to crash after users try to boot it back up, ultimately stopping victims from accessing the service on their iPhones.

Last week, reports surfaced saying that a single Telugu character was enough to wreak havoc on iPhones. When the character is sent via any messaging or social networking app, the affected user’s app will crash. While it’s an obscure bug that only affects Apple’s iOS 11, it’s one that pranksters and those trying to cause harm are exploiting across the Internet. Worst of all, there’s no fix at the moment and unsuspecting victims needn’t do anything to be affected.

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Apple acknowledged the Telugu bug last week and has promised a fix. The company hasn’t yet delivered, though, and it’s impossible to say when it’ll be released.

According to Mashable, which tested the bug on Twitter, the only way for affected users to regain access to the app is to log in via Safari and block the person that shared the character. At that point, the character won’t show up in their feeds and Twitter will be accessible.

Here's Why You Shouldn't Pay $1.10 For A Dollar Of Investment Grade Bond Assets

I’ve received questions from prospective subscribers about the types of trade alerts that we issue to the members section of the Cambridge Income Laboratory. One type of trade is CEF arbitrage, or more specifically a pairs trade, where we simultaneously identify an overvalued CEF and an undervalued CEF in the same sector. The strategy then entails selling or selling short the overvalued fund while simultaneously buying the undervalued fund.

The advantage of a CEF pairs trade is that because both the sold and bought funds are from the same sector, we aren’t making a directional bet on the performance on the underlying assets. Instead, we’re simply relying on the powerful concept of reversion of CEF premium/discount values (see Reflections On Chemist’s CEF Report Pick Performance In 2017 for how this has worked well for us in the Chemist’s monthly CEF picks).

There are two main limitations of the CEF arbitrage strategy. The first is that the magnitude of the gains are unlikely to be very large, simply because it is by nature a hedged strategy. That’s the trade-off for the strategy being relatively low risk. The second limitation is that unless you already own the overvalued CEF identified in the pairs trade, you would have to locate shares of the overvalued CEF to sell short. With some of the smaller, less liquid CEFs, this can range from expensive to downright impossible. The most optimal set-up is therefore already owning the overvalued CEF, and then locking in profits by selling the fund and then replacing it with the undervalued CEF in the same sector.

With the introductory blurb out of the way, let’s see how this has played out for one of the more recent CEF pairs trade that we identified in the members section of the Cambridge Income Laboratory.

About 4.5 months ago (see Sell This Investment Grade Income CEF Now), we noticed the premium of Western Asset Income Fund (PAI), an investment grade bond CEF, suddenly spiking up to +10.16%. The 1-year z-score was +3.6, indicating that this fund was significantly more expensive than its recent history. My comments from the initial article are reproduced below:

I was looking through the CEF database today and noticed the Western Asset Income Fund (PAI) trading at an exceptionally high z-score of +3.6.

Its current premium of +10.16% is at a 5-year high.

(Source: CEFConnect)

A 1-year z-score of +3.6 tells us that the premium/discount is trading 3.6 standard deviations above its 1-year historical value. Statistically speaking, this would be a 0.02% probability of occurrence, assuming that the distribution of values is normally distributed (which it isn’t, but the point is that such a high z-score is a rare occurrence).

The 5-year chart above showed that the fund traded at quite substantial discounts over the past 5 years, sometimes exceeding even -10%. This makes the current premium of +10.16% even more unusual than the 1-year z-score of +3.6 would indicate.

At this juncture, I wanted to look at the entire history of the CEF since inception. Perhaps the past 5 years was just an anomaly, and that the CEF has commanded a consistent premium in the past? It turns out that was not so.

Going back to inception, only during a brief period in 2009 did the fund’s premium exceed 10%. An unusually high premium for an investment grade fund might be understood during the immediate recovery period after the financial crisis…but why now? I can’t think of a fundamental reason why someone would pay $1.10 for a dollar of investment grade debt.

(Source: CEFConnect)

I then check out the premium/discount values of the peer group. Maybe investment grade bond CEFs are for some reason on a tear thus accounting for PAI’s unusual premium? Nope, that’s not it.

The premium of PAI is 3rd-highest out of the 15 CEFs in the “investment grade” category of CEFConnect. But I don’t consider PIMCO Corporate & Income Strategy Fund (PCN) and PIMCO Corporate & Income Opportunity Fund (PTY) to be traditional investment grade income CEFs, so not counting those two funds PAI has the highest premium in the peer group.

(Source: Stanford Chemist, CEFConnect)

OK, so PAI is a pretty good sell or short candidate. What did I pair my short PAI position with?

What did I pair my short PAI position with? I chose the BlackRock Credit Allocation Income Trust (BTZ). I wanted to choose a fund with a negative z-score, but rather amazingly all 15 investment grade CEFs had z-scores 0 or greater. BTZ’s z-score of +0.8 wasn’t the lowest, but its discount of -9.04% was the widest in the peer group, as you can see from the chart above.

Next, I wanted to see compare the price and NAV returns of these two investment grade bond CEFs to check if there were signs of deteriorating portfolio values in the undervalued CEF, which might cause me to consider BTZ as the long partner in this pairs trade.

The opportunity for the pairs trade comes from the fact that PAI’s price return is significantly outpacing its NAV return, whereas that is not the case with BTZ. We can see from the chart below that PAI appears to be blowing BTZ out of the paper with a +19.29% YTD return compared to only +8.94% for BTZ.

Chart

However, their YTD NAV returns are nearly identical.

Chart

No warning signs there. That leads me to the conclusion that:

In summary, if you own PAI, now would be a great time to sell!

Let’s see how the thesis played out 4.5 months later. BTZ had a total return loss of -3.88% over this time frame. That’s bad, of course, but still relatively much better than PAI’s loss of -14.1% over the same period. In other words, BTZ outperformed PAI by 10.22 percentage points in only 4.5 months, or about 27% annualized.

Did PAI’s portfolio do much worse than BTZ’s? No, and in fact the reverse was true. PAI’s net asset value [NAV] fell by -2.10% over this time period, but BTZ’s was even worse at -3.24%.

If BTZ’s portfolio did worse than PAI’s, why was its total return (much) better? My regular readers will have already guessed at the answer: premium/discount mean reversion! Over the last 4.5 months, PAI’s premium of +10.16% has sank to a discount of -4.82%, while BTZ’s discount of -9.04% has widened slightly, to -11.9%. Therefore, the majority of the outperformance of the long BTZ/short PAI pairs trade was due to the contraction of PAI’s discount.

Chart
PAI Discount or Premium to NAV data by YCharts

Summary

This article hopefully conveys our thought process in recommending a pairs trade to our members. Anyone who owned PAI and swapped to BTZ to would have profited to the tune of ~10% in only 4.5 months (~27% annualized), which is equivalent to about 2.5 years worth of distributions from PAI!

Note that I did not need to do a deep dive analysis of either PAI or BTZ to initiate this pairs trade. This was based almost entirely on premium/discount mean reversion, or as my fellow SA author Arbitrage Trader likes to say, “simple statistics”.

Taking stock of the situation today, the long BTZ/short PAI trade has to be considered to be largely completed, as PAI is now trading with a discount of -4.82% and a 1-year z-score of -1.5, indicating that is now cheaper than its historical average. Although BTZ’s z-score of -2.5 is even lower, as is its discount (-11.9%), the gap in valuation is no longer there.

Are there any current opportunities? The following table shows the 12 CEFs in the database that currently have z-scores greater or equal to +2.5. If you own ones of these funds, if might be a good idea to seek out another fund in the same category that is trading with a more attractive valuation, particularly if the fund that you own is also trading at a premium. Don’t let mean reversion catch you out!

Name Ticker Yield Discount z-score
MS Income Securities (ICB) 2.71% -1.47% 3.9
BlackRock Science and Technolo (BST) 5.32% 3.05% 3.2
Tortoise MLP Fund (NTG) 8.61% 9.26% 3.2
ClearBridge Energy MLP (CEM) 8.85% 5.53% 3.1
Gabelli Utility Trust (GUT) 8.50% 44.95% 3.1
Templeton Emerging Mkts Income (TEI) 3.79% -8.17% 3.1
Sprott Focus Trust (FUND) 4.97% -8.86% 3.0
Nuveen S&P Dynamic Overwrite (SPXX) 5.58% 9.54% 2.9
RiverNorth Opportunities Fund (RIV) 12.09% 6.83% 2.7
Deutsche High Income Oppos (DHG) 5.42% -0.60% 2.6
First Trust New Opps MLP & En (FPL) 10.52% 6.67% 2.5

Western/Claymore Infl-Lnk Opps

(WIW) 3.79% -9.71% 2.5

(Source: CEFConnect, Stanford Chemist)

We’re currently offering a limited time only free trial for the Cambridge Income Laboratory. Prices are going up on March 1, 2018, so please join us and lock in a lower rate for life by clicking on the following link: Cambridge Income Laboratory.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long the portfolio securities.

Can Machines Save Us From the the Machines?

Is it just me or is the cyber landscape getting more scary? Even as companies and consumers get better at playing defense, a host of new cyber threats is at our doorsteps—and it’s unclear if anyone can keep them out.

My doom-and-gloom stems from the dire predictions of Aviv Ovadya, the technologist who predicted the fake news epidemic, and now fears an “information apocalypse” as the trolls turbo-charge their efforts with AI. He points to the impending arrival of “laser phishing” in which bots will perfectly impersonate people we know by scraping publicly available images and social media data. The result could be the complete demolition of an already-crumbling distinction between fact and fiction.

Meanwhile, the phenomenon of crypto-jacking—in which hackers hijack your computer to mine digital currency—has quickly morphed from a novelty to a big league threat. Last week, for instance, hackers used browser plug-ins to install malignant mining tools on a wide range of court and government websites, which in turn caused site visitors to become part of the mining effort.

The use of browser plug-ins to launch such attacks is part of a familiar strategy by hackers—treating third parties (in this case the plug-ins) as the weakest link in the security chain, and exploiting them. Recall, for instance, how hackers didn’t attack Target’s computer systems directly, but instead wormed their way in through a third party payment provider. The browser-based attacks feel more troubling, though, because they take place right on our home computers.

All of this raises the question of how we’re supposed to defend ourselves against this next generation of threats. One option is to cross our fingers that new technologies—perhaps Microsoft’s blockchain-based ID systems—will help defeat phishing and secure our browsers. But it’s also hard, in an age when our machines have run amok, to believe more machines are the answer.

For a different approach, I suggest putting down your screen for a day and picking up How to Fix the Future. It’s a new book by Andrew Keen, a deep thinker on Silicon Valley culture, that proposes reconstructing our whole approach to the Internet by putting humans back at the center of our technology. Featuring a lot of smart observations by Betaworks founder John Borthwick, the book could help us fight off Ovadya’s information apocalypse.

Have a great weekend.

Jeff John Roberts

@jeffjohnroberts

[email protected]

Welcome to the Cyber Saturday edition of Data Sheet, Fortune’s daily tech newsletter. You may reach Robert Hackett via Twitter, Cryptocat, Jabber (see OTR fingerprint on my about.me), PGP encrypted email (see public key on my Keybase.io), Wickr, Signal, or however you (securely) prefer. Feedback welcome.

Swiss watchdog to treat some coin offerings as securities

ZURICH (Reuters) – Switzerland’s financial watchdog will regulate some digital currency fundraisers, known as initial coin offerings (ICOs), either under anti-money laundering laws or as securities, it said on Friday.

The guidelines provide more clarity on the country’s stance toward the hot fundraising method in which Switzerland has become a global leader but whose regulators had not yet weighed in significantly.

ICOs skyrocketed in 2017, reaching nearly $3 billion through September, with Switzerland attracting around a quarter of the money, according to data compiled by cryptocurrency research firm Smith + Crown.

Groups based in Switzerland have launched many of the world’s biggest ICOs.

Regulation has become a hot button issue since the U.S. Securities and Exchange Commission deemed last year that some ICOs could count as securities. Many other global authorities followed suit.

“Blockchain-based projects conducted analogously to regulated activities cannot simply circumvent the tried and tested regulatory framework,” Financial Market Supervisory Authority (FINMA) chief Mark Branson said in a statement.

“Our balanced approach to handling ICO projects and enquiries allows legitimate innovators to navigate the regulatory landscape and so launch their projects in a way consistent with our laws protecting investors and the integrity of the financial system.”

FINMA said regulation would be based both on the purpose digital tokens served as well as whether the tokens were already tradeable or transferable when the ICO took place.

Fundraisers launching digital currencies intended to function as a means of payment, and which could already be transferred, would be subject to anti-money laundering regulations but would not be treated as securities, FINMA said.

Fundraisers launching digital tokens intended to provide access to an application or service would be treated as securities if they functioned as an economic investment.

Access — or “utility” — tokens that didn’t function as an investment and could already be used to access the application at the time they were issued wouldn’t be considered securities.

Fundraisers launching digital tokens that represented assets — like a share in a company, earnings or underlying physical goods — would also be regarded as securities, subject to trading laws and prospectus requirements.

Editing by Michael Shields

Number of crypto hedge funds doubles in four months: Autonomous NEXT data

LONDON (Reuters) – Hedge funds focused on trading cryptocurrencies more than doubled in the four months to Feb. 15, hitting a record high of 226, showed new data from fintech research house Autonomous NEXT on Thursday.

The firm had recorded just 110 global hedge funds with a similar strategy as of Oct. 18, up from 55 funds at Aug. 29 and just 37 at the start of 2017.

Assets under management hit between $3.5 and $5 billion, according to the firm.

Reporting by Maiya Keidan and Jemima Kelly