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This Trade Could Make a Potential 233% Profit in 14 Months

11/30/2013

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MARKET CONDITIONS


         PROFILE:
CurrencyShares Australian Dollar Trust (NYSE: FXA)

By Alan Knuckman, Profitable Trading


The proximity of resource-rich Australia to China makes it an important barometer for the strength of the Chinese economy. Australian dollars were even held as a bullish play on China until the renminbi was liberalized.

The Aussie dollar just hit a fresh two-month low on Monday following Federal Reserve taper talk, but the currency has been sliding for the past week after reports that Chinese manufacturing expanded at a slower pace.

The very strong correlation between the CurrencyShares Australian Dollar Trust (NYSE: FXA) and iShares China Large-Cap (NYSE: FXI) over the past five years has weakened recently. In the past 52 weeks, FXA is off 11% with FXI up 8%.

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FXA has traded in a $20 range between $90 and $110 for more than three years. At present, it has once again retraced to key support at the bottom of the range. The first upside target is a move to the top of the channel at $110, and a breakout above it could eventually lead to a move to $130.
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The $110 target is about 20% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could see a 200%-plus return on a move to that level. One major advantage of using a long call option rather than buying a stock outright is putting up much less capital to control 100 shares — that’s the power of leverage.

But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.
You want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:

Rule One: Choose a call option with a delta of 70 or above.
An option’s strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so.

(In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)

It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they’re worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.

The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option’s delta using an options calculator, such as the one offered by the CBOE.

With FXA trading near $91.75 at the time of this writing, an in-the-money $85 strike call option currently has about $6.75 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option currently has a delta of about 76.

Rule Two: Buy more time until expiration than you may need — at least three to six months — for the trade to develop.

Time is an investor’s greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.

With these rules in mind, I would recommend the FXA Jan 2015 85 Calls at $7.50 or less.

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A close below $90 in FXA on a weekly basis or the loss of half of the option’s premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $750 or less paid per option contract. The upside, on the other hand, is unlimited. And the January 2015 options give the bull trend over a year to develop.

This trade breaks even at $92.50 ($85 strike plus $7.50 options premium). That is less than $1 away from FXA’s recent price. If shares hit the $110 target, then the call option would have $25 of intrinsic value and deliver a gain of more than 200%.

Recommended Trade Setup:

– Buy CurrencyShares Australian Dollar Trust (NYSE: FXA) Jan 2015 85 Calls at $7.50 or less
– Set stop-loss at $3.75
– Set initial price target at $25 for a potential 233% gain in 14 months

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This High-Yield Stock Is A “Strong Sell

11/30/2013

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MARKET CONDITIONS

A lot of the REITS particularly the mortgage REITS are in trouble. The earnings are sliding not because business is bad but because borrowing money has become expensive. The banks have raised their rates and the equity and hedge funds aren't refinancing debt any longer. The REITS cannot borrow enough to make new deals or get better options on their CMOs. A lot of their portfolios are made up of long-term yields which are good for dividends but as rates rise so does the NOI and eventually dividends will be the first area of cuts.

By Eric Dutram, Zacks Investment Research


Mortgage REITs (mREIT for short) have long been favorites of dividend investors, and especially before taper concerns came back into the picture. Securities in this space often pay double digit yields, and with such a sluggish market for income, these were preferred picks by many.

The structure of mREITs also increased their appeal when rates were stable. That is because mREITs generally borrow at short-term rates and then invest in longer term securities. So in this strategy, a big spread between short term and long term rates is key for strength in their business model.

However, as taper talk has resumed the spread has shrunk between these two key figures, while there is a threat of further compression in the weeks and months ahead as well. This has been terrible news for the space and many have jumped out of stocks in this corner of the market as a result.

In particular, one to watch for further losses is American Capital Agency Corp (AGNC).

AGNC’s Recent Earnings
The latest earnings report for AGNC was pretty terrible by any estimation. Third quarter results came in at 61 cents a share, falling well short of the consensus estimate of 84 cents a share. Results also represented a decline sequentially too, as last quarter saw 66 cents of earnings, while the year ago period saw 79 cents a share.

Especially concerning from the report was the average yield on its agency security portfolio, which slumped by 33 basis points down to just 2.59%. Meanwhile, its cost of funds which was more or less stable—down just four basis points—to 1.39%. This means that the interest rate spread declined by 29 basis points to just 1.20%, eating into the company’s profits and future prospects as well.

Live by the dividend, Die by the dividend
Dividends, one of the main reasons to buy a mortgage REIT, have also been on the decline for AGNC. The firm’s Q3 dividend came in at 80 cents a share, a nearly 24% decline from the previous quarter, and when annualized, a huge drop from previous years.

Thanks to declining margins and slumping yields, investors have sold off AGNC in droves. Shares of the company are down more than 30% YTD, and the stock is within striking distance of its 52 week low as well.

Estimates are falling too
And based on the latest earnings report and the sluggish trend in the interest rate market, many analysts seem to believe that the slump isn’t over for AGNC. In fact, analysts have been slashing their forward estimates for AGNC to the bone as of late, suggesting that more pain is on the way.

The magnitude of these revisions has been colossal too, with estimates for the current year falling from $6.92/share 30 days ago to just $4.37/share today. Next year figures are also depressing, with estimates falling from $3.26/share 30 days ago to just $2.60/share today, representing a decline of over 20%.

Due to these factors, and a horrendous history at earnings season—four straight misses of at least 11%– we have no choice but to assign AGNC a dreaded Zacks Rank #5 (Strong Sell). So we are looking for more underperformance from this struggling company to close out the year, and especially so if the interest rate spread compresses even more in the coming months.

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Other Options
Unfortunately, the mREIT industry has a terrible industry rank, coming in at just 229 out of 260, putting it near the bottom 10%. Yet despite this poor rank, there is one company that appears well-positioned in the space and could actually be a decent pick; Ellington Residential (EARN).

This company has a Zacks Rank #1 (Strong Buy) and this actually represents an increase from a week ago when the stock had a Rank of 3. The firm also saw a strong surprise in the previous earnings release, and solid estimate revisions higher too.

So if you are looking to stay in the mREIT space, consider going a little smaller and focusing on EARN. This company has a double digit yield and it could be better positioned than the struggling AGNC at this time.

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Insiders Are Buying Up These 7 High-Yield Stocks -- Should You?

11/30/2013

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One thing rich people like is to stay rich. With that being said, a lot of "gossip" is thrown around at country clubs and exclusive parties.
MARKET CONDITIONS

Some moves are made and the rest of the elite flock follow. People who aren't rich need to be in-tuned with CEO and investor gurus that go on shopping sprees for stock.

You don't need a lot of money to get started; just follow the rich guy's lead. You repeat the process more than several times and eventually, there will be a pot of gold at the end of the rainbow.

By Nathan Slaughter 
  

They say to never trust a skinny cook, the logic being that any chef who works in a kitchen all day and creates irresistible dishes probably can't help but overindulge and pack on a few pounds.

For much the same reason, I find it reassuring when a mutual fund manager invests their personal cash in his or her own fund. And I like it even better when CEOs and other top executives stash a sizable percentage of their net worth in their own company's stock.

Conventional wisdom says that it's a bullish sign when a company invests in itself through stock buybacks. If that's true (and in most cases it is), then what does it say when these same managers sink a few million dollars of their OWN money in the shares?

After all, board members, directors, chairmen and other upper executives know the business and the industry better than anyone else. Who understands the inner workings of Apple (Nasdaq: APPL) better than Tim Cook? Who has their finger on the pulse of online advertising quite like Google boss Larry Page?

These well-connected individuals also have access to privileged information that the rest of us don't get to see. That's not to insinuate anything underhanded; public companies don't have to disclose everything. The point is, when these people act, they do so with good authority.

Personally, I don't pay terribly much attention to insider sales. Can they be an indication of trouble ahead? Sure. But they could also mean that the seller is simply diversifying his holdings or raising cash to pay for his daughter's wedding or grandson's college education. Bottom line, sales aren't necessarily a red flag.

On the other hand, insider purchases tend to be far more instructive. You only invest in a stock for one reason: you believe it's undervalued and headed higher. And again, when a chairman or CFO is the one buying, you can bet they aren't doing it on a whim -- but have sound supporting evidence.

The numbers back this up. There have been numerous empirical studies done over the years to quantify the effect.

A recent study at the University of Illinois found that stocks receiving heavy insider support historically outperform the market by 4.8% in the year following the transactions.

These and other studies examined different groups of stocks under different methodologies. But taken together, they do point to the same conclusion: Stepped-up levels of insider buying often foreshadow market-beating returns.

If one inside buyer is a positive show of confidence, then two or three (or more) all buying in unison sends an even louder message.

With all this in mind, I went in search of stocks that had strong levels of insider ownership relative to the overall share count. And since I'm more interested with insider buying activity that has taken place over the past few weeks or months in anticipation of an upward move or positive catalyst, I screened for stocks whose insider buying volume through the third quarter had shown the biggest surge relative to the same point last year. To tighten up the results, I also looked for companies with steady earnings prospects and, of course, generous current yields (4% or better).

Here are some of the more notable stocks that made the cut.

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When sifting through the results of this screen, a few things became obvious.

There are quite a few midstream energy companies on the list, including one holding I recommended previously in my High-Yielding Investing advisory. Even better, readers were able to pick up the stock at an even cheaper price -- and well before the CEO bought shares on August 9.

The regional banking sector was also well represented. But insiders appeared to be most enamored with private equity and business development stocks. Could that mean that the entire sector has some tailwinds at the moment? I'd say yes. Thankfully, these sectors are all represented in my High-Yield Investing portfolio, and this list should provide a good starting point for readers to conduct further research for winners.
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RIG Readying To Make a Big Splash?

11/30/2013

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MARKET CONDITIONS

Billionaire financier Carl Icahn has wrestled yet another corporate behemoth to the mat, wringing major concessions from senior managers at Transocean (NYSE: RIG), the oil rig giant with an $18.4 billion market cap. This is the second time we have reported on Transocean.
If you took my recommendation then, you probably built
a shrine to me in your home now that the "Icahn Lift" has
occurred. You're welcome.

By Brian O'Connell

Taking another corporate scalp is right out of the Icahn playbook. The Icahn formula is to target a specific company, and start acquiring enough shares to give him controlling interest in the firm, thus making him "first” among company shareholders.

With his new management and board team in place, and with increasingly enthusiastic shareholders and investors pushing the firm's stock price upward, Icahn pads his already deep pockets in the process (he's rumored to be worth $20 billion).

"They call him 'King Carl' for a reason—he's a legend,” notes Vijay Marolia, MBA, CFP and managing partner of Regal Point Capital in Orlando, Florida. Marolia, who has tracked Icahn's investments for years, says that the financier's investment style isn't exactly new—but it is effective.

"In essence, Icahn's a value investor, but he sees value where other value investors don't,” he explains. "He's known as a tough negotiator and you don't want to go against him. I actually have exited a short position solely because he was on the long side, and he has the money and power to do what he wants to do, including turning a losing company into a profitable one."

"His name is so powerful and respected on Wall Street that there's a name for what happens to a stock after he announces that he's buying: it's called the "Icahn Lift,” as the price tends to immediately go higher based just on his reputation and track record,” adds Marolia.

So is that the case with Transocean? I think so, and you can count on a nice bump-up in dividend payouts in the process, as well as a strong long-term portfolio play.

Icahn got four major concessions from the RIG deal that was announced on November 11:

  • He reduced the size of the company board of directors, from 14 to 11, and added two Icahn Enterprises LP (NASDAQ: IEP) insiders, Samuel Merksamer and Vincent Intrieri, to the board.
  • He convinced RIG management to hike the firm's shareholder dividend payout from its current level of $2.24 to $3.00 (although Icahn, holding 6 percent of company shares, wanted the dividend to rise to $4 per share). That dividend payout, representing a 34 percent hike to stockholders, was the first dividend hike since 2011, when the oil rig giant had to turn off the spigots on dividend payouts to pay for legal and regulatory damages stemming from the 2010 Gulf of Mexico oil spill.
  • He jawboned Transocean executives into beefing up the firm's bottom line via a proposed $800 million cost-cutting and operation efficiency campaign (up from the $300 million management proposed).
  • He convinced RIG officials to okay a new master limited partnership spinoff to launch in 2014, thus providing some built-in tax savings for the firm, and locking in even more cash for Icahn after the MLP's initial public offering rolls out next year. The deal fueled an immediate 4 percent run-up in RIG shares, and had some Wall Street energy analysts staking out some aggressive turf on Transocean. Guggenheim, for example, raised its outlook on RIG to $70 per-share, up from $56.
But not all the news coming out of Transocean is that rosy.

Data from inside the company released last week notes that of the 39 deepwater global offshore drilling rigs expected to be dormant in 2014, 14 of them belonged to Transocean. That's a disturbing number, given that most deepwater drilling contracts last five years, and it's a possible sign that oil and gas exploration companies will wait out Transocean in hopes of landing more favorable terms for those drilling leases.

That could happen, but would only be a temporary setback, according to the company. Transocean execs say that the firm will drill 1,250 deepwater wells over the next 12 years, compared with 550 such wells today. The company expects to invest about $1.5 billion to $2 billion in revamping its wells over the next five years, as the average age of a RIG-owned well is 14 years, compared to three years for chief competitors like SeaDrill (NYSE-SDRL).

That's the long-term view, and it's a necessary one to take for Transocean.

In the meantime, Icahn believes he has bought the company some much-needed time, and has made the company's stock story a more compelling one for investors.

"I am especially happy about the commitment to pursue an MLP, raise the dividend and increase margins by $800 million through cost cutting and increased efficiency,” Icahn said in a November 11 statement. "I believe that Transocean is now on the road to realize its great potential.

With Transocean returning to profitability in 2013 (it has posted three straight quarters of profits so far in 2013, with a net income of about $1.17 trillion during that period), Icahn may be on to something.

It wouldn't be the first time that's ever happened.

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Big Profits From Big Data

11/30/2013

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A couple of years ago when "Big Data" was just making headlines, I was asked to consider a CEO position at a big data start-up. 
MARKET CONDITIONS

Although I decided not to take the position, the industry changed my perspective on the value of public sentiment. I saw how companies could position that kind of commodity into a huge revenue stream. I became a pioneer investor in the big data frontier and benefited from that early entry. There are a lot more players in the space now and I recommend you look at the companies that are linked heavily to retail and sports gambling. Don't forget to hedge your equity investment with an option chain.

By Chad Fraser

Big data continues to attract a lot of attention from companies and investors around the world.

Strictly defined, the term refers to a collection of information so large that it's difficult, if not impossible, to process with the hardware and software traditionally used for the job. As a result, we need a new set of tools to manage it. But this definition underestimates both the challenge and the opportunity that big data poses for businesses.

Big Data by the Numbers
The rapid growth in the amount of data we're generating (and collecting) is staggering. Consider the following:
  • The world creates 2.5 exabytes of data every day (1 exabyte = 1 billion gigabytes). Wal-Mart (NYSE: WMT) alone collects 2.5 petabytes of data an hour from customer transactions (or roughly 50 million filing cabinets' worth);
  • 90% of the data that exists today—everything from tweets to readings from electronic sensors in buildings, trucks and weather stations—was created in the last two years alone. The amount of data created in the past 10 years is estimated to be 500 times what was generated throughout the rest of human history;
  • The overall big data market is set to grow quickly in the coming years. According to recent figures from research firm Markets and Markets, the industry will be worth a total of $46.34 billion by 2018. That represents a compound annual growth rate of 25.52%;
  • Research by IT firm Gartner found that businesses using big data technology outperform the competition by roughly 20%.
The sharp increase in the amount of data being generated is the result of two main factors. For one, as our lives become more mobile and digitized, we're leaving a "digital trail” everywhere we go, which includes everything from credit, debit and online purchases to web searches and tweets. At the same time, the price of storage is decreasing. For example, at your nearest electronics store, you can buy an external hard drive that will hold a terabyte of data for less than $70, which was unthinkable just a few years ago.

Big Data Goes Hollywood
Technological advances have made processing this massive stockpile of information possible at lower cost. As a result, more businesses can use it to unlock previously inaccessible patterns in their data archives and use them to improve efficiency and decision-making, and even launch new products to better match consumer tastes.

For example, Netflix (NasdaqGS: NFLX) collects a wide array of data about its millions of subscribers worldwide, including where they stop, rewind and fast-forward the programs they're watching, the devices they're watching them on, their ratings of the shows they view and the searches they conduct. That's in addition to external data, such as information from social media sites like Twitter and Facebook.

Before it launched its original political series House of Cards, Netflix was able to glean that a significant portion of its users had watched the work of David Fincher, the series' director, from beginning to end (Fincher was also the director of the film The Social Network). It was also able to crunch the numbers on movies starring lead actor Kevin Spacey, as well as the British version of House of Cards. Both of those had drawn positive responses from viewers, as well.

Based on this data from its viewership, Netflix was able to make a number of conclusions about the new series—including that it had a strong chance of being a hit.

Other uses for data analytics include creating coupons targeted at specific customers based on their particular purchasing patterns. Many companies are also tracking and analyzing tweets, status updates and other feedback on social media to develop new products to take advantage of rising trends.

Some Big Data Stocks to Watch
Roughly 80% of the world's data is unstructured, making it more difficult to analyze than information tucked away in databases or other, better-organized formats. That's where data analytics software comes in. Here's a look at two companies with growing presences in the space.

  • IBM's (NYSE: IBM) big data products include its big data platform, which consists of applications that let users store and analyze large amounts of information. Other features also include stream computing capability, which lets users analyze data as it comes in and act on it right away.

    The company has made a number of acquisitions in the analytics space. Arecent one is U.K.-based Daeja Image Systems. This privately held firm makes software that lets users view documents and images in a range of formats, even if they don't have the application that created the file. That saves time and allows for easier sharing. 

    Daeja's customers operate in a number of industries, including banking, insurance and health care. Terms of the deal were not disclosed. Through the first three quarters of 2013, IBM's business analytics revenue is up 8% from a year ago. 

    In its latest quarter, the company's overall revenue was down 4.1%, to $23.7 billion, while earnings before one-time items rose 10%, to $3.99 a share. That beat the consensus forecast of $3.96 a share, though revenue missed the Street's expectation of $24.75 billion.
  • NetApp (NasdaqGS: NTAP) sells systems and services that help companies store, manage, protect and archive their data. In the second quarter, the company controlled 13.3% of the external (networked) storage market, up from 13.3% a year ago, according to IT research firm IDC. That's good for second spot, behind market leader EMC Corp. (NYSE: EMC), with 31.3%.

    Among the company's products is the Data ONTAP 8 data storage operating system which helps IT departments improve efficiency by making better use of their data storage infrastructure. It also lets them perform maintenance and upgrade software without disrupting company operations.

    In NetApp's fiscal 2014 first quarter, which ended July 26, its revenue rose 5.0% from a year earlier, to $1.52 billion. Without one-time items, earnings came in at $0.53, up 26.1% from a year ago and ahead of the $0.49 that the Street was expecting. Revenue missed the consensus forecast of $1.53 billion.
The big data space continues to evolve quickly. Some other firms to keep an eye on in this area include EMC Corp. (NYSE: EMC), General Electric (NYSE: GE), Teradata (NYSE: TDC), and Oracle (NYSE: ORCL), to name just a few.
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Currency Investing: An Alpha-Rich Environment

11/29/2013

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MARKET CONDITIONS

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Mark Whitmore explains, most investors steer clear of currency markets, thinking this market is for traders who must stay awake at all hours, keeping "one eye open," moving in and out of positions in the dead of night. He makes a compelling case instead for patient, long-term investment in currencies.

What makes Whitmore's article timely and thought provoking is the ongoing tug of war between inflation and deflation. Central banks around the world are desperate to spark some price inflation to help their debt-burdened governments and businesses. Printing more money makes existing money worth less and lessens the burden of debts owed.

It hasn't been so simple, though. While the Federal Reserve, the Bank of Japan, and the European Central Bank buy debt securities and grow their balance sheets attempting to light inflationary fires, the velocity of money (GDP/M-2) and the money multiplier (M-2/monetary base) have slowed to a crawl.

In September of 2008, when the financial world crashed, velocity was 1.89 and the money multiplier was 8.61. Five years later, velocity is 1.54 and the money multiplier is 3.10. These are the lowest readings for either ratio since the Federal Reserve started keeping the relevant data.

While the tinder is there to create a hyperinflation brushfire, the still-crippled commercial banking industry isn't lending. So, money multiplication in the US is slow going. The other major central banks have had no better luck getting prices to move.

Whitmore has been investing currencies for decades. He is the chief executive officer of Whitmore Capital Management and manages Whitmore Capital, a currency-based hedge fund. As he illustrates in his piece below, there is a patient and disciplined approach to currency investing that can plug a hole in your portfolio diversification.



By Mark Whitmore, Whitmore Capital Management

Having primarily invested in currencies for over a decade now, both personally and recently as a fund manager, I do not think there is an asset class that is less understood. The most common misconception is that the currency markets are for traders, not investors. To be successful, one must sleep with "one eye open," nimbly entering and exiting positions throughout the day and night. I take the opposite view: Currency trading is at best an uphill battle, while currencyinvesting can provide investors superior opportunities for profit.

The Case for Currencies as an Asset Class

Some simply dismiss currencies as an asset class since all countries have fiat-based legal tender. The argument goes that since no currency is backed by gold or any other precious metal whose supply is constrained, all currencies are simply confetti—poised for debasement ad infinitum.

However, it does not follow that because fiat-based currencies are prone to debasement, they do not offer strong investment opportunities. What those who stress the perils of investing in paper currencies often fail to appreciate is this: The operative question should not be whether a particular currency is subject to debasement on an absolute basis, but instead whether a particular currency is more or less prone to debasement on a relative basis.

The modern era of untethered legal tender, beginning with Nixon abandoning the gold standard in 1971 and culminating in 2000 with Switzerland becoming the final nation to remove its currency from even being partially backed by gold, has created even greater investment opportunities in foreign exchange. Up until 2000, the range of central banking activities related to monetary expansion was much more limited, both in terms of qualitative policies and quantitative actions. Now, the disparities between the merely reckless central bankers and the central bankers who are reckless with extreme prejudice are made manifest.

Failing to appreciate the fact that significant disparities exist in the monetary policies of, and economic prospects for, different countries is to forgo the chance to potentially profit as future currency prices reflect those differences. To paraphrase Orwell, when it comes to investing in a world in which there is nothing but fiat money, while all currencies are equal, some currencies are more equal than others.

The standard case for including currencies as part of a diversified portfolio is twofold. First, currency investing has exhibited very low correlations to other asset classes, making it attractive for those looking to reduce portfolio volatility as well as potentially increase risk-adjusted returns. The second, more interesting, argument is that since a huge percentage of foreign exchange turnover comes from non-profit-seeking actors aiming to hedge currency exposure, market pricing may be prone to "inefficiencies" that can be exploited.

Personally, I think the latter argument mischaracterizes the potential profit opportunities the currency market offers. Perhaps the greatest debate in all of academic finance is whether it is possible to "beat the market" and generate positive alpha, or whether all such outperformance is explained by random distribution. Basically, the efficient market theorists and their ilk contend that markets factor in all relevant information in determining asset pricing. This means that the market price is the "right" price, making the expected profit of speculation into any given asset to be no greater than what the broader market for the asset itself would generate.

At least as it relates to currency markets, efficient-markets theorists are most certainly correct when it comes to the degree to which currency markets factor in virtually all relevant information, yet they may still be answering the wrong question. The key issue is not whether market pricing is the "right" price, but rather is it the right price for whom? I contend that foreign exchange markets have a persistent bias towards pricing that reflects almost exclusively the short-term prospects for currencies.

This presents currency investors with a longer time horizon the opportunity to take advantage of disparities between the current price of currencies and their fundamentally derived fair value, towards which currencies should gravitate over time.

Currency Strategies—One Tortoise for Every 220,000 Hares

Hedge funds and large commercial banks with proprietary currency desks have at their disposal virtually unlimited resources to expend in research and analysis. It would seem that an individual expecting to successfully "outmaneuver" these institutions when attempting to place currency trades would be a case study of hope triumphing over reason.

The evidence concerning retail currency trader track records would seem to confirm my suspicion that these traders are playing a game where the deck is stacked against them. The social network investing site eToro reports that about 90% of currency traders lose money.

Yet despite the obvious hurdles associated with currency trading, a large and growing percentage of the volume in the currency markets is from participants who anticipate holding their positions ephemerally. The Bank for International Settlements estimates that approximately 25% of all spot market volume in 2010 was from High Frequency Trading (HFT) sources, and that almost 80% of foreign exchange swaps were held for less than one week. The Aite Group estimates that by the end of 2012, HFT increased to 40% of spot market volume.

The structure of the futures market also manifests an extreme indifference among market participants towards longer-term investments in currencies. A review of the Chicago Mercantile Exchange data for August 2013 shows that of the $75,000,000+ in notational value of pound/yen (GBP/JPY) futures traded over a one-week period, not a single contract was bought or sold beyond September 2013. Even euro futures, the most popular and liquid currency future to trade, had less than 0.3% of its total futures contracts traded on August 13th go beyond one month out.

Shockingly, only one contract out of more than 220,000 euro futures that were traded that day extended into the first quarter of 2014!

Currency markets' pricing dynamics may thus offer long-term investors an advantage. After all, when it comes to having an edge against your competitors, it helps if they simply forfeit every game. With the vast prevalence of computers, money managers and individual traders making extremely short-term bets based upon non-fundamental factors, momentum and the reaction  to "noise" are the chief determinants in the day-to-day pricing of currencies.

"Big picture" considerations that impact a currency's longer-term movements consistently fail to be reflected in market pricing. This creates fantastic opportunities for the handful of tortoises in the currency markets as they can bet against the momentum players who often push currency prices to unsustainable extremes.

A Model for Dynamic, Value-Based Currency Investing

If fiat-based currencies are actually a boon to investors, and currency markets can be profitably exploited in the longer term, what are the tools required for successful currency investing?

When I left the practice of law to pursue investing full-time in 2002, I was convinced there were huge opportunities for profiting in the currency markets if one employed a long-term, disciplined approach that was based on weighting macroeconomic variables and using regression analysis to somewhat frequently rebalance one's portfolio as prices and data constantly changed. Developing such a calculus became my passion and focus. While I have refined the model significantly over the years, its essential elements have remained unchanged.

What Benjamin Graham observed about the stock market is true a fortiori about the currency market: In the short run it is a voting machine, but in the long run it is a weighing machine. A wide variety of fundamental factors affect currency valuations. Personally I use roughly ten key macroeconomic variables, weighted based upon my observations on how significantly they impact currency prices over time. Perhaps the most intuitive and obvious is that of purchase power parity (PPP). Investors should select relevant macroeconomic variables by determining which ones, should they change, would make a currency more or less desirable to hold, ceteris paribus.

A critical element of my approach is dynamic scaling of positions. Once we can assess approximate fair values for currencies based upon their fundamentals, designing a currency investment portfolio becomes a matter of weighting most heavily those currencies that have the largest gaps between their market price and fair value. I take positions in no fewer than fifteen currencies, and usually closer to twenty, so as to ensure reasonably broad diversification.

Due to the fact that pricing in the currency markets can be quite fluid and dynamic, it is absolutely imperative that one somewhat frequently rebalance such a currency portfolio to reflect changes in pricing and even fair value. For instance, while the yen was Whitmore Capital's largest short one year ago, it is now not even one of the Fund's five largest shorts after its 20% decline in value versus the dollar.

Discipline and Patience

One of my favorite movies of the 90s is Bryan Singer's neo-noir thriller, The Usual Suspects. The film centers on an interrogation of Verbal Kint (played masterfully by Kevin Spacey) after he is witness to a port massacre. Eventually it is revealed that Keyser Söze, a criminal boss of almost mythical stature, is responsible. In detailing the unspeakably cruel and vicious things Söze had done over the years, Kint noted that Söze's great revelation was that, "To be in power, you didn't need guns or money or even numbers. You just needed the will to do what the other guy wouldn't."

While in a far more benign context, I find this observation to be extremely relevant to investing in foreign exchange markets: I am increasingly convinced that the most important characteristic a currency investor can possess if he hopes to achieve great success is the will to do the one thing that the money management industry and the vast majority of investors cannot countenance—lose money.

Inherent in the strategy I favor is the need to increase exposure to currency positions as they go against you. It requires discipline and patience, two things that most investors (and hence money managers who answer to them) have shown time and time again not to possess.

While seeing "cheap" currencies you own get cheaper (or having overvalued currencies you are short become even dearer in price) may seem unwelcome at the time, dollar-cost averaging into losing currency positions has proven to be the most profitable strategy I have employed throughout the years.

When the totality of fundamental factors for a particular currency is at extreme levels of overvaluation or undervaluation, I have found that price movement towards fair value is all but inevitable. But something being inevitable does not make it imminent. I see this as "when, not if" investing, but the question is whether an investor will have the stomach and the liquidity to weather what can be significant and seemingly interminable rallies in the other direction.

The importance of being willing to lose money in the short run to ultimately profit has been made clear to me on a repeated basis. Each of my most successful currency investments had either large initial losses or endured countertrend rallies that caused significant, but temporary, losses in the midst of a secular move. In one instance, the USD broadly increased in value more than 10% right in the midst of its 2001–2008 secular decline (see Figure 1).

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Despite that, a disciplined, patient currency investor stood to profit nicely as the dollar declined more than 20% from its 2005 countertrend rally peak.

I cannot stress enough how investing in currencies is fundamentally different from trading them. Perhaps the most evident way in which they differ relates to the concept of discipline. In the trader's lexicon, the concept of discipline has a manifestly Orwellian doublespeak component. One is constantly encouraged to set tight stop-losses on orders, never letting losses "run."

From my experience, this is exactly the opposite behavior one would expect from a disciplined investing strategy. Indeed, using conventional trading discipline, I would have been stopped out of many of my short USD holdings in 2005, thus failing to maintain positions that were ultimately quite profitable.

Currency Opportunities Today

I am of the opinion we are in the most treacherous investing environment since the 1970s as the tug of war between inflation and deflation plays out in the global economy. While too vast of a topic to address here, in sum, we are left to consider the odds of what looks to be a distinctly bi-modal global economic future. It thus strikes me as prudent to execute currency investments in a manner so as to limit downside exposure in the event the world economy breaks in one direction or another.

Accordingly, my favored currency strategy at the moment is to find currency pairs whereby one is much more attractively priced than the other, yet both would move in a similar fashion no matter what the economic environment.

Both the Russian ruble (RUB) and the Turkish lire (TRY) have historically performed very poorly in financial downturns, and tend to appreciate when global economic complacency is high. But whereas Russia has almost no national debt (a pleasant result of going through a sovereign debt collapse, I suppose) and significantly positive current account balances, Turkey has about the worst current account balances of any country whose currency is significantly traded.

But Turkey's vulnerability to external financing shocks is even graver. As of July, Turkey's central bank reported its foreign reserves as a percentage of GDP stood at roughly 15%, putting Turkey in the lower ranks of emerging market nations. By way of comparison, Russia's foreign reserves as a percentage of GDP is 65% higher, coming in at approximately 25% (see Figure 2).

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Other fundamental factors favor the ruble as well. Whereas Russia has a marginally positive real interbank interest rate level, inflation in Turkey exceeds its interbank interest rate by a substantial 4%. Finally, on a PPP basis, Turkey is shockingly expensive, particularly if one properly adjusts for standards of living. While Moscow is ridiculously expensive, prices in most other places in Russia are quite attractive. Thus RUB/TRY positions should appreciate in any economic environment in the medium to long term, with the RUB declining less than the TRY if markets are down, and the RUB increasing more than the TRY should markets continue to appreciate.

Another pair that appears to be a good risk-reward play is the Australian dollar (AUD)/New Zealand dollar (NZD). The NZD looks to be the most vulnerable to a significant correction among the dollar-bloc currencies. Its current account deficit as a portion of GDP is approaching 5%, while Australia recently reported a yearly current account deficit at less than 3.2%. Should asset markets become roiled once again, this level of a structural deficit in New Zealand's current accounts could be seen as an acute vulnerability.

Moreover, when adjusting for wage inputs, the NZD looks even more overvalued than the AUD on a PPP basis. The NZD is also still trading very near its all-time highs versus the dollar, whereas the AUD has recently pulled back more than 15% from its all-time USD highs. As a contrarian, I like the fact that the AUD is utterly despised. (In August, non-commercial traders had the largest net short position against the AUD in years.) Finally, should the precious metals complex eventually recover some, the AUD would be likely to get a little bit of a tailwind at its back compared to the NZD.

Given what I perceive to be a long history of foreign exchange markets offering relatively obvious opportunities for significant profit to the patient and disciplined investor, I am somewhat shocked that currencies continue to be almost completely overlooked as an asset class.

I just recently reviewed a model portfolio for high net worth individuals that had more than fifteen components. There was even 3% devoted to "trade finance receivables." Yet not a sliver was devoted to currency holdings.

I suspect that as a fund manager I will never have a plethora of competitors in the realm of longer-term currency investing. Nevertheless, for those investors willing to play a little outside the lines of traditional asset allocation, currency investing offers the opportunity to obtain both significant portfolio diversification and the prospect for excellent returns.

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The World's Cheapest Market

11/29/2013

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Don't miss the insightful interview with Chris Mayer on The Radio Blog. Frank Curzio gets him to open up concerning FOREX, precious metals and market sentiment. 

PictureChris Mayer
By Frank Curzio, editor, Small Stock Specialist 


If you want to make money investing abroad, I suggest you listen to Chris Mayer. Chris is the editor of the Capital & Crisis newsletter. He spends most of his time traveling to developed and non-developed nations in search of the next big idea. In the last five years, he's visited over 30 countries.
 
I caught up with Chris this week and he talked about the huge long-term potential in places like China and Africa. But one of his suggestions caught me by surprise. Chris is putting money to work in Russia.
 
Russia is dirt-cheap. As measured by the RTS Index (a capitalization-weighted index made up of the highest-capitalized stocks in Russia), Russian stocks trade at about six times earnings and pay a 4% yield. Russian stocks are so cheap because no one wants to invest there.
 
Russia is known as a tough place to do business. Last year, Russia ranked 133 out of 176 countries on the Corruption Perceptions Index. And the National Anti-Corruption Committee estimates that the cost of bribes and nepotism in Russia totals $300 billion each year.
 
But Chris sees a huge opportunity to make money... You see, the last time Russia traded at these valuations was in 2009. And Chris told his subscribers to buy the Market Vectors Russia Fund (RSX). RSX holds a basket of Russia's largest companies.
 
At the time, RSX was trading at $12 a share. In just 24 months, RSX rose to $40.That's a gain of more than 230%.

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Today, Chris calls Russia "the world's cheapest emerging market." And he suggests investors put money back to work in RSX.
 
Chris believes we could see similar gains over the next 24 months buying RSX right here. More important, with the index trading at just six times earnings, the downside risk is limited. He has one of the best track records for investing abroad. And the last time he recommended investing in Russia, his subscribers saw huge gains.
 
I suggest following his advice this time around. At current valuations, Russian stocks look like a steal.
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Reinventing an Asset Class

11/9/2013

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Betting on technology is not for the faint of heart. As any Silicon Valley venture capitalist will tell you, many technologies never cross the "valley
of death," the divide between technology creation/invention and early commercialization.


But income investors, accustomed to staid, low-risk utilities, are at a historical juncture. In the coming year, they may be forced to make some venture capitalist type decisions about which utilities have the best technologies to comply with new Environmental Protection Agency (EPA) emissions standards, should they be enacted.

In early July, we wrote about how the Obama administration was moving to have the EPA enact carbon regulations on existing and future power plants, and how this forever could change the valuations of low-carbon versus high-carbon utilities.

President Obama has said his initiative would seek to reduce US greenhouse gas emissions to 17 percent below 2005 levels (comparable to previous programs) by the end of the decade. And he plans to implement various other policies that would incentivize a doubling of renewables by 2020, as well as new incentives for more transmission, efficiency tech and biofuels, for example.

And so on Sept. 20, EPA Administrator Gina McCarthy proposed a rule for new coal plants that set such a high standard on carbon emissions that it essentially forces utilities to incorporate carbon capture and sequestration technology (CCS) into all future coal plants.

This rule says a new coal plant must be able to emit at a rate of no more than 1,100 pounds of carbon dioxide per megawatt hour (CO2/MWh). That is far below an estimated 1,700 pounds of CO2/MWh to 1,900 pounds of CO2/MWh for the most efficient plants currently in operation anywhere.

A new plant that uses CCS would capture carbon from the smokestack, inject it underground and either store it or use it in an oil-recovery process. The average US coal plant emits 1,768 pounds of CO2/MWh, so coal plants would have to capture and store 20 percent to 40 percent of the CO2 they produce. Cleaner-burning natural gas plants won't be required to capture their emissions.

Power producers had urged the EPA to set the standard at 1,800 pounds or higher. Standards for new power plants will give coal-fired producers an option to meet a "somewhat tighter limit" if they choose to base compliance on an average of their emissions over a multi-year period.

According to the EPA, these rules will ensure new plants are built with "available clean technology to limit carbon pollution," a requirement in line with investment in clean-energy technologies already taking place across the industry.

Technology: Faith vs. Fact

There are a lot of big names that have faith in CCS technology. The question is whether the cost of compliance with new EPA standards by using this technology will significantly reduce earnings in comparison with utilities that have more natural gas, nuclear, renewables and other low-carbon energy resources.

As it stands, according to research completed by your correspondent's predecessor firm, consultancy Green Edison, the value proposition should shift toward low-carbon utilities in the short term.

The Top Low-Carbon Utilities

  1. PG&E Corp (NYSE: PCG)
  2. Exelon Corp (NYSE: EXC)
  3. Entergy Corp (NYSE: ETR)
  4. Public Service Enterprise Group Inc (NYSE: PEG)
  5. NextEra Energy Inc (NYSE: NEE)
  6. Dominion Resources Inc (NYSE: D)
  7. Sempra Energy (NYSE: SRE)

But that is not to say that, over the long term, high-carbon utilities might not be able to crack the technology and cost issues that would make "clean coal" competitive with other low-carbon energy sources. Secretary of Energy Ernest Moniz has said, "No discussion of US energy security and reducing global CO2 emissions is complete without talking about coal and the technologies that will allow us to use this resource more efficiently and with fewer greenhouse gas emissions."

And we know that even without such technologies, global coal use will be on the rise. But less certain is whether US utility investors will stick around while the domestic coal industry perfects carbon capture.

According to the US Energy Information Administration's International Outlook, world coal consumption will rise at an average rate of 1.3 percent per year, from 147 quadrillion British thermal units (Btu) in 2010 to 180 quadrillion Btu in 2020 and 220 quadrillion Btu in 2040.

The forecast for near-term demand reflects significant increases in coal consumption by China, India, and other emerging markets. Over the long term, growth of coal consumption decelerates as policies and regulations encourage the use of cleaner energy sources; natural gas becomes more economically competitive as a result of development in the shale plays; and growth of industrial coal use slows largely due to China's industrial activities (See Chart A).

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In fact, Thomas Fanning, the CEO of Southern Company (NYSE: SO), which is building a CCS plant at its facility in Kemper County, Ga., has warned the EPA that the cost of building this plant should not be used by the agency as indicative that the technology is proven. Southern has argued that even at $4.8 billion, which with cost overruns is now double the project's initial estimate, the Kemper plant would still be cheaper than others proposed, given the location of the plant in proximity to coal reserves and where the CO2 will be used for enhanced oil recovery.

Indeed, one critic of the EPA's proposed rule says that the agency has jumped the gun, at least for coal, arguing that CCS technology has not been adequately demonstrated, and its implementation costs are not reasonable. "The EPA is abusing natural language to suggest projects which have not yet entered into service, some of which are still on the drawing board, somehow prove the technology is viable and can be implemented cost effectively." The Clean Air Act requires the EPA to pay due attention to costs and technical feasibility when it draws up new standards.

But even as the industry argues over the costs, there are also some unresolved issues regarding potential legal liabilities resulting from the storage of carbon in non-oil and gas areas such as aquifers, not to mention the continued debate as to whether storing carbon in the ground is even an ideal approach. And capture and storage is where the greatest amount of emissions reductions can be achieved, so this is a fundamental question with respect to the technology.

There have been concerns raised in the past that cracks or leaks in the underground cavities could lead to dangerous gasses escaping to the surface. That happened in 1986 when a naturally occurring carbon dioxide leak led to the death of 1,700 people at Lake Nyos in Cameroon.

Furthermore, transporting CO2 from factories and other facilities to safer storage units would require long pipelines, and residents in these areas fear that faulty pipes could lead to the uncontrolled release of dangerous fumes. Others have argued that captured carbon emissions from coal plants should be used to grow algae as part of a move to a new biofuel that would support the industrial manufacturing and transportation sectors, eliminating the need for storage.

Income Investor or Venture Capitalist?

This implementation of new environmental rules will be similar to decades past when investors had to choose the winners and losers of electric deregulation, or between A/C or D/C technology, which was known as the War of Currents.

Almost like venture capitalists, investors will have to choose which utilities they believe will be best at commercializing new technologies while being the lowest cost producer.

But never fear if you find this a daunting task. As in previous years, we will be with you every step of the way, advising you on which utilities will provide the best opportunities for both growth and income.

This article originally appeared in the Utility & Income column. Never miss an issue.
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Time To Consider Flushing

11/9/2013

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Risks to Consider: No matter how many hedge funds are buying or how strong the technical and fundamental pictures are, all stock investing involves risk. Unforeseeable "black swan" events could occur at any time. Always use stops and position size correctly when investing.

Action to Take --> Buying shares now on the pullback with stops right below the 200-day moving average in the $16.50 range makes good sense. My six-month target price is $23.
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Are These The Big Dividend Gainers Of 2014?

11/9/2013

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As I regularly scan the Wall Street Journal, I sometimes come across an eye-catching headline. Merrill Lynch's recent report on agricultural equipment provider Agco (Nasdaq: AGCO) is a great example: "Margin Upside, Divy Could Soar, Raising Estimates." It's the middle part that got my attention. 

Merrill's analysts noted the dividend could be poised for a big change: "AGCO currently pays out only 7% of earnings per share (EPS) in the form of dividends. The dividend could triple in the next few years on flat EPS of $6 if the company simply goes to a 20% payout ratio."

What those analysts didn't say: Many companies pay out 40% or more of their income to dividends, which means the dividend payments could actually swell far higher than these analysts suspect.

The Revolution Is Already Underway
Have the executives at Agco been under a rock these past few years as other companies have already sharply hiked their payouts? No, they just wanted to show an extra dose of patience before making such a big move. After all, it feels as if we're not far removed from many recent global crises.

Yet Agco, like many other firms, now sees that the U.S. and Europe, which still account for half of global GDP, are proving to have increasingly resilient economies. And you can see the confidence in the form of improving financial projections: In its view of Agco, for example, Merrill Lynch foresees "further opportunity for margin expansion in coming years based on the company's numerous internal initiatives," predicting free cash flow will rise nearly 150%, to $570 million, by 2015.

Not Yet On The Radar
As Agco's dividend currently yields just 0.6%, most income-focused investors still haven't looked at this company. A tripling of the dividend would simply push the yield into respectable (but not great) territory. But what about companies that have decent yields now, but are poised for great yields in the years to come?

I went in search of stocks that currently yield more than 1%, but could be yielding 3%, 4% or even 5% in a few years. To find them, I focused on companies with very low payout ratios. Of all the companies in the S&P 500, 400 (mid-cap) and 600 (small cap), these are the companies with the lowest payout ratios with a current dividend yield of at least 1%.
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Of course, investors may want to seek out companies that already offer more appealing yields but are in a position to boost their dividends at a still-strong pace. Looking at that same group of 1,500 companies, here are the highest current yielders that have a payout ratio below 30%.
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You'll notice that women's apparel retailer Cato Corp. (Nasdaq: CATO) makes both lists. The company is what we call a "Hidden High-Yielder." Go to any popular financial website, and it will appear as if Cato pays annual dividend of a paltry $0.20 a share. But looks are deceiving. Cato likes to maintain a conservative formal dividend, but often manages to slip in irregular dividend payments that can start to really add up.
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In its most recent fiscal year, Cato delivered an extra $1-a-share dividend ahead of looming changes in the tax code, so don't look for a similar payout this year. But if history is any guide, future annual dividends will be a lot closer to $1 a share, and not just the $0.20 a share that many websites will tell you.

Dow Chemical (NYSE: DOW) is another example of a company positioned for robust dividend growth, thanks to an ongoing balance sheet transformation. The chemical giant had been carrying an ungainly balance sheet, as long-term total debt rose to $20.6 billion by the end of 2010.

Yet Dow now appears committed to shrinking that debt load: It's already less than $17.5 billion and should sink below $15 billion over the next two years, according to management. As debt moves to more manageable levels, look for Dow to shift its focus toward dividends. The payout has already been boosted from $0.60 a share in 2010 to a current $1.28 a share (good for a 3.3% yield).

But the smaller debt load should enable Dow Chemical to double its payout ratio in coming years, setting the stage for a dividend yield above 6% (if you lock in at today's stock prices).

Risks to Consider: We're in the midst of a steady expansion in payout ratios, but companies tend to reduce their dividends when the economy contracts, as was the case in 2008. So keep an eye on the broader economic environment in which each of these companies operates.

Action to Take --> Certain industries predominate the "low payout ratio" theme. Banks and insurers, many of which are only now sufficiently capitalized to satisfy regulators, stand to pay solid attention to their dividends in coming years. Insurers Chubb (NYSE: CB), Unum (NYSE: UNM), Assurant (NYSE: AIZ) and Protective Life (NYSE: PL), for example, all have payout ratios below 20% (and typically trade below book value as an added value kicker).

If you're in search of stocks that can offer robust dividend growth, simply calculate how much of their current earnings are geared toward the dividend. If the payout ratios are below 20%, and cash flow appears to be stable and growing, then you may be looking at some of the dividend stars of 2014.
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