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A Few Reasons To Remain Invested In American Electric Power

Summary American Electric’s fundamentals and valuation are favorable. American Electric is employing a number of strategies to improve its operational efficiency, and is also expected to invest aggressively in infrastructure projects. American Electric is expected to grow at a faster rate than the industry average. Electric utility company American Electric Power (NYSE: AEP ) has turned out to be a profitable investment so far this year. The company’s stock has done better than the S&P 500 index, gaining 28% so far. But, the god thing is that American Electric still remains a good investment due to its strong fundamental position and sound strategies that will help it improve further. Fundamentals are strong Trading at 16.33 times last year’s earnings, American Electric is cheaper than other players in the industry. Moreover, in the future, it is expected that the company will see better growth in its bottom line. In the previous five years, American Electric has clocked an annual earnings growth rate of 4.81%, and in the next five years, the growth rate is expected to improve to 5.2%. In comparison, the broader industry’s earnings are expected to improve at a rate of just 1.23%. Hence, American Electric is expected to grow at a faster rate than its peers. In addition, American Electric’s cash flow and dividend are appealing. The company carries a yield of 3.60% at a payout ratio of 55%. Now, since its bottom line growth is expected to be strong, it should be able to sustain the dividend. Moreover, American Electric has generated impressive cash flow numbers in the past twelve months. Its operating cash flow stands at $4.8 billion, while levered free cash flow is $287 million. As such, American Electric is in a fundamentally strong position considering the above argument. Strategies are sound Going forward, the company’s strategies should ensure that it continues to get better. American Electric Power is executing on its plan of expanding the transmission business model, and it is allocating an extra $100 million of incremental capital in 2014 for the model. Looking ahead, American Electric has approximately $2 billion of incremental transmission projects that will be executed in the coming four years. Also, to make operations more efficient, American Electric has deployed trucks at the Cardinal Plant for loading the entire welding materials at one place, and thus saving much of the time to transport and get inventory for parts. The time saved can be utilized in attending to tube leaks and alternate areas to get back the generation quickly. At the South Ben storage yard, it is simplifying and organizing storerooms and toolkits for improving the work times. The creation of new documents by the engineering group will also allow for accelerated response for projects to its customers for enhancing the customer experience. In addition, the Cook Nuclear plant is undergoing a first of its kind LEAN activity, and American Electric has already reduced the duration for targeted re-fueling, along with the costs related to it. Hence, the company is focused on reviewing several processes to eradicate redundant activities, along with the ones that fail to add value. Also, American Electric has evaluated a barge unloading system at the Amos Plant, which has resulted in an estimated investment of $6 million. It is estimated that this move will reduce coal costs by $10 million per year. Moreover, the company has decided to wash the flagging vests in the APCo Charleston area, thus saving $6,000 per year for a single employee, amounting to a total of $120 million of savings for 20,000 employees of the company. Risks to consider However, there are certain risks that investors will be taking on if they invest in American Electric. First, the company has a very weak financial position. Its cash position is weak at $299 million as compared to the total debt of $19.34 billion. In addition, a current ratio of 0.70 indicates weak short-term liquidity. A look at the graphic below indicates American Electric’s financial position as compared to industry peer Duke Energy (NYSE: DUK ). AEP Debt to Equity Ratio (Annual) data by YCharts Hence, American Electric has a pretty high debt-to-equity ratio as compared to Duke, while the current ratio is also lower than Duke. As such, American Electric will need to continue growing its earnings and cash flow at a good pace in order to improve its financial position. But, the good thing is that American Electric is well-positioned to improve its earnings, as analysts expect its bottom line at a rate of 5.2% for the next five years as compared to the industry average of 1.3%. Conclusion Hence, there are a number of reasons for investors to remain invested in American Electric. The company’s fundamentals are sound, it is focused on delivering more efficiency, and it has lined up investments to make the business better. As a result, though the stock has performed impressively this year, it is likely that it can deliver more gains going forward.

CWI Has Solid Diversification In Every Way, If Investors Will Pay For It

Summary I’m taking a look at CWI as a candidate for inclusion in my ETF portfolio. The expense ratio is high for my taste, but the diversification is great. The correlation to SPY is based on high trade volumes and a long sample period. I’d be cautious about entering at a premium to NAV since I don’t expect those premiums to be maintained indefinitely. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the SPDR MSCI ACWI ex-US ETF (NYSEARCA: CWI ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. What does CWI do? CWI attempts to track the total return (before fees and expenses) of the MSCI All Country World Index ex USA. At least 80% of the assets are invested in funds included in this index, or in ADRs representing the assets in the index. CWI falls under the category of “Foreign Large Blend”. Does CWI provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I start with an ANOVA table: (click to enlarge) The correlation is moderate at 86.6%. I’d like to see a lower correlation on my international investments, but this is still low enough to provide some diversification benefits. Extremely low levels of correlation are wonderful for establishing a more stable portfolio. I consider anything under 50% to be extremely low. However, for equity securities an extremely low correlation is frequently only found when there are substantial issues with trading volumes that may distort the statistics. Standard deviation of daily returns (dividend adjusted, measured since January 2012) The standard deviation is moderately high. For CWI it is .8916%. For SPY, it is 0.7300% for the same period. SPY usually beats other ETFs in this regard, so this isn’t too absurdly high for another ETF. The combination of the high standard deviation and correlation being at 75% mean I probably won’t consider this ETF for anything more than 5% to 10% of my ETF portfolio. Liquidity looks fine Average trading volume has been high enough that I’m not concerned. The average was around 300,000 shares per day. Mixing it with SPY I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and CWI, the standard deviation of daily returns across the entire portfolio is 0.7835%. With 80% in SPY and 20% in CWI, the standard deviation of the portfolio would have been .7438%. If an investor wanted to use CWI as a supplement to their portfolio, the standard deviation across the portfolio with 95% in SPY and 5% in CWI would have been .7325%. Why I use standard deviation of daily returns I don’t believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations. Yield & Taxes The distribution yield is 3.12%. The SEC yield is 2.22%. That appears to be a respectable yield. This ETF could be worth considering for retiring investors. I like to see strong yields for retiring portfolios because I don’t want to touch the principal. By investing in ETFs I’m removing some of the human emotions, such as panic. Higher yields imply lower growth rates (without reinvestment) over the long term, but that is an acceptable trade off in my opinion. I’m not a CPA or CFP, so I’m not assessing any tax impacts. Expense Ratio The ETF is posting .34% for an expense ratio. I want diversification, I want stability, and I don’t want to pay for them. The expense ratio on this fund is higher than I want to pay for equity securities, but not high enough to make me eliminate it from consideration. It is pushing that way though. I view expense ratios as a very important part of the long term return picture. Market to NAV The ETF is at a 1.09% premium to NAV currently. Premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. I wouldn’t want to pay this premium unless I could find a solid accounting justification for it. The ETF is large enough and liquid enough that I would expect the ETF to stay fairly close to NAV. Generally, I don’t trust deviations from NAV and I will have a strong resistance to paying a premium to NAV to enter into a position. Largest Holdings The diversification is fairly solid in this ETF. My favorite thing about the ETF is easily the diversification. If I’m going to be stuck with that expense ratio, I expect it to buy a fairly strong level of diversification and in this case it appears to do just that. (click to enlarge) Conclusion I’m currently screening a large volume of ETFs for my own portfolio. The portfolio I’m building is through Schwab, so I’m able to trade CWI with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the “ETF OneSource” program. I like the correlation and the diversification in the holdings, but the expense ratio is a bit high and I wouldn’t want to enter into a position at a significant premium to NAV. In my opinion, 1% is a fairly significant premium to pay with no assurance that I could exit the position at the same premium. This looks like an ETF to keep on my list as an option for international exposure. If selected, I would wait for an entry price with a much smaller (or non-existent) premium to NAV.

How Strong Is SCHV? I’m Considering It As A Core Holding.

Summary I’m taking a look at SCHV as a candidate for inclusion in my ETF portfolio. The risk level is great, though the high correlation to SPY shouldn’t be a surprise. The ETF has fairly decent yields and a great composition of companies. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the Schwab U.S. Large-Cap Value ETF (NYSEARCA: SCHV ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level What does SCHV do? SCHV attempts to track the total return of the Dow Jones U.S. Large-Cap Value Total Stock Market Index. At least 90% of funds are invested in companies that are part of the index. SCHV falls under the category of “Large Value”. Does SCHV provide diversification benefits to a portfolio? Each investor may hold a different portfolio, but I use (NYSEARCA: SPY ) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY. I start with an ANOVA table: (click to enlarge) The correlation is about 98%. That’s simply too high to provide a very meaningful diversification benefit. I measure risk with the standard deviation of daily returns. It isn’t perfect, but it works fairly well for my purposes and seems to hold up over time. Because the correlation is very high, the standard deviation of returns will be a fairly significant factor. Standard deviation of daily returns (dividend adjusted, measured since January 2012) The standard deviation is great. For SCHV it is 0.7027%. For SPY, it is 0.7300% for the same period. Since SPY usually beats other ETFs in this regard, I’d look at that standard deviation level as being fairly favorable. Of course, since SPY and SCHV hold several of the same companies a high correlation was pretty much a given. Since the Value side of the index should have more stability and less risk, the findings are in line with my expectations. Mixing it with SPY I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and SCHV, the standard deviation of daily returns across the entire portfolio is 0.7128%. The value side of the index (which SCHV is tracking) has been outperformed by the growth side of the portfolio. I would expect that to usually happen during a bull market. When a bear market occurs, I would expect the value side to hold up a little better. Since I believe in being fairly defensive about protecting capital, the value side is more appealing to me. Why I use standard deviation of daily returns I don’t believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations. Yield & Taxes The distribution yield is 2.33%. The SEC 30 day yield is 2.52%. I’m pretty comfortable with this ETF as an investment for retirees so far. In my opinion, it is a fine investment for younger investors as well. I have quite a while to go before retirement, but I still like healthy dividend yielding companies. Investors concerned about tax consequences should seek advice from someone knowledgeable about their tax situation. Expense Ratio The ETF is posting .07% for an expense ratio. This is great expense ratio. I treat the expense ratio as a very important metric when considering an investment. I want diversification, I want stability, and I don’t want to pay for them. Market to NAV The ETF is at a .02% premium to NAV currently. In my opinion, that’s not worth worrying about. It is practically trading right on top of NAV. However, premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. Largest Holdings The portfolio isn’t really top heavy. There are no holdings over 4%, but I still could go for slightly more diversification. With so many companies over 2%, the low standard deviation speaks to the stability of the companies within the ETF. (click to enlarge) I love having Exxon Mobil (NYSE: XOM ) as the top holding in the portfolio. I want exposure to gas because high gas prices can slow down the rest of the economy. In my opinion, it is hard to make an argument for any portfolio (under modern portfolio theory) that does not contain at least some exposure to gas prices. In my opinion, XOM is a reasonably safe way to get that exposure. You may notice Chevron is also in there. I think that is great as well. I don’t want to hold just one of the major gas companies. In my opinion, this is a fairly solid lineup. I’m still uncomfortable with Verizon (NYSE: VZ ) because I don’t like that industry in the current environment. However, at less than 2%, I have no problem with including it in a long term ETF position. When the industry becomes attractive again, it should be a great company to hold. Conclusion I’m currently screening a large volume of ETFs for my own portfolio. The portfolio I’m building is through Schwab, so I’m able to trade SCHV with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the “ETF OneSource” program. I’m finding SCHV pretty attractive and will consider giving it a niche in my portfolio. The size of the position depends on if I decided to use it as a core holding in place of SPY or SCHB. In that scenario, it could end up with a position as large as 20 to 25%. Otherwise, I would probably aim for something around 10%. Before I make a final decision I’ll need to run some analysis on complete potential portfolios. One way or another, my complete portfolio will include strong exposures to large cap U.S. companies and to heavy dividend paying companies.