GrubHub (GRUB) is a food delivery service that also operates under the Seamless and Eat24 platforms currently servicing over 80,000 restaurants.

Last week, the company delivered a triple play of an earnings report, beating both the top and bottom line, and boosting guidance. Revenue grew by 53% to a record $286 million in the quarter.

Despite this top-notch report, the stock slumped over 12% and continued lowering the following day. This decline comes even after the stock had fallen some 18% in preceding weeks.

Now down over 40% — from its 52-week high of $150 a share — it looks deeply oversold. The $85 level is old support and is a great entry point to long the shares.

GrubHub’s business model is a prime example of the network effect in which scale matters and becomes a defensive business moat.  

The right location is said to be crucial for the success of a restaurant.  This is especially true of independent and mid-priced casual, which might not have large marketing budgets and are not deemed “destination” spots that foodies are willing to travel to and discover.

Locations on a busy street or well-trafficked area usually command higher rents for a good reason; they drive business. Likewise, as consumers are increasingly ordering food online (or with mobile app) for delivery it becomes crucial for restaurants to locate or set up shop where they are most likely to be found and provides an easy transaction experience.

While consumers are pleased to eliminate their drawers full of paper menus, they also don’t want a screen cluttered with food delivery apps.  They want one app that covers the most choices, and GrubHub is increasingly getting a spot on their mobile device.

In the latest quarter, 85%+ of sales on GRUB is from repeat sales. Perhaps the more astonishing fact from Q2 is that despite persistent growth in active diners, sales and marketing expenses have been falling as a percent of revenue. New diner acquisition costs have fallen down to a historical average

As the location/app of choice, GRUB commands upwards of 25%-30% fee on each delivery — providing the company with huge margins. While that’s a fat fee, many restaurants find it more economical to outsource delivery because it can better adjust the supply-demand of busy time periods. Also, as mentioned, they simply cannot forgo being listed GRUB, or they risk losing customers.

The real game changer is that GRUB is now expanding from focusing on independent restaurants in dense urban markets to doing deals with regional chains, such as Hurricane Grill and Sushi Samba — as well as national chains like Buffalo Wild Wings and Red Robin Gourmet.  This may cut into margins but should accelerate growth and overall profitability.

Even Amazon and UberEats’ entry into the food delivery business has not slowed its growth. Revenues are still growing at nearly 50% annually and may accelerate as the company, which initially targeted independent restaurants in dense urban locations, begins to sign national chains.  Look for sales to top $275 million this quarter, a 41% increase over in a one-year span — over $800m for the year.

Grub still has a long runway of growth and the recent sell-off is a great opportunity to get the shares at a discount.

Over the past few weeks — even as the broader market has a meltdown — McDonald’s  (MCD) has been hot, hitting a new 52-high, following last week’s solid earnings report.  But, there may be trouble cooking behind the counter.

You can see shares of MCD were rising through most of October, despite overall market weakness and then surged to new highs following its October 23 earnings report.

But from a technical standpoint, the chart has now made a major double top — as it failed to take out the high above the $180 level.

Source: FreeStockChart.com

But what caused bigger and longer-term problems are growing tensions between MCD corporation management, which ultimately answers to shareholders, and the franchisees who own and operate the individual restaurants. They are responsible for their own bottom line profitability.  

In 2015 when Steve Easterbrook took the helm and President and CEO of MCD, he initiated many transformational plans.  One of which was to “refranchise” the stores.

Nearly 95% of the 14,000 U.S. locations are owned by franchisees, up from 75% just three years ago.  Overseas, the number is 85%, up from 70%, with a 90% target by end of 2019.

The goal was for McDonald’s as a corporation is to become “asset” light while still retaining tight controls over operations — such as how and what is served, and benefiting from fees, higher margins, and increased cash flow.  All things that shareholders of public companies love.

And while no-one can dispute Easterbrook’s changes, from all day breakfast, simplified yet better menu offerings, investing in technology and remodeling the stores, have all been smart leading to improved sales. There are signs that franchisees are beginning to buckle under the pace and cost of all the changes.

It’s estimated to cost from $200,000-$500,000 per location to bring the stores up to corporate code. This includes remodeling, refurbishing, new kitchen equipment. Also, new technologies such as kiosks and integrating mobile apps.

While corporate can contribute as much as 50% of these costs, the capital outlay for franchisees who often own five or more locations can run into the millions of dollars.  This money often needs to be borrowed, which is coming at a higher cost in this rising interest rate environment.

Couple this with an emphasis on value or $1 money promotions, which do drive traffic, but come with lower margins, and franchisees are feeling the squeezed.

Unlike other national chains such as Wendy’s, MCD franchisees don’t have an independent representative committee.  Instead, a group of franchisees have formed an advocacy group which sent a letter and made plans to meet with corporate executives in Tampa at the end of the month.  

Their goal is to push the company to help improve profit and cash flow at their restaurants.

This tension comes at a crucial time; during the most recent quarter same-store sales grew only 2.4%, a record 26th consecutive quarter of growth but the slowest rate in over two years.  

McDonald’s management claims continued investment is needed to keep growth positive in an increasingly competitive quick-serve industry.

Franchisees say they are not getting a return on their investment. But, rather the profits are bypassing their bottom line and going into shareholders pockets.

Until corporate and franchisees can align their interests and agree on win-win plan I think the stock will stumble from its current lofty levels.

A few years back, cybersecurity stocks were hot — expected to enjoy massive growth in both earnings and its share price. But somewhere between 2015 and 2016, things seemed to fizzle out, as the stocks never lived up to the hype. Presently, in the wake of election meddling, fake news and an increasing number of data breaches, these firms are seeing a boom in demand for their services.

One company that seems to be gaining a lot of traction is FireEye. FEYE is a cybersecurity company that offers protection to detect, prevent and respond to virus attacks.

They provide various security products to companies worldwide in order to fight off those cyber attacks. The stock had its IPO in September 2013 at $20 and went as high as $97.  The cybersecurity sector were investor favorites at the time but became extremely overvalued.

That optimism turned against shares and the stock fell back below its IPO price, languishing to this day.  The company, which reports earnings on October 30, is expected to have its first annual profit of 3 cents a share.

In August, the stock got a big 10% boost when Google announced that the company helped find and shut down a network of secret online accounts linked to the Iranian government.

The stock is notorious for being a takeover candidate. Although this pops the stock, rumors never amounted to any real news. The stock rallied yesterday over 3% for just this reason as a report that Facebook is looking for an unnamed cybersecurity company to purchase. This makes sense for them, as recent hacks have caused major problems for the social network site. The chart is starting to take on a much better look, as it recently broke the year’s downtrend and is above all the major moving time frame averages.

The rally off the low of 14.20 prompted by Googles announcement has now formed a new uptrend which broke the years downtrend. The high for the year at 19.36 is now the upside target for the bulls.

The earnings next week can be an upside catalyst but even if the reaction is negative we can use options and go out 3 weeks in time relatively cheaply to let the upside thesis play out.

An in the money call spread to take advantage of the already built in intrinsic value will be to buy the 17 strike calls and sell the 19 calls to reduce our cost.

Such a spread can be done for about $0.80, meaning the profit potential is $1.20 or a 150% return.

Written by The Option Sensei (https://optionsensei.com/)

October is living up to its reputation for a month when trading gets volatile and bad things happen to stock prices.

The reputation is not just based on the fact that a few of largest one-day sell-offs, or “crashes,” have occurred during the month. It rests on statistical evidence, which shows October as the most volatile month of the year.

This has been especially true since the financial crisis first flared up in October of 2007.

Source: macroriskadvisors.com

Now with the S&P 500 having tumbled 8% from its high, many money managers and market observers have turned decidedly more negative.

Even long time bull JC Parets, has gone as far to say that, “In my opinion, we are in a stock market environment where a crash is entirely possible.”

So what are some of the issues that could bring about a bear market?

Last week I wrote about the U.S. market decoupling from the rest of global markets and how it was vastly outperforming since the summer.

Initially my premise was they would converge by the rest of the world playing catch up. Instead, it appears that U.S. stocks are heading lower.

Source: freestockcharts.com

As the saying goes, the generals can lead the charge, but if none of soldiers follow, they will soon beat a hasty retreat.

This seems not only to be true of the overall U.S. market vis-a-vis the rest of world. But also within the U.S. market itself.

It had been large cap technology leading the indices higher. But, they had been going higher on narrow leadership. In fact, the bulk of stocks had already moved into down trends, and the number of issues hitting new 52 lows was the highest in nearly two years.

Source: jlfmi.tumblr.com/

This loss of leadership has led to investor outflows with tech funds seeing their largest withdrawals of the year last week.

Source: BofAML Global Investment Strategy, EPFR Global

How Higher Rates Hurt

The near zero rate environment of the past 6 years had created the TINA (There Is No Alternate) helping fuel the bull market as investors were forced in stocks to seek yield.

But with 2-Year notes now yielding 2.5%, many wealth managers can now move client money into fixed income without feeling foolish — meaning they are selling stocks to make this reallocation happen.

A more detrimental aspect of rising rates is that companies with weaker balance sheets that were able to borrow (and basically stay in business) are starting to default on loans.

Last week, Bank OZK (formerly Bank of the Ozarks), blew up after reporting earnings that contained two shockingly large write-offs that were tied to commercial loans for construction projects – the kind of projects you see underway in cities and states all over America, such as skylines filled with cranes revitalizing downtowns, business districts, and millennial-friendly urban spaces everywhere.

George Gleason, the Chairman & CEO of Bank OZK, predicted that there will be more to come, and the stock immediately lost 25% of its market cap. This brings us to housing. You can see the U.S. Home Construction Index (ITB) — which had been underperforming for most of the year — went into an absolute free-fall late September. This happens to be when 10-year interest rates crossed above the psychological 3% level, and quickly rose to 3.25%.

Source: stockcharts.com

The housing market had already been hurting because of a lack of supply, especially at the lower to middle market. This made it difficult for first time buyers. With 30 year mortgages now moving above 5% affordability, it is even harder.

Housing has an outsized impact on the economy, some say as “it punches above it’s weight,” because of the number and variety of other industries it touches — from a broad range of jobs (plumbers, electricians, brokers, architects, lawyers) to all the material and equipment purchased, rent and what was consumed (lumber, pick-up trucks, tile, etc.

Any further slowdown in housing will ripple through the broader economy, possibly leading to a recession.

Lastly, low rates have spurred a record number of stock buybacks over the past few years. companies were able to borrow money. This was essentially done for free to use for stock repurchase plans. This shrank share count, which boosted earnings per share and helped put a floor under prices.

Without the free money, buybacks are likely to dwindle. This will leave the market vulnerable air pockets, and free falls.

Written by The Option Sensei (https://optionsensei.com/)

Paypal (PYPL) a digital mobile payment company just delivered blow out earnings and its stock jumped some 10%. Is it still a buy? Yes! Thanks to the recent broad market selloff shares of Paypal, which hit a $75 low, or some 20% from September high. Even with earnings-induced pop, it remained some 15% below the recent peak. This is a great buying opportunity:

Technically, the earnings bounce burst shares back above resistance, at the $80-$82 level, which was both horizontal distribution and the 200-day moving average. I expect Paypal to make new highs above $94 within the next few months.

What will drive the growth and stock gains?

New Platforms

Paypal operates a variety of digital and mobile payment platforms under its Paypal name and owns other platforms such as Venmo. It recently acquired Hyperwallet, which are supplying renewed growth. Expect the growth to accelerate — thanks to natively mobile platforms that are geared toward millennials.

This was born out of during last night’s report and conference call with Venmo — growing transactions in volume and total dollar amount by 67% and 45%, respectively. It appears they’re close to proving that they have pricing power and nudge up costs to $0.25 per transaction.

New Deals

A notable sell-off occurred, following last January’s report, when it announced it would cease being the featured payment method for eBay in 2020. But, this was a known event and PYPL still has an agreement to work with eBay through 2023.

The split was actually planned with the purpose of allowing PYPL to pursue a larger number of commerce partners; it wasted no time inking a deal with Wal-Mart and Chevron gas stations, to provide mobile cash payments and withdrawals from their thousands of locations.

This is helping PYPL build its mobile commercial use while Venmo can focus on the peer-to-peer consumer segment. Other growth is coming from acquisition; PYPL recently sold its account receivables Synchrony for $6.9 billion and made it clear it plans on using the war chest for mergers and acquisition. It recently purchased iZettle for $2.2 billion — a clear indication that PayPal wants to get serious about its European business.

In the last quarter, the company’s European revenue represented just 10% of PYPLs revenue. iZetti will give it an immediate $150 million boost with expectations for 50%+ annual growth over the next 5 years.

The other benefit to its $6.9 billion raised will let management keep its commitment to using 35%-40% of free cash flow to buy back shares for the next three years. This should underpin the stock price. When the buyback plan is coupled with the expected growth rate, the current valuation is just 25x forward p/e, which seems downright cheap. All told, Paypal is a great way to play the migration to a cashless society and the increasing the use of mobile to transfer money and make business transactions.

Written by The Option Sensei (https://optionsensei.com/)

The U.S. stock market has hit a rocky patch over the past two weeks. But the S&P 500 Index still remains less than 5% below all-time highs.

This is a marked contrast from the emerging markets, which have been sliding, and many in bear market territory, for the past few months.

You can see the extreme decoupling that occurred between the S&P and Emerging Market Index (EEM) that began in May.

This of course coincided with the ramping up of trade war and tariff talk. While a resolution between the U.S. and China is still up in the air, many of the satellite players have already absorbed any fall-out and have shored up their sovereign balance sheets.

The markets seem to have discounted this fundamental dispersion. Countries with surpluses have had stable or appreciating currencies this year. Those with deficits have had declining currencies.

It appears that negative sentiment may have even overshot — as emerging markets currencies have sold off by more than debt and equity outflows would generally imply. Notably, in the last week of September, emerging markets bond inflows rose to their highest level, $2 billion, since February’s $483 million.

On the other side of the coin, emerging market equities recorded outflows in nine of the past 10 weeks. But the pace is decelerating. Trade protectionism remains a real risk although this seems to be fully discounted.

Emerging markets equities now have the lowest valuations of any major asset class, and free cash flow yields are estimated at 5%–7% over the next 12–15 months. Their discount to developed markets has deepened to the 30% range.

Some markets, most notably Brazil, have already started to turn high. The catalyst for the turn in Brazil is the election where it now seems the right wing, pro-business candidate has a legitimate shot at winning. Since he closed the gap in polls last months ago the Brazilian market has surged some 30%!

Rising commodity prices, for which emerging markets tend to be net exporters, will also bolster those markets.

It’s interesting to note Brazil’s main exports — coffee, oil, and soybeans, also jumped in recent weeks.

Here’s the coffee ETF which is also up some 34% in the past month:

Source: freestockchart.com

All things economic tend towards reversion and it would seem emerging markets are poised to rally, and play catch up to the U.S.

Written by The Gold Enthusiast (https://thegoldenthusiast.com/)

Your friendly Gold Enthusiast here, jumping in to give you a quick heads-up. There are two important short-term factors for gold prices over the next few days you’ll want to keep an eye on.

The first is a potential short-covering rally. As you know, a lot of traders went short on gold over the past 2-3 months. If we’ve seen the bottom for gold, all those shorts need to unwind. Some we let go last week but there are still a lot out there. The pop in gold on Oct. 11 showed a fair amount of volume in most gold-related vehicles, like GLD shown below.

You can clearly see the big spike in volume on the 11th. But did it take enough shorts off the table to prevent a short squeeze? Only time will tell.

Second: The US Dollar is gaining strength. And as we know, the fundamental relationship between gold and the Dollar means that will put a lot of downward pressure on gold prices in the US. Overseas demand isn’t seen as enough right now to override the gold-Dollar relationship. So if the Dollar does head up that means down for gold.

Which of these forces will prevail? Only the Shadow knows, and as usual, he ain’t talking. We’ll be keeping a close eye on it though…

Signed,

The Gold Enthusiast

DISCLAIMER: The author has no position in any mentioned security, nor plans to enter any such positions in the next 48 hours. The author is long NUGT and JNUG, and may trade those if conditions appear advantageous. These are very small, non-market-moving sized positions.

Written by The Option Sensei (https://optionsensei.com/)

All the political and policy noise is about to brushed aside by what really matters for stock prices; earnings. And this is shaping up to be one of the most interesting, and possibly treacherous, earnings seasons in many years. Here is what you need to know.

Earnings season kicked off on Friday with big banks such as JP Morgan (JPM), Citi (C ) and Wells Fargo (WFC) all delivering better than expected results.

The stocks initially opened higher, but within the first hour of trading, all reversed lower. It may a have been a case of the company-specific good news being overwhelmed by a broad market sell-off. But this may also be a canary in a coal mine of what’s to come.

For some active traders, these jolts of information and the accompanying stock price movement represent terrific short-term money-making opportunities. And many will try to juice the returns by using options.

Before getting to some of the concepts and strategies that can be employed in playing earnings reports, let me provide the caveat that all earnings plays are extremely speculative and should only involve a minimal allocation of risk capital. The challenge trading earnings is that there are many variables that need to be accounted for, and correctly forecast.

Not only must you determine if the company will meet estimates (and have those estimates recently been lowered or raised) but also what kind of guidance will be provided. But what has already been priced into the stock — whether it’s recently run up or sold off. And most importantly, what percentage price move the options are pricing in as measured by their implied volatility

Prepare for Post Earnings Premium Crush

This tendency for a Post Earnings Premium Crush (PEPC) make understanding the relative “expensiveness” of options and the magnitude of the price move being priced crucial to improving the probability of achieving a profitable trade.

Here’s a great visual look at how Netflix (NFLX) historical volatility versus its implied volatility diverges then converges before and after earnings reports.

Netflix options usually “price in” at 10%. Meaning, if you just buy options outright, whether puts or calls, and the stock moves less than the expected 10%, you lose.

Expensive is Relative

On face value, Google’s (GOOGL) which reports October 25 options with an implied volatility of around 45% — appear “cheaper than Apple’s. But when looked at, relative to each stock’s 30-day realized or historical volatility (HV), Google is actually more expensive. Google’s HV is 19%, meaning the options IV are running a near 90% premium compared to Apples HV which is 22%, meaning its options are “only” a 45% premium. A great free site for tracking options volatility, both historical and implied, is iVolatlity.com.

The reason most options see a decline in implied volatility — following the report — is that it’s wise to use a spread rather than the outright purchase of options in making a directional bet. The next step is using that implied volatility level to determine what size price move is being estimated, or priced into the options. This will help you determine which strike prices you might want to use in setting up your position.

Premium sites such as Bloomberg.com provide the data one can use to perform the calculation relatively easily. The down and dirty formula would be to simply take the price of the at-the-money straddle — add the price of the puts and calls and divide that total by the price of the underlying shares.

Given that most of the popular issues will have weekly options listed for their earnings reports, it would make sense for those looking for the speculative action of earnings plays to stick with the leverage of these short-term contracts. But remember, this leverage cuts both ways; if you are wrong to expect to lose 100% of your allocated capital.

I’ll drill down into some specific earnings options trades, which use PEPC in our favor, as the season plays out.

Written by The Dividend Sensei (https://dividendsensei.com/)

On Monday, October 15th, in a move that shocked absolutely no one, Sears (SHLD) filed for Chapter 11 bankruptcy protection. The company is hoping to line up sufficient financing to make it through the holidays, and shut down stores itself in an orderly fashion. That ability is in doubt, with the company’s largest creditors recommending a wholesale liquidation of the business. That would mean that this 126 year old retailer, once the largest in the world, would cease to exist. The downfall of Sears, a long, slow motion train wreck, has three important, and potentially very profitable lessons for all investors. Lessons that can help you improve your long-term returns, and better reach your financial goals, including of a prosperous retirement.

Buy And Hold Forever Is Best…Unless The Wheels Fall Off

While decades of market studies show that buy and hold investing is generally the best strategy to use, that doesn’t mean you can or should ignore deteriorating fundamentals over time. Even old and well established industry giants, (Kmart was once larger than Walmart and Sears the largest retailer in the world), can fail.

For example, Sears has seen its sales decline rapidly for 13 years. Management, in the form of hedge fund CEO Eddie Lampert, tried to cost cut and financial engineer the company’s revival by closing 2,600 stores over that time. However, the mistake Sears made was not in owning too many stores, but in not adapting to changing consumer tastes. It was one of the last retailers to adopt loyalty programs or incorporating online sales in the omni-channel approach that many of its thriving rivals have proved can survive, and even thrive in the age of Amazon.

Ultimately it was poor capital allocation and strategic decisions that resulted in Sears posting 13 straight years of declining same store sales growth (and $11.2 billion in losses since 2011). And keep in mind that’s even with steadily closing thousands of “weaker performing” locations. This shows that Sears’ problems weren’t in its locations, but in its overall business model. One that simply couldn’t compete with more nimble retail rivals.

The takeaway for investors is that even the bluest of blue chips are not “buy and ignore forever” stocks. You need to check in every year or two, to make sure that the company’s fundamentals remain strong and moving in the right direction. Yes all blue chips must periodically restructure their business models, to adapt to changing conditions. But never ignore steadily declining revenue, profits, and rising debt levels that threaten not just the dividend, but the company’s survival.

However, as important as this lesson is for investors, there are two even more important ones that might help your portfolio prosper in the long-term.

Never Blindly Believe Popular Investing Themes

The media likes to pretend that Sears is the quintessential example of the so called “retail apocalypse”. This is the common, but factually incorrect, idea that the rise of online sales will kill brick & mortar retail.

In fact, since 2002, when ecommerce really took off, traditional retail sales have averaged about 2% annual growth. And thanks to adding omni-channel to their business models, total annual sales for traditional retailers have never fallen below 2.5% over the past seven years. What about the record number of store closings in 2017? According to analyst firm Statista, in 2017 10,168 stores closed in the US. But 14,248 new retail stores opened for a net gain of 4,080 stores. What about 2018?

Here too we see that analysts expect a net gain of about 3,000 stores. That means that despite numerous large retail chains going under, and closing well over 15,000 stores over two years, the number of retail locations will increase by about 7,000 over this time. If the industry’s sales and profits are growing, and overall store count is rising, then the “retail apocalypse” is actually just a figment of the media’s sensationalistic imagination. The point I’m making is that investing returns are ultimately determined by real world, fundamental conditions. Facts, not popular themes, are what matter in the long-term.

For example, another popular meme is that Amazon’s rise has cost America jobs, due to about 140,000 net retail job losses over the past few years. However according to Michael Mandel, an economist at the Progressive Policy Institute, in that same time period e-commerce and warehouse jobs have increased by 400,000, meaning a net increase in jobs (and most that pay as much or better).

Or how about the coming unemployment disaster that automation will cause? The robots and AI programs are coming for all our jobs, or so the pessimists claim. That includes Carl Frey and Michael Osborne, two researchers at Oxford University who are predicting that over the next 20 years up to 47% of Americans might lose their jobs to automation. Since 2014 Amazon has deployed 100,000 robots into 25 warehouses, (13% of its total fulfillment centers). In that time the company’s US workforce has nearly quadrupled from 120,000 to 350,000 and globally it employs 550,000 people (and hiring 25% more workers each year).

Think that Amazon is a fluke and that the AI revolution will put us all out of work? According to a 2017 report by Deloitte between 2002 and 2017 800,000 UK jobs were lost to technology induced changes such as automation. Terrible right? However, 3.5 million new, higher skilled and on average, $13,170 per year better paying jobs were created. Not just did automation not cost the UK jobs, but it improved the quality and pay of the net jobs it was creating.

What about in the US? According to analyst firm Gartner, by 2021 AI will augment professionals (like doctors, lawyers, clerical workers, etc) enough to save 6.2 billion annual hours of productivity, while generating $2.9 trillion more in value for companies. Or to put another way, rising productivity will mean falling costs/worker and greater value/hour created per employee. That kind of productivity growth is exactly what allows rising wages that don’t boost inflation. And productivity + labor force growth is ultimately what causes economies to grow and standards of living to rise. The net effect of AI in the US, according to Gartner, will be that by 2020 1.8 million workers will lose their jobs. But 2.3 million new jobs will be created, a net gain of 600,000. Jobs that are far more productive, useful, and generally pay more. By 2025 the net gain is expected to reach 2 million.

And those are just two popular themes the media likes to spin. Others include:

Rising long-term interest rates are bad for stocks
Rising long-term rates are bad for dividend stocks (like REITs) in particular
Record levels of consumer debt mean that another financial crisis and recession is coming soon
The facts are exactly the opposite. According to a study by JPMorgan Asset Management, between 1963 and 2017 stocks did well as long as 10 year yields were 5% or below. Given that interest rates are likely to peak at about 3.5% or below this cycle (per bond market inflation expectations), investors have no reason to fear that rising rates will trigger a bear market.

What about consumer debt being at a record and that impending recession? Well actually consumer debt on a per person basis, as well as household debt service coverage ratios (debt service/disposable income), are actually far better than they were in 2008. And according to the bond market, the most accurate predictor of recessions in history, the next recession isn’t likely to start until December 2020 or later, at least 2 years away.

As for dividend stocks, including REITs being harmed by rising rates? Well since 1972 there’s been near zero correlation between 10 year yields and REIT total returns (0.04 to be precise). That means that knowing with 100% accuracy the 10 year yield at the start of any given year would have allowed you to predict just 2% of REIT returns. And only if you assumed rising rates were slightly beneficial for REITs. And in the past six rising rate cycles (since 1995), REITs not just posted positive returns 75% of the time, but in 63% of them actually outperformed the stock market. Why is that? Because rising rates signal a strong economy, and real estate is a natural hedge against inflation. Thus when inflation and growth is stronger (and rates higher), REITs can pass on higher rents to tenants, grow their cash flow and dividends, and their share prices rise.

The bottom line is that the media likes to pretend that simplistic “themes” are a good way to invest. But the real world is far more complicated, and companies are constantly adapting over time. Thus popular investing themes often prove to not just be generally wrong, but often the exact opposite of the truth. And since fundamentals (earnings, cash flows and dividends) are what stocks ultimately trade on, this brings me to the most important profitable lesson of all.

Take Advantage Of Short-Term Market Pessimism To Buy Great Companies On Sale

Benjamin Graham, the father of modern value investing and Buffett’s mentor (and professor at Columbia), famous said: “In the short run, the market is like a voting machine–tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine–assessing the substance of a company.”

This means that stock prices are NOT a good indication of a company’s intrinsic value at any given time. Short-term sentiment, driven by media hysteria and the popularity of simplistic and often totally wrong investing memes, can cause prices to become largely, or even totally disconnected from reality.

This is why you can find great quality stocks on sale, no matter what the broader market is doing. For example, in 2000, at the height of the tech bubble, Realty Income (O) was trading at just 5 times AFFO (cash flow and what pays the dividend).

The stock yielded 11% because of a perfect storm of negative short-term investor beliefs:

10 year yield was 7% (rates up REITs down)
Value is dead, long live tech growth stocks (sucked all the cash out of REITs and into bubble stocks like Cisco)
E-commerce will kill physical retail (a theme that has persisted, incorrectly, ever since)
Well guess what? Realty Income went on to rise 127% during the great tech crash, while market darling Cisco fell 90% (and tech stocks in general fell 80%). What’s more if you bought Realty Income back then you’ve enjoyed 17 years of 17% annualized total returns. And today your yield on cost is 27%. This means had you bought Realty Income in 2000 when the market hated it, today’s annual dividends would repay you 27% of your initial investment each year. And that figure is rising steadily over time as the REIT increases its payout at about 4% to 5% per year.

Today three quality retail REITs in particular are offering great long-term opportunities which is why I’ve bought them for my portfolio. These are: Brixmor Property Group (BRX), Kimco Realty (KIM), and Kite Realty Group (KRG). This article explains the 4 reasons why Wall Street is dead wrong about Brixmor and Kimco, and soon I’ll be doing an in depth one on Kite. All three REITS are likely to generate 17% to 19.5% annualized total returns over the next decade from today’s valuations.

This means anyone buying today may be able to not just increase their investment five to eight times in the next 10 years, but achieve sufficient safe income to potentially retire from these investments alone.

Bottom Line: The Downfall of Sears Shows What Investors Should, And Shouldn’t Do with Their Portfolios

While my heart goes out to the 89,000 employees of Sears who are almost certainly going to lose their job in the short-term, ultimately the demise of this decrepit retail dinosaur is for the best. Capitalism is about creative destruction, in which companies compete to offer the best goods and services, at the best value, with the most convenience. Sears had 13 years to adapt to changing industry conditions, including more investment into upgrading its stores, and integrating online sales into an omni-channel model as all of its major rivals have done. Management instead chose to try to cut and financial engineer its way to profitability, which in today’s modern retail world just isn’t what consumers are looking for. This shows that no matter how venerable a stock may have been in the past, long-term buy and hold investors should always check in every year or two, to make sure the fundamentals remain intact. Or to put another way, buy and hold investing is best, but don’t ignore signs the wheels are falling off the business model.

But don’t let the demise of Sears convince you that popular investing themes like “the retail apocalypse” are true. Many retailers continue to struggle to adapt to changing consumer tastes, and many will likely also be wiped out by the rise of online shopping. But the fact is that the number of net store openings in 2017 and 2018 will be about 7,000, showing that for every Sears, Toys “R” Us, and Sports Authority, there’s a TJ Maxx, Ross Stores, Home Depot, Walmart, Target, and Costco. Stronger, and better run rivals that are successfully offering consumers improved value and convenience, and so likely have a bright future.

Finally, don’t forget that short-term market hyper pessimism on certain industries, such as retail REITS, can offer incredible long-term buying opportunities. That’s because, like their retail tenants, these companies adapt and change over time. While some distressed dinosaurs (like low quality mall REIT CBL) will fall, better run, and financially stronger peers (like KIM, BRX, and KRG), will prosper, grow, and make deep value investors rich.

It’s during times of peak market fear and pessimism, such as the “retail apocalypse” that doesn’t actually exist, that value focused high-yield investors can load up on quality income stocks. Investments that can generate mouth watering, safe, and steadily rising dividends, as well as market crushing total returns when these stocks return to trading on fundamentals over the long-term.