Angel Investing

For simplicity, angel investing is any investing that is not for one of the purposes listed above. Angels invest in businesses, individuals or even just an idea. The scope of investments is limitless. One common characteristic of an angel investment is it rarely involves a short-term, one-time sale.

The word “angel” investor came originally from wealthy investors to Broadway stage productions that banks and other financial institutions would not finance due to perceived unmanageable risks. The productions would run several weeks to a year or more, depending on its success.

It is through that period of the production run the angel investor earns income that eventually repays, hopefully with a profit. Once the production shuts down, the investment period is over.

Thus, angels typically take on much more risk than a banker. For that risk, angels require a much higher return rate on investment. Not all businesses can promise a high rate of return, so are not suitable for angel investing. Not all businesses are long term, either.

For instance, a company may be founded to promote the Olympics for a specific country. That company may be involved in events planning, marketing initiatives, any number of services. There could be sizable income generated in executing contracts and order fulfillment related to promoting events and services in and around the Olympics. But, that business as a concern essentially comes to an end when the Olympics ends.

This may be a reasonable type of short- to medium-term investment for an angel investor; and one that a bank may not finance due to the short-term and high risk nature of the investment.

But, angel investing involves dealing with businesses that have much less transparency than publicly traded companies, and higher risk than with businesses that have tangible assets like gold or real estate.

Jeff Hamilton’s paper on angel investing gives a much more thorough discussion on how to make angel investing more transparent, in order to be more successful, and is available here at the Technology Leadership website as an instant download: Knowing When Angel Investing is Good for Investor and Business Alike

Real Estate

Real estate is not too different of an investment from some commodities, like gold or oil. The big difference again being the time or duration of the investment. Gold or oil can be exchanged daily. Real estate must be held at least a few weeks for closing, renovations and resale. More likely, a piece of property is held months or years. The biggest similarity is the need to sell the commodity or real estate property at a higher price than what you paid, in order to make a profit.

Like dividends on a stock, unless that property can generate a steady income during the ownership period, such as through sale of raw materials, rental income, or farming, the only way to realize income on real estate is through selling at at a higher price than what you paid. Investing in real estate for its rental, raw material or farming income is called ‘commercial’ real estate.

Owning your own home (or two) for personal use is considered ‘residential’ real estate. Only commercial real estate can generate income outside of (in addition to) the sale of the property. For residential real estate: selling higher is the ONLY way to make it profitable.

A trader can make fractions of a percent each day, and end up with a sizable yearly income. The overall direction of the commodity, up or down, has almost no bearing on a day trader. Similarly, a loss one day can easily be offset by gains the next.

For residential real estate, the only money that can be made is on its sale. And, the turnaround time is in the months or years range, so losses are not so easily offset.

Commercial real estate carries slightly less risk because there is a greater likelihood of earning sufficient income through non-sale activities (e.g. subleasing) to offset the lower sale price of the property.

In the next section we shall look at Angel Investing

Exchange Traded Funds

Exchange Traded Funds (ETFs) are traded like equities, but they carry very different risks and rewards to actual shares. They are less risky because they are comprised of a basket of stocks, usually either tracking a popular index like the S & P, 500 or culled from a particular industry sector, like the energy sector.

These funds also pay a dividend. The popular S & P 500 ETF “SPIDER” has a yield, as of August 20, 2009, of 2.71%.

This may be significantly less than what you could have made investing in one stock in the S & P 500. For instance, if you invested in Chesapeake Utilities Corp, you would make 4.2%. At 2.7% it takes 36.9 years to break even; at 4.2% the break-even period is 23.8 years.

But, you have a far greater risk of Chesapeake losing all its share value before 23.8 years has elapsed than you have of every share in the SPIDER losing value in 36.9 years.

In Part 7 of this series, we will look at US Treasury Bonds.

Individual Equities – Going Short

Short term investing is a completely different type of investing than long term investing. All of the qualities a long term investor looks for in a company and its shares may be nothing a short term investor is interested in. Similarly, qualities a short term investor is eying may not be important or even counter to what the long term investor is seeking.

A short term investor does not necessarily need a ’sustainable’ business model. A short term investor is not interested in dividends, unless they are in the 20 to 30% range, which doesn’t exist. A short term investor does need to follow the news and filings as does the long term investor, but what a “sell” signal is to the short term investor may be completely different from that of the long term investor.

A volatile market with a clear battle between bulls and bears, which is what we have today, is an excellent environment for short-term trading. You can bet a stock swings up or down, and win in either direction. As corporate earnings continue to sag, and dividends further slashed, we see increasing risk to long term share holders ‘breaking even’ with dividends alone, meaning 75 years may not be long enough. Share price will factor significantly in the overall determination of net income – far outstripping dividend yields in importance.
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Let’s do some easy math to illustrate the hazards of a long position. At 2.7% (the average of the S & P 500 dividend yields), it will take almost 37 years to ‘break even’, at a zero percent tax rate, if you never sell. You must understand this number (almost 4 decades!) to be the realistic time of investment.

If you are not going to be alive for 40 more years, then you should reconsider this investment strategy. If you never sell, you have to wait 50 to 75 years for your break even period, when accounting for taxes on those dividends.

Certain companies in their respective industries are relatively certain income generators that pay dividends. They are also large enough that if the company mis-steps, fraud and accounting issues aside, you can always sell before being ‘wiped out’.

Technology companies like IBM, HP, and Oracle; certain energy companies like Exxon or British Petroleum; certain retailers like Federated Department stores; should all be considered safe investments. They have sufficient internal and external controls where the chance of a huge fraud that wipes out shareholders instantaneously is extremely unlikely.

The caveat for equities investing is that you absolutely need to follow that company in the news and look at the required quarterly SEC filings. You must sell when you and/or others feel the company is running an unsustainable path (i.e. headed towards bankruptcy). This is the only way to ensure a significant sale price such that, when accounting for dividends and taxes, you net positive income from the sale.