Stocks vs. Municipal Bonds

 

How to Become Invisible

The Best Revolutionary Stock # 7

A Company That's Thinking Big

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I received the following letter last week.

"Hello,

Please comment how your service/assistance could help me to become Invisible Man (that is Hide My Assets from Prying Eyes)? Beyond my current subscription with Cabot Wealth Advisory I am going to join Mr. J. Royden Ward's service, but would need to stash some excessive gains (as long as they arise). I am going to trade U.S. stocks, ETFs although I am European (that is distinct tax etc. legislation).

Thank you in advance.

Rihard

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Unfortunately, I have no advice to give on how to become invisible (how to avoid the taxman) other than the usual. Either use a tax-free account (apparently not an option for my European correspondent) or buy tax-free bonds.

But tax-free bond funds yield peanuts these days, so if you're trying to actually grow your money, there's only one sensible course; grow your money as best as you can and then share some of it with the government as the law requires.

To many investors, the sharing part of that prescription is not a particularly attractive proposition, and I sympathize. As Arthur Godfrey quipped, "I'm proud to pay taxes in the United States; the only thing is, I could be just as proud for half the money.

But the law is the law, and I've always found the peace of mind that comes from paying my fair share worth the price.

Furthermore, I have a profound reluctance to invest in municipal bonds simply to avoid paying taxes, and here's why.

When you buy a municipal bond (or a fund that buys them), your money, indirectly, goes to a municipality of some sort-a town, city, county, school district, public utility, airport, seaport, etc.

And the people employed by that government organization then spend the money as they see fit, whether it's filling potholes, building hospitals and paying teachers-or hiring their friends and relatives, double-dipping to pad their retirements and generally working to ensure their own security.

Which is not to imply that all municipal workers are doing this, but simply to say that government organizations tend to be inefficient because, unlike for-profit enterprises, they lack the incentive (or requirement) to use the money in the best way possible. Thus too much sub-par behavior-which would seldom be tolerated in a for-profit enterpriseois accepted.

Consider two young men, for example.

One takes a job as a public schoolteacher, and immediately has trouble achieving his goals. What happens? He gets extra help, the same way his students get extra help after they underperform on the material he was supposed to teach them-but the extra help just doesn't work. Still, he keeps his job, and as a result, his students suffer-year after year after year. (This is one reason that the U.S., which ranks fifth in the world in spending per student, came in 17th among the 34 OECD countries who recently had their students take the latest Programme for International Student Assessment.)

The other young man takes a job in a for-profit business, and immediately has trouble achieving his goals. What happens? He gets fired, and the company tries again until it finds a person who can do the job. Yes, the young man suffers, but only until he finds a job suited to his talents. And the company thrives because it has the right people doing the right jobs.

Bottom line: While government organizations (especially those, like schools, that are devoted to serving people) typically have very good intentions, without the fast and hard feedback loop that exists in private enterprise, they often underperform. That's one reason public works projects, from sewer systems to stadiums, so frequently run over budget.

The free market, on the other hand, penalizes failure and rewards success, and as an investor, you can share in those rewards if you invest in fast-growing companies that are succeeding, like Chipotle (CMG), Facebook (FB) and Spirit Airlines (SAVE).

But that's not the end of the story. When you invest in a successful company (and other investors do the same), you send a signal to the market that this company is doing something right. The market then values the company's stock higher, in effect saying that this company is creating value where it didn't exist before. And the company (when it is well-managed) takes advantage of that increased valuation by borrowing money or issuing more shares or doing a variety of things that enable it to grow faster.

As it does this, the company hires workers. Ideally they're productive workers, because otherwise they'll lose their jobs. It makes its customers happy, whether they're buying lunch (Chipotle), advertising (Facebook) or plane tickets (Spirit Airlines).

Lastly, the company pays taxes. And the investors in the company pay taxes (unless they're in a tax-free account). And these taxes paid (generally) grow most years as the company's profits and employee count grows. In that way, government is funded at increasing levels as a by-product of positive achievement.

Overall, it's a far healthier and productive scenario than government funded by investments in municipal bonds.

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10 Revolutionary Stocks

If you look in the rear-view mirror, finding revolutionary stocks that turn into big winners is easy. Amazon, Apple, eBay, Google, GoPro, Green Mountain Coffee Roasters, Home Depot, Netflix, Oracle, Starbucks, Tesla Motors, Teva Pharmaceuticals, Walmart, Whole Foods and Yahoo! have all changed the world dramatically, and made billions in profits for far-sighted, risk-tolerant investors.

But real-time investing in revolutionary stocks is difficult, not least because the stocks are often very expensive, they can be quite volatile, and the future of the company behind the stock is far from assured.

Over the past six weeks, as I've been presenting this list of 10 Revolutionary Stocks (nominated by the Cabot analysts and finalized by me), I've repeated the four cardinal rules of investing in Revolutionary stocks.

Rule #1 Ignore Valuation

Rule #2 Use Your Imagination

Rule #3 Pay Attention to Management

Rule #4 Invest Only When There's Potential For a Major Increase in Perception

Today we'll look at how those, and other considerations, apply to candidate #7, which has the audacious goal of becoming the largest electric utility in the United States.

Solar City (SCTY)

Solar City is already the largest provider of solar power systems in the U.S., providing clean power to tens of thousands of residential and business customers in 15 states: Arizona, California, Colorado, Connecticut, Delaware, Washington, D.C., Hawaii, Maryland, Massachusetts, Nevada, New Jersey, New York, Oregon, Pennsylvania, Texas and Washington.

In the second quarter of 2014, the company accounted for 36% of total U.S. residential solar installations in Q2 2014-more than the next 50 installers combined!

Someday (assuming all goes as planned), the company's photovoltaic installations will be in all 50 states. (That alone might be reason enough to convince you to invest.)

The company began operating in California in 2006 and has been growing rapidly since.

Revenues were $60 million in 2011, $127 million in 2012, $164 million in 2013, and are expected to top $253 million when 2014 numbers are released on March 17.

For 2015, analysts are looking at $461 million.

Which is all very impressive.

Still Losing Money

But the company has never had a profitable year, and for many investors who use screens, that's a deal-breaker. Traditional investment theory says you should invest in companies that are profitable!

Yet SolarCity is a horse of a different color, and once you understand the business, you'll find that it's quite normal that the company hasn't made any money yet.

In fact, the reason is simple.

In most cases, when SolarCity installs solar panels on a customer's roof, it doesn't sell them to the customer-it leases them, via a Power Purchase Agreement or PPA.

In this arrangement, the company owns the system, and the customer simply contracts to buy power at a fixed rate for years to come, leaving SolarCity the responsibility of maintaining the system (which they have incentive to do, because the more efficient the system, the more profitable it is for the company).

In 2013, 51% of revenue came from operating leases, while 49% came from outright sales. But late last year, the company rolled out a third option, financing. With options as long as 30 years and rates as low as 4.5%, this means homeowners now have three choices for how to pay for their systems-and thus more reasons than ever to install SolarCity's systems.

And the company is making great progress on the manufacturing side, as well. Last summer the company acquired high-efficiency solar panel manufacturer Silevo for $168 million in stock, $9 million in cash, and the assumption of $23 million in liabilities. Silevo was building a 200-megawatt module factory in upstate New York, and SolarCity plans to scale those efforts up to eventually build a 1-gigawatt factory in the state. The goal: to ensure that SolarCity has a ready supply of solar panels to supply its expansion efforts-and to become the most vertically integrated solar company in the world, the better to improve margins.

For all the company's success, its market penetration remains minuscule, under 1% in the markets it serves. Yet the momentum is impressive. At the end of the third quarter of 2014, the company had more than 168,000 customers, up 105% from over 82,000 the year before. And CEO Lyndon Rive commented, "At our goal of one million customers by mid-2018, we would have accumulated solar assets operating with an annual revenue run rate of over $1 billion contracted for 20-30 years thereafter and poised to grow even further."

Note: Lyndon Rive is the cousin of Elon Musk, who serves as the company's chairman (while also leading Tesla Motor and SpaceX), so it's not surprising that he's thinking big.

What About Oil?

And then there's the oil factor.

Everyone knows that oil prices have plummeted over the last year.

And all investors know that oil stocks have been terrible performers over the past year, with many stocks down more than 50% and some small-time explorers likely to go bankrupt this year.

Prices on alternative investment have also suffered as well. Everyone's thinking, "Why install alternative energy systems when oil is so cheap?"

But that's short-term thinking and investors in revolutionary stocks must think long-term. In the case of SolarCity, for example, it's almost certain that this short-term thinking will fade as investors remember two things.

Efficiencies of solar installations will continue to improve, thanks to both technological progress and efficiencies of scale.

Taxes on oil (the politicians are already scheming) and tax credits on alternative energy will continue to tip the scales toward alternative energy.

Thus the long-term potential for the industry remains intact, and SolarCity is most likely to be the industry's leader.

But we can't invest without looking at the chart

SCTY came public in December 2012 at 8 and peaked at 88 nearly a year ago, in late February of 2014.

It then pulled back to below 46 at the end of April (a correction of 48%), rallied to 79 at the end of July, and now, thanks to the mass exodus from energy stocks, it's back down in the 40s. In fact, it hit 47 both in October and last week.

It's not a strong stock, and it's not a cheap stock, but it's a lot cheaper than it used to be.

Furthermore, the fact that the stock has repeatedly held support at 47, even though the news (oil prices) keeps getting worse, is a good sign.

Long-term, I think an investment in the stock is likely to work out very well. But I might be early, so the ideal way to play it is to wait for more signs of strength, so you truly know the bottom is behind it.

In the end, it's up to you. And if you're not comfortable with that responsibility, I suggest you take a look at my Cabot Stock of the Month, where I recommend one great stock to readers every month, and tell them exactly how to play it.

For details, click here.

Yours in pursuit of wisdom and wealth,

Timothy Lutts

Chief Analyst, Cabot Stock of the Month

and Publisher, Cabot Wealth Advisory

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RELATED ARTICLES:

The Best Revolutionary Stocks to Buy: BABA

The Best Revolutionary Stocks to Buy: CNC

The Best Revolutionary Stocks to Buy: GPRO

The Best Revolutionary Stocks to Buy: IMLN


Timothy Lutts can be found on Google Plus.

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Facebook

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