Time to Think Like a Hedge Fund

Every three months, after the release of quarterly data, we start to hear Congress talk about how Big Oil is making too much money and how we need to initiate some kind of windfall profits tax. Of course, when you look at the data, you see that profit margins for oil companies on a percentage basis are not stellar, or at least not exceedingly high. Compared to other industries, they are quite average. To see the data, check out Mark Perry's blog at Carpe Diem, or do a simple sector/industry sort at Yahoo! Finance.

I do sometimes wonder how many of those talking about windfall profits are even looking at the data (or care to). I also wonder if they realize that when you tax something you tend to get less of it. The issue is obviously more complicated than this, but it is important to also make sure we consider the unintended consequences of our actions and decisions.

Ethanol is a good example. Right or wrong, it is affecting commodity and food prices. Of course, as a trader or investor, what is important is not only noticing the obvious, but also considering the consequences. In doing so, one can use their insight to hopefully profit from the changes in the regulatory-, tax-, or program-mandated landscape.

Just recently, those investors and traders who realized that fertilizer companies would do well given the need for more corn production, or that chip makers would benefit from tax breaks to solar companies, or that the railroad companies would do better given high trucking fuel cost along with the need to transport increased commodity production, have all profited from their knowledge and foresight. Looking out for the next "consequence" can sometimes make us profits, while easing the additional burdens we may be incurring in the rest of the market and economy.

In a sense, smart investing and trading can allow us to act more like a hedge fund by increasing our returns while reducing our overall level of exposure to the market and those that control prices and policy making. Of course, finding these plays, and finding them early, is always difficult. Nonetheless, looking for secondary plays which have not yet made their moves is sometimes a good place to start.

Comments

[Brian Pursley]

Only totalitarian Bolsheviks are in the business of determining "fair" corporate profit margins. Ironic we never hear about windfall tax profits to Big Government generated by tax margins that are too high. If big oil's profit margins are too high at 10% then what is big government's income tax rate at 30%?

[Whisper On The Wind]

What is the profit percentage on "unearned income?" And why aren't we talking about taking some of that back? If they didn't EARN it, isn't it PROFIT?