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Friday, September 21, 2007

5 year plan

It was Warren Buffet who once commented that he invested as if the stock market would be closed for the next 5 years. I am amazed how often I hear this remark repeated by alleged value or relative value investors/. I am both amused and amazed be hearing these guys talk about holding stocks three to five years and then find in the Morningstar report they have 150% turnover in their fund. As for individuals, much of the research shows that investors hold the average mutual fund less than three years, never mind individual stocks. But, if we are buying stocks as a business and not just speculating on short term price movements, that is exactly the approach we should be using (I am not knocking short term speculation. I like it as much as the next guy and frequently write about using options to trade value but that’s not what THIS article is about).

Right now it looks pretty ugly out there. Thanks to the bernake bust up, the dollar is falling, interest rates are rising, energy costs are climbing and the backdrop for the US economy is just frugly. It is easy as investor to get paralyzed when we consider all that can wrong out there. However I decided to take a look at this as if today was it for the next five years. After today the stock market is going to close and not reopen for trading for five years. There will be no further daily price updates and the only idea of how you were ding was how well the business itself was doing. This means that getting the price and the business right is going to be crucial for success. Pretty much leaves out the big growth names. At 40 times earnings you can not uy a shorter-term glory shock like Apple. The chance that someone comes along and upstages them in the IPOD or IPHONE markets over 5 years is too risky. Goldman. Maybe. But what if rates keep rising and decimates their private equity and debt trading platforms? Five years is a long time in the trading business. A lot can go wrong and kill the value of our franchise.

So what to do? Lets find some great companies at a good price and a few good companies at fire sale prices. Seems to me that that is the best way to profit over the 5-year pal. First, I say lets grab up a few shares of COMS. The beleaguered networking stock trades today at $3.55 and about half of that price is in cash. They have exposure to both china and on line video, two huge growth areas over the next five years. Next, more tech in the form of ADPT. The data storage company trades at 3.78 has a book value and has over 3 bucks a share in cash. Further Steel Partners is the single largest shareholder with over 15% and Warren Liechtenstein and friends have a pretty good history of unlocking value in stock. I would also add share of EDCI. Decent company in a crappy business. CD’s and DVD’s are pressured more everyday by online content. However we have a stock at 1.35 or so over a buck in share in cash and total book value of 1.50. They also have 4 dollars a share of NOLS that can be used going forward. Chapman Capital and Third Point two activist investors of some note are aware of the value of this situation and are large shareholders.

One thing the bernake Bust has done is steepening the yield curve and I suspect he will cut again to make it steeper still. This should allow the major banks to capture the net interest margin and earn their balance sheets healthier. One major beneficiary of this is going to be the small banks that didn’t really have a problem to start with. Many small banks share have started trading down near book value and historically this has been a great place to buy. First a couple of local guys. Severn Savings, SVBI, is consistently ranked of one of, and frequently the best savings institutions in the country. These are smart local guys. They know the real-estate markets, they know all the builders and developers, where to lend and when to say no. Further they are expanding their commercial loan business to insulate against too much real estate dependence. The stock is just under 1.5 times book and although I might normally let prices come off a bit, the hypothetical market is going to be closed and these guys should prosper over the next five-year. Selling at just 9 times earnings it seems a great inclusion to the five-year plan. Same with Annapolis National Bank (ANNB) at 1.3 times book value. The Annapolis area is unique in that we have lots of real estate demand from turnover in State, Local and federal government and of course, we have the only Chesapeake Bay right at our doorstep. It is a very vibrant are that has escaped real estate collapses in the pat. With the steeping of the curve local banks should thrive and prosper. From the slightly larger city of Manhattan comes BERK. This a 900 million in assets bank that trades at book value and does business primarily in Manhattan, an area also seemingly insulted from real estate woes based on demand.

From the grab bag lets add shares of GNCI. The infrastructure roads and bridges in this country are going to need massive repair and rebuild in the next five years. Trading at book value with solid earnings, this manufacturer of heavy equipment for highway construction and environmental control equipment should benefit handsomely. EIHI is just a high quality well run insurance company. Offering primarily workers comp and group benefits, the stock trades below book value, 10 times earnings and has a small dividend of 1.3%. Since I think coal becomes more and more of a player in the energy arena I will also add shares of ICO. The bonus ere is that the majority owner is Wilbur Ross ands he ahs a long tradition at magnetizing his assets over time. In the 4 dollar area the stock is cheap and appears to have a good future.

In the area of larger companies that are good business at good prices I like CHIC. The retailer of ready to wear for the younger set has a 20% return on equity, 87 million in cash with no debt and generates over 88 milliohm more every year. I also like Motorola here. The company has struggled off late but it is still a player in mobile technology. Also betting the Carl Ichan gets paid off over the next five years strikes me as a god bet. Energy will continue to be an issue going forth and at less than ten times earnings, driller PTEN should be a beneficiary. FSS, the maker of safety and security systems, fire apparatus industrial vacuums and street sweepers seems very cheap here and the heavy insider buying would indicate I am not the only one who thinks so.

So there we have it. Some stocks that I would be thrilled to own at these prices, tuck away and forget about for five years confident that we paid a low price for a portfolio of good business that will be worth more than they are today by a significant sum. In addition they all have great balance sheets, very little debt and there’s a greatly reduced risk of permanent loss of capital over time. I have talked to some bulls who say that the rate cuts and 4th quarter earnings will drive us substantially higher. I have talked to bears that think the parties are over and we are going to have a huge sell off soon. The stock market is party mode, the bond market and the dollar look like newly divorced guys under a neon moon so they are so pessimistic. Who’s right? I don't really know. My suspicion is they both are. We ll get a continued rally off the rate cuts, earning for the third quarter will be okay and we ll go a bit higher. However the bill in the form of inflation and reduced economic strength will get paid early next year. However, no matter what happens in the short run I think this portfolio of stocks will be much higher 5 years from now. If I am investor and conducting myself in a business like fashion that should be all I care about. Day to day and week to week don’t matter as long as we have great balance sheets and are able to improve the underlying business over the years.

Next time I ll look at the current environment form a trading angle and see what conclusions I can draw. You can be both you know. A five-year portfolio and a trading portfolio. That way if you blow it all out trading you know the five-year plan will bail you out over time. If you do well trading..BONUS!

Tuesday, September 18, 2007

move to fall

As measured by the REBC(Red Eye’s Bikini Clock) summer is officially over. We had one of the worst and best rides of the summer this weekend so it was a fitting ending. On the way to Baltimore we hit turbulence from ships exiting the harbor and quickly turned from boaters to small airborne craft pilots. At one point I looked back to check on our passenger and he was in the fetal position of the boat begging for mercy from the boating gods. Which was granted in the form of flat waters all the way back across the bay and we had three boats running flat our all the way back in the best ride of the summer. As we sat later at the bar of Lisa’s small plate attempting surgery on my finger from the latest and last of summers injuries with tweezers, a paperclip and scotch, The Tic-Tac kid and I shared a toast to a great season with lots of boating, a sprinkling of pretty girls and liberal doses of good times and good friends. So, away go the flip-flops and shorts; trade the red for white, gin for scotch, break out the tennis shoes and blue jeans. Baseball is headed to the stretch and the genetic misfits known as football teams capture our fancy as we head into the early days of fall. It was a great summer but given the injuries sustained in the Squirrel Wars of 2007, the the curious incident of the whiskey and biting dog incident, and now the holy god not only is that the biggest splinter I have ever seen that’s all the way under you nail accident (FYI-Doctors lie.4 Novocain needles in your finger is not a little stick. It is a big painful evil,nasty mother of all sticks) and other assorted missing nails, banged bones and torn bits of flesh another couple of weeks of summer may have well been the death of me.

Which brings us to the stock market. It makes less sense than my personal life at this point. At least there I understand the cause and effect of what happens (Basically, I am an idiot and set in my ways. As I have been given to understand I am also arrogant, obnoxious and condescending. And they say it like it’s a bad thing!). But I confess to being a little confused by the market and its seeming disconnect form the real world. As long as you do not eat or use energy, there’s no inflation. However a trip to the grocery store shows me that food prices are the highest I can recall seeing. Oil is at a new high. Back out auto gains driven by model year discounting and rebates and retail sales in Augusts back to school period were down. The consumer has depended on the housing ATN for the last several years, but with the credit dry up and in some areas declining values, that bank is closed. But everyone now expects the Fed to cute rates later today. This allegedly will reaffirm consumer confidence. But it also has the impact of bailing out banks and funds from the consequences of stupid decisions. Apparently takes risk and win. Great! Take risks and fail? No worry that’s what the fed is for. Unless you are an individual who took a jumbo two or three year Arm with a teaser rate and are going to see you mortgage rate double in a few months. You are just screwed. In the face of this the stock market is within 4% of all time highs. Lehman creates earnings in excess of estimates by changing their tax rate. Rally time in spite of the fact that revenues fell 47%.

Most of the activity I am seeing is in the indexes, leading me to believe that short tem money continues to dominate stock market action. The focus is on how will we react to the fed today, or ABC ‘s revised earnings SWAG. 4: 15 IS long term. Great company trading at book profitable pays a dividend, buying back shares and insiders buying the open market. Who cares? Special situation with a high-annualized yield? Sold it to pay margin calls on debt positions. Convertible preferred paying over 10% with strong management. No interest. Index baby. Bid em.

I have heard convincing arguments from Louis Navellier and even Jim Cramer of late that we are going to move into a market that favors value over growth. Here a shocking statement coming fromm me. I think I agree with them. Value has outperformed growth for over 7 years, a pretty much unprecedented run. Usually the periods are much shorter. This run has been fueled by falling rates and rising housing prices that have pushed traditional value industries forward and allowed for easy takeovers and refinancing of under performing stocks. Companies were bought on credit at stupid multiples of assets and earnings and launched the prices of cheap, undervalued stocks. Those days I think, are over. Having said I agree with the statement, now we have to look at where does this growth come form. It is not going to be tech unless corporate America gets a lot looser with the cap ex checkbook. We have already seen by the IPOD price cuts that consumers aren’t going to pay up (as they did in the past for new toys. The toy budget is already pretty stretched.) I think areas like heavy construction rebuilding the country’s badly stretched infrastructure perhaps. I like GNCI here and it sells at valuations I like. Coal should be a growth industry in years ahead as we look for ways to get away from foreign energy. Coal to liquid technology could play a big part in making coal a growth story. I like MEE, CNx and ICO here. Growth will come from new areas not yesterdays growth story. We will have to look for them. My other problem is that I think we have a few years of downright sloppy markets ahead. I don’t see how we cant. We have priced stocks for perfection in an imperfect world. It’s going to be tough to deal with and take some innovative and adaptive thinking to not just survive but earn good absolute returns. How do we do this? Selling put options on market sell offs on stocks we like. (A caveat here, I think it will be necessary to add some trader think to our methods and be willing to own the stocks put to us and use covered calls to trade around the positions and exit at a profit. I am kind of anti buy and hold here; also don’t post minimum margins. Post the full price of the underlying stocks). I think trading the value line 1 and 2’s under ten, buying on sell offs in the overall market and selling the next rally will work. The Dorsey Wright high low indicator has been successful in the past at timing shorter-term entries and exits in the stock market. We need to watch it closer. I remain very impressed with Navelliers Portfolio grader pro service that’s spots institutional buying in individual stocks. Paying attention to the grading of our stocks could materially improve our entries and exits and therefore on profits. It is going to be harder to make money for the next few years. When we run our screens finding stocks with profits and dividends trading below book, we are probably going to have watch our market entry point as well as institutional activity in the stock a lot closer than years past and be quicker to trade than we used to be. Further we should try to focus on areas that offer earnings growth because I think that’s where the money will flow. Just cheap isn’t going to be enough anymore. It’s going to have to grow as well. The idea isn’t to beat the market. If stocks are down 20% and I am only down 10, it is not a win. It’s a loss. You cannot eat relative performance.

So we move into fall now and look forward to crisp days and cool nights, breaking out the blankets and wamr socks. Sweatshirts are going to replace tee shirts and its just about time to shut the pool and clean the chimney in anticipation of crackling fires ad good red wine. After a wandering summer, the Great Girlfriend Hunt of 2007 begins in earnest (although hopefully out the (mostly self inflicted) weirdness of the 06 hunt). The Yankees and Boston are keeping it interesting; Detroit refuses to go quietly into the September night. The ravens beat the hated Jets, The redskins are surprisingly 2-0, and navy is not as good as years past but still fun to watch. Of course, there is the downside of Notre dame being truly horrible but we have to take the good with the bad. The leaves will turn here in the Mid Atlantic in a few weeks as well as all over the northeast with a spectacular splash of colors, giving us an injection of color before the gray of winter sets in. There is much to like about fall with the only real drawback being the women wear so damn many clothes!

We are going to get a rate cut today. I just do not think we are going to like it as much as current sentiment thinks we will.

Monday, September 10, 2007

an oldie

found this one lurking in some old files

My what a wonderful week we have had around these parts. We have learned al about dow theory. We have learned that it works almost all the time..except that it really doesn’t, it isn’t really a trading strategy and its kind of sort, just maybe a little. Or perhaps even a lot subjective.We have learned that denny mclain and pete rose were bad people who did bad things but it might not have been their fault because its well done that pitching too many innings or playing hard on the diamond makes one make bad nets on clubs,spades and even athletic contests.We have learned that phd students don’t like when phd holders makes jokes at their expense. To everyone’s shock and horror, we discovered that retail comp numbers don’t tell us much about where the stock price is heading.(kudos where due..)that was a nice piece of work). It was deeply disturbing to discover that a number cherished and admired by wall streeters was was revealed that Americans and british don’t have the same sense of humour.apparently george carlin is not as sophisticated as monty python…just funnier.they do however think homer simpson is an okay guy.

However I must take great issue with the discussion of American beer as a poor product and American women as..what was the phrase..stroppy? As the lists in house expert on American drinking habits, along with my dedicated colleagues drs crossman and Hillman..although it is my understanding that dr Hillman is retiring from the active research field his contributions must be noted and appreciated…..and American woman and their relative levels of ..umm//stroppiness, I feel I must intervene to correct some misunderstandings and wrong assumptions in the data collection and analysis process.

Dr millers, whose work in finance,gambling and now drinking and womanizing I much admire and look forward to all his contributions, suggestion of a field trial is indeed a wonderful thought. However he has structured his control group in such a way to almost guarantee disaster. First, NEVER use fosters as a control. It is a good beer, however its US based advertising campaign is full of blond Australian surfer types and outdoor crocodile killers. The image that this creates in our quarries mind will be rather difficult for your average khaki and polo shirt type to overcome. If you are in one of the Dr Melvin under the bridge hall of fame establishments and proffer a fosters, the can is entirely too large. Far better to have the young lady bounce a 12 oz off your head for offering her some namby-pamby foreign crap in a funny looking can.As for the use of Colt .45 40 ouncer, this is fraught with peril. If it is accepted, you are on the wrong side of town and death is imminent. If the lovely of your intention accepts the cold 40 - one suggests you slam your own drink down and begin the process of hail marys or whatever archaic pre death ritual your religion practices.The French champagne may in fact be the worst of the bunch..if like so many of us you consider out right rejection and public humiliation to be worse than death.You see, we Americans have trained our women to understand that the proffering of expensive bubbly liquids and the acceptance thereof is an binding contract for immediate and prolonged sexual activity. Should you offer this to a lovely as a first drink, it would be considered extraordinarily forward and you can expect to find yourself red faced and wearing the remains of whatever watered down sucky American beer she was drinking.

When examining the drinking happiness and stroppiness factor of american women, one suggest the following control groups. The best test is of course the lovely with two empty miller lite bottles in front of her and a third on the way, accompanied by empty shot glasses of jaegemeister. It is preferred that she have the ring tan or other indicator that suggests the recent departure of a significant other.This is a young woman in a decidedly non stroppy mood who is drinking beer for the purpose we Americans use it for…to other more sophisticated overseas brethren we leave discussions of hoppiness and after taste..over here we use the stuff to lubricate the good times and unleash libidos.This young woman will consume enough watered down American crap beer and foul german rocket fuel to forget her troubles and begin making up for lost time having good times. The other worthy prey..I mean field subject is for course the cosmopolitan drinking female. If she is over 35, she has long ago decided what she likes and wants and you will know where you stand 30 seconds after you offer a drink….if she is under 35, she is a sex in the city junkie and feels a social contract to drink too much and have sex with relative strangers….not a bad character trait for our research studies. To be avoided at costs out the fruity umbrella drinking flocks…these are girls night out types and like herds of wildebeest in the wild they band up to protect the gaggle form invasion by predators. To attempt research here will soon exhaust the funds available for the project as they will accept all the 9 dollar fruity concoctions you offer but you will never get close enough to discuss trans continental stroppiness. White wine drinkers also make a poor choice as they tend to be settled, centered types and there’s probably a protective alpha male somewhere near by. Now the whiskey drinking woman…here is a woman with so many virtues that the great redneck troubadour Toby Keith recently penned a tribute to her and all her sisters nationwide…but no point looking for her..odds are she left with me an hour ago

Wednesday, September 05, 2007

endless summer? I don't think so

So now we have slipped past the dog days of autumn and begin down the slippery weeks of summers end. Labor day has passed, a wonderful weekend with a poker game to kick it off and some great boat rides blasting up the Chester River under clear blue skies enjoying the company of friends and all the great things that make up this last three day weekend of summertime. In the interest of editing we will leave out the part of the story that involves whiskey, ex-wives and angry dogs (who knew dog bites hurt that much or got that infected? My leg has colors in it that were never part of any rainbow I ever saw). Only two summer weekends left (keep in mind we are on the red yes calendar around here. Final bikini contest. End of Summer). Thoughts turn back to work and markets as volume returns to the street and begins to reassess exactly where we are as far the direction of the economy and stock market.

It remains a pretty mixed picture as of this moment in time. In the beige Book released today the fed stated that there was little economic turmoil outside the real estate markets. That’s like saying outside of those very large fang marks on it, your leg is fine, Mr. Melvin. What it doesn’t say of course is that the real estate market is huge in this country and the source of most people’s personal wealth. To say nothing of all the real estate agents, mortgage brokers, and associated jobs that will be lost in a real estate slump. Of course there is still the 800-pound gorilla of all those mortgage resets coming up. Even if many of these borrowers could qualify for a loan in the new environment, they could never afford the new payments.

Sounds bad doesn’t it? Maybe we need a rate cut to soften things up a bit, make a few more bucks available to smooth things out. But Wait. There’s more. As any person who eats food, buys gas or clothes or any other type of goods can tell, prices are rising across the board. Pretty much most raw materials are up near new price highs. We are a service economy so pretty soon service providers will raise the prices they charge so they too can continue to buy food, gas and all the other fun stuff we need to get through the day. The dollar is in a free fall against just about all currencies right now (this is causing me particular distress as the price of scotch has jumped 20% in the last month). Higher raw materials and energy costs? How can we lower rates in the face of these events?

Glad I am not fed Chairman right now. If he doesn’t act, he will disappoint the financial markets and cause stock prices to fall. If he does, he runs the risk of creating a stagflation scenario. Somehow I do not see the markets embracing that very fondly either.

So what now? First admit that I probably should have bought the 1380-1400 are on cash SP 500. The few market-timing factors I like showed it as a buying point. But I felt then as I do now that the risks of such a move were not worth the potential return. My monthly price chart shows 55 months of rising prices. Do we really have a one-month sell off those retraces150 points of a 700-point move? We have risen 100% off the lows but a 20 day 10% decline is all we get. A fed injection heals an economy that had all the loose lending and bad deals that mark a frothy economy? Did think so then and don’t now. Caution makes a lot of sense to me.

I did pick up shares of mortgage concerns and reits that make commercial and business loans a few weeks ago. They had fallen, were well below book value and had real loans on real property that had not been diced and sliced into derivative securities. I felt that they could ride this wave out and corporate insiders agreed with me. Yields were north of 10% on all of them and they have risen slightly since. I think BRT, CSE, GSC, JRT and NRF are probably still buys. Can they go lower in the short term? Of course. Will they be a lot higher in three years? I think they will and I ll be collecting some fat dividends along the way. I picked up a few shares in FMAR. This fast growing bank in Baltimore trades below book as a result of their own mortgage mistakes but they have a good CEO who is buying stock. ADPT is still a net-net worthy of purchase as well. I think you also can still buy BERK, BHBC, EIHI and ESST.EDCI is too cheap not to buy given the NOLs lurking on the balance sheet waiting for someone to figure out how to turn them into real money. Those inclined to sell options should be having a blast right now as huge moves in volatility make for a lot of trading opportunities.

Let me reiterate that I am not a long-term perm bear. In fact I think the real estate issues are going to take some time to work through the economy and the stock market. When it is time to buy I think it will resemble 2001 and 02 as an incredible buying opportunity that generates a lot of long-term wealth. I look forward at that time to being a lot more aggressive, employing strategies like the value Line 1 and two under 10 dollar list, the yield and return on equity strategy. As a bonus as the lending markets churn, with wall Streets all too reliable habit of throwing out the baby with the bathwater, small local banks will get very cheap. Historically buying these little gems has been incredibly profitable when you get them below book and ender 10 times earnings. We are close here but not just yet. I am watching insider buying in this sector very carefully looking for a sign to increase my buying here. The time to jump in with both feet is coming. It is just not here yet.

So, summers gone and the flowers are indeed all dying. Or soon will be. But this gives a fall to look forward to. This just might be a good thing. Lets be honest, a few more fast boat weekends with the tic-tac kid and my knees and liver would both sue for damages. There is no better time to be a sports fan. College football, that glorious pageant of sport where one group of twistedly mutated young men takes on another and an entire states pride rests on the outcome of the contest. Already we have seen one of the greatest upsets in all of college ball history when Michigan was upset by tiny Appalachian State (search youtube for their recruiting video to understand just how small this school is. I have made better films on my phone. My phone, btw doesn’t have video. That’s how bad it is) We have determined that my Beloved Notre Dame is not very good. Okay, they are actually very bad and I am dreading the amount of crap I ll have to take from beachclub Boy Saturday when we play his Penn sate Nittany Lions. I hate my bet even with the 17 points. Pro ball starts tomorrow night with what should be a barnburner between New Orleans and The Colts. I have to say that the over at 52.5 looks like a good bet from here. The ravens look very good and there are some great story lines though out the league. As a bonus we can now watch football on ESPN and not have to listen to Michael Vick stories. There is something grand, glorious and uniquely American that encourages eating and drinking excessively while watching violent powerful men do violence to one another whilst slightly dressed beauties dance among them sinning sings of praise. Goes to Tim’s central theory of life. All things are better with partly to mostly naked women in attendance.

Baseball races are heating up. The Red Sox look to be waltzing into the playoffs, the Yankees have to play in against the mariners but this will be tough with the roughed up pitching staff. The orioles might avoid last place (although I would not bet much more than a can of warm Schlitz on this), the cubs are prime to break hearts again with their lead in danger now and the Brewers charging forward like hopped up Dartmouth freshman on a panty raid, Crossmans Indians look like a lock for the playoffs. There does exist a very strong possibilities of the only two truly evil baseball teams on the planet meeting in the world series and I will be faced with the prospect of having to spend the last week of October snarling and hurling savage curse at the screen as the red sox play the mets. Still it is a great time to be a sports fan. Hell, even NASCAR has the race for the chase coming. No Junior though so no one south of the mason Dixon line will watch it.

The pipe, the pipes are calling, from the docks and to the games.

Caution in the markets, sports on the tube. Green label Bushmills on order. No dogs in the immediate vicinity. Life is good.