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Thursday, October 18, 2012

Use Your Edge

In addition the sports explosion around my house this weekend, I had the chance on Saturday to spend a few hours at a gathering of business and professional folks at a networking event.  My wife had a table at the event so I tagged along to see what I could learn and who I could meet. One small group gathered around the coffee table talking about markets and I wandered over and joined.  Anytime I join one of these conversations I listen and grunt a lot without offering too much commentary. I view it as a learning experience. What I learned this week is all too consistent with what I have taken away from similar gatherings.

This was a group of business owners and professionals, not full time investors or traders. They are not in front of the screen with sophisticated tools to evaluate short term market moves. One gentleman was bragging that he “figured out” that David Einhorn was not going to talk about Herbalife (HLF) at last week’s Value Investing Congress and made a few hundred bucks by buying the stock and flipping it later in the week. Another bemoaned the fact that he thought we would have a really week employment report and bought a double inverse ETF and lost several hundred on Friday.

The conversation went on and as I stood listening to this group of investors talked about the stocks they owned and traded. There was much talk of Apple (AAPL) and Google (GOOG) and how third quarter earnings would look for these tech giants. The prospects for local favorites Darden (DRI) and Disney (DIS) were mentioned as well. I heard talk of the same popular stocks you see on TV every day as well as lots of chatter about breakouts, trend lines and such. I have been a part of this discussion a million times it seems and it is always the same.

Individual investors give up all the advantages we have to play a game we cannot win. Figuring out what David Einhorn may or may not do and trying to front run is a loser’s game. If he had presented Herbalife that stock would have tumbled like Chipotle(CMG) did that day. What makes anyone think that while running a business, paying taxes, doing regulatory filings, making it to the kid’s soccer game and remembering your wife’s birthday you can successfully trade a data release? There is an army of economists with super computers trying to guess the number and even they usually get it wrong. Short term trading of the hot stocks puts you in the lion’s den against the professionals and you are not the lion.

All the commercials from the brokerages and advisory services leads individuals to believe they can compete in the trading arena. Odds are you cannot. Successful traders are immersed in the markets as a full time profession. They have tools and capabilities that you simply do not. Even then more traders fail than succeed. Trading is not an easy game that can be won by part timers.

As investors individuals have an enormous edge. We do not have an institutional mandate that limits what stocks we can buy or what percentage of our accounts must be invested in specific asset classes. No one is going to criticize us if we fail to win the quarterly performance game. We do not run the risk of getting fired for having a stock no one has ever heard of in our portfolio. No one is going to search our quarterly reports to make sure we own the popular most recently successful stocks. We have the luxury of not having to care what other people think of our investments.

We have the luxury of waiting. We do not have to play just because the casino happens to be open on a particular day. We can wait until we get the conditions that put the odds of investment success in our favor. We do not have to have an opinion on the next series of economic data but we can react to extreme market reactions to any data set that tips pricing and valuation in our favor. We can buy stocks that in companies that are too small for the big funds or too unpopular for most fund managers to buy.

Trying to play the same game the professional do is a losing game for individuals. Trading the way your brokerage firm wants you to will make them very happy but I doubt it does much for you in the long run.  Invest in sound businesses at good prices and hold for long periods of time. Trade less and hold longer. Worry more about long term profits and less about short term bragging rights and you can beat the pros returns handily.
\Consider how most people will be approaching the current earnings season. It is a losers game with no edge for most of us.As we head deeper into earnings season over the next couple of weeks I am once again amused at all the noise and fury that is concentrated on the reports. It is a quarterly snapshot of a corporation and nothing else. Far from being the holy grail that Wall Street’s short term focused has turned it into the quarterly earnings report and 10Q filing are just a tiny slice of c corporate life span. The report does contain valuable information about the current business and financial status of a company but is just an update. It was never intended to be the stock market equivalent of the Daily Racing Form.

As I roam around the net and listen to the various stock commentators everyone is focusing on, and biting on, these short term reports. Hundreds of billions of market cap will be created and destroyed by how actual earnings compare to the always highly accurate analysts’ estimates.  Incredibly most of this money will be bet on the same stocks that always dominate the news, the high flying high multiple darlings and a few select bellwether type blue chip names. Investors and traders playing the earnings game are competing against the super computer armed market makers, themselves and the big wall street firms  to pick up pennies betting on the favorite.

I approach earnings season a little differently. Please understand that I am not going to engage in the feverish trading activity that will mark the next few weeks. I do occasionally engage in speculation but betting on the unknowable against a player with a formidable edge does not interest me much. I like to look at those companies that are cheap, or near cheap and have run off a string of earnings disappointments. No one cares about these companies except for the shrinking handful of analysts forced to cover them. No one expects anything g good to happen to these companies and often excessively negative expectations are built into the share price.

There are some interesting stocks on my list of disappointing companies. Pico Holdings (PICO) is an interesting collection of real estate, agricultural and water assets. The also have an insurance business in run off mode and investments in fixed income and equity securities. Pico has the misfortune of being an asset rich company in an earnings driven market. The shares trade right at book value but they have a lot of land and water rights that have been on the book for an extended period of time and may be understated in value. There is only one analyst following the company right now after Pico had two consecutive enormous earnings shortfalls.

This stock is a win- win in my eyes. If the company has another bad earnings quarter the shares could drop further and allow me to buy the shares cheaper than the current quote. If conditions have improved no one is going to notice and I can pay around the current quote for a solid collection of assets with an improving earnings stream. The company reports early in November.

Tutor Perini (TPC) is another stock I will be following this earnings season.  The contractor and construction management company is dependent on infrastructure spending and has posted 3 consecutive large earnings short falls. Wall Street estimates of the company have fallen by about 25% over the past three months.  In spite of the weak environment for large scale construction contracts Perini is managing to stay busy. They currently are working on projects like the Tappan Zee Bridge rehab in New York, the Alaskan Viaduct in Seattle and the freedom tower in New York City.  They have an existing backlog of more than $5 billion and pending awards of more than $4 billion. They may not live up to Wall Street’s expectations but this company should make $1.50 or so a share for the full year.

Tutor Perini is a 115 year old company that has been publicly traded for more than 50 years. When the economy firms this company will win more than its share of new infrastructures construction as well as large commercial and industrial projects. I hope they fall short once again so I can pay single digits for a stock that traded in the 70’s less than five years ago.

I have never found it productive or profitable to watch the same stocks as everyone else or trade like the crowd. I will be watching the unloved and unpopular names in hopes earning s season creates an attractive long term entry point.

originally published on real money


BB Canada said...

It is amazing the amount of knowledge some of these analysts have on companies in certain industries like technology. It makes almost no sense for an average investor to try and compete here as we have no edge.

Give me a $2.7 billion market cap stock like insurer ORI with 1 analyst and an unusual runoff situation and I see easy money. Try and compete on $2.5 billion market cap BRCD with their 27 analysts and all you can hope for is you get lucky.

BB Canada said...
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