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Tuesday, November 27, 2012

Don't Be That Guy. Smart Put Selling

One of the more interesting discussions around Chez Melvin this past weekend has now spilled over into the week. The topic of option selling came up as a couple of folks have recently had their heads kicked in and net worth diminished by disastrous short put positions. I have been known to sell puts form time to time and found the conversation of great interest. The traders with losing option positions were experienced investors but new to the option selling game. Thyme made the same mistakes I always see made by pros and neophytes alike.

Selling puts on stocks, indexes and ETFs can look like free money.  We all know that most out of the money options expire worthless with the seller keeping the premium. What most traders fail to take into account is that option payoffs are asymmetric in nature. You can sell premiums and have 90% winners and end up broken by that final trade. Option sellers can find themselves collecting pennies and paying out dollars.

I only sell options on stocks I want to own. Valuation of the underlying stock is the first and foremost concern. If it is not cheap I do not care where the option prices. I have no interest in the trade. This is where most people lose money as option sellers. The premiums on the darling and popular stocks are often fat and just too tempting to pass up for many traders and investors. Why sell options for a 2 or 3% monthly return when you can collect much more than that by selling premium on stock like Apple (AAPL) or Chipotle (CMG)? After all they just keep going up and everyone loves them. What could go wrong?

What can wrong is the stock can fall out of favor as we have seen with these two glamour names this year. If you sell puts on one of these names and collect the fat premiums and the stock falls out of bed you are going to lose a lot of money. You could end up being put the stock and being forced to buy a stock you do not really want to own for the long term. If you compounded the error by posting minimum margins you are going to face a margin call of epic proportions. I always post the full purchase price of the underlying stock at the strike price.

The other mistake I see made is going to seem counter intuitive  I really do not like to sell options on a rising tape. It would seem that selling puts when the prices are rising. The price goes higher and you collect the premium. The problem with this theory is that each time you roll over the position you will be selling higher strike prices. In a rising tape volatility is usually rising and pricing is weakening. Markets are not unidirectional and if you have lost track of valuation first and sold at ever higher prices a small correction cap wipe out a years’ worth of gains.

I like to sell puts on stocks no likes at prices that I think are too cheap not to own. I am hoping the stock gets put to me and forces me to buy at lower than current market prices.  I prefer to sell them when there market is declining and there is a touch of fear in the air as this leads to fatter options pricing and better back in entry points for my long term position or higher premiums in my pocket. As a rule I pretty much never want to sell options of any kind when the VIX is below 20. I have seen way too many people carried out of the arena on their shield because of a volatility spike. I would rather be the guy selling insurance when everyone is willing to pay too much to protect against a downside that has already started.

I have found over the years that my best experience selling options have been in stocks that are so unloved there is not much option related activity. These usually have wide spreads and lower open interest. I will post an offer between the spread based on my calculation of option value and I get filled more often than not. It may take a few days but I am able to sell an option on a stock I like at a price I like. I scale into stocks so I do not need to sell 50 or 100 contracts at a clip. Just as with stocks my best results in the options selling business have come from doing what no else is doing and trading where larger competitors simply cannot.

Options selling can be a profitable tool for value investors. As with all tools there is a time to use it and a time to leave it in the box. Using the tool in manner for which it was not unintended can lead to serious injury or even financial death. Don’t be that guy.

Tuesday, November 20, 2012

Annual Thanksgiving Drivel

So here we are once again. Thanksgiving is fast upon us and the madness we refer to as the “Holiday Season” is upon us. Thanksgiving is like the feast before the slaughter in many ways. For one day we can eat, drink and watch football without worrying about gift giving or shopping. Unless of course you are one of the many dumbasses heading out for Black Friday shopping in the wee hours of the morning then it’s just the pre-battle dinner. I cannot for the life of me imagine of anything I need badly enough to head out for Black Friday or pre Thursday shopping.  I do not think I could look some poor minimum wage store clerk in the eye that had to come to work Thanksgiving at midnight so I could save a few bucks on a big screen TV and Tickle me (but not there without checking ID first) Elmo. Call me sentimental but I remember when Thanksgiving was about family, friends with lots of food and booze and not carb loading for shopping madness that puts WWE action to shame.

Tomorrow is the big travel today although some signs of the exodus have already started to appear. I am always that people will fight their way along turnpikes, through airports and jam into trains like sardines to spend a day with a bunch of folks they really don’t like that much anyway. There is nothing like fighting your way up I95 to spend two or three days of hearing about all the things you did wrong 30 years ago and rehash all the wrongs done to your siblings over the years. It must be magical to do a Usain Bolt through the Atlanta or Dallas airports to be in time to once again watch Uncle Frank get shit canned on your dads good booze while your cousins new baby daddy explains the intricacies of the parole and probation system over dried turkey and mashed potatoes that could easily double as stucco and mortar. There is a reason most of us don’t live that close to our extended family. Thanksgiving is a time to explore all those highly dysfunctional and unpleasant reasons while fueled up on liquor. Ah, the holidays indeed.   

We will see all those commercials and Hallmark movies that show families gathered to delightful dinners in a glow of soft candlelight. Most of us that have experienced the large extended family holiday gatherings over the years know that a far different picture usually emerges. Mom is frazzled beyond the breaking point  after two days cooking and cleaning and is desperately trying to resist the urge to smother her younger single professional sister in the green bean casserole after the 19th story about her fabulous weekends, Dad and Uncle Ernie are drinking Jack in the back yard and about to break into a fistfight over who won the 1972 Super Bowl, Aunt Ethel is puking in the potted plants, the baby has managed to obtain and eat an entire pumpkin pie, and although  Johnny is home from the army  no one has seen him or his pretty little 17 year old step cousin in some time now although there is bright red thong where his car used to be parked.  The TV is blaring a football game no one cares about and the youngsters are in the den watching 9 and ½ Weeks while Grandpa snores strenuously in the middle of it all and Grandma is slumped in the recliner with a bottle of sherry and a bendy straw. The great American family holiday!

After a few too many holiday gathering exactly like the one described above, along with threats of rectally inserted turkeys and full on food fights among unrestrained youngsters I have the misfortune of sharing a blood line with, the kids and I years ago came to the conclusion that we would rather say home and celebrate things our way. The Melvin way means tons of food, good wine and we only allow people we like to join us. My wife is of the same mindset so our holidays have become good times with people we actually enjoy being around. We admit no one we don’t care for regardless of birth circumstances, social status or blood type. It makes for a much more enjoyable relaxed holiday experience.

It is also a time of year when we really should set aside our worries for a moment and be thankful for all we have in life. There is plenty to worry about this year. Our government is heading away from a free market republic to more of a democratic big government form of socialism. There are plenty of historical precedents for this but that doesn’t mean I have to like it. The economy sucks.  Soccer is gaining in popularity. The Blue Jays just got a lot better and will be a threat this year. Taxes are going up. There is either global warming, climate change or a looming ice age depending which channel you have on at the moment. Honey Boo-Boo has her own show. Rush Limbaugh and Al Sharpton are still taken seriously be entirely too large a percentage of the population. Teen paranormal romance is now a section in Barnes and Noble stores. My Mother is coming next month. Rap music has not died off yet. The head of the CIA can’t even have a covert affair. There aren’t going to be any more Twinkies or ho-hos soon. There are plenty of things to worry about but this time of year is about being thankful.

As always I have to start with family. I have been blessed with an amazing if somewhat eccentric and weird immediate family. I have no idea why my amazing wife would marry me but every day I am damn glad she did. She calms me, excites me, and makes my life better in every way imaginable. I have no idea what she sees in me. I am messy, absent minded, stubborn and difficult…and those are my good qualities. She is a saint for putting up with me much less loving me. Every day I wake up next to her is a good one. Lisa has grown into this smart confident young woman and Tommy is a businessman of the highest order without losing an ounce of his magnificent if crude sense of humor. Maeve is growing smarter and more artistic with each passing day. Each day I am reminded that I am a lucky man and that I blessed that these amazing people put up with me.

I am also blessed with some great friends. Many culled themselves off the list in the aftermath of the great IRR last year but those that remain are steadfast and true companions along the road of life. I don’t travel as much right now so I may not be sharing bar adventures and dubious cocktails with the Chicago Curmudgeon, the Voodoo Professor, The world’s only living Iranian Jewish cartoonist, the degenerate Kentucky Colonel, the Cheesehead or others but I talk to them frequently still through the magic of Facebook, Twitter and other modern communication devices. I don’t see the island crowd every other night at the bar like the old days but I am still in touch with people like the littlest firefighter, Tic-tac, Rag Lady, and others. I expect to see them when the snow is ass high in the Mid Atlantic this winter. I am in contact with great people like Baldy, the Beard, the Preacher and Granola on a daily basis during market hours and beyond. I have a solid group of friends and for that I am thankful.

When you get right down to it at it is core life is magnificent. There is so much to be thankful for each year that we really should take time to express and explore our gratitude more often. My list grows all the time but among other things I am thankful for:

Each day I wake. This beats the living shit out of the alternative.

The dog. I still hate pets but walking the thing around the neighborhood here in Florida has led to me walking a few miles a day and losing about 10 pounds since we got here. Still not a fan of picking up the steaming piles of fresh shit but at least I don’t gag or throw up anymore.

Alligators. I love alligators. The dog and I see two or three a day and they are just cool.I may be gray and losing my hair but I am like a little kid when I see alligators.

Same for Pelicans. Have to drive to the coast to see them but I get a huge kick out of pelicans.

Books. Friends ,educators, entertainers, companions. Brain food. It’s a lifelong love affair.

Wine. Rounds off the edges off a bad day and adds a sparkle to the good ones. Damn tasty too.

The fact that less than 1/10 of one percent of investors pay a lick of attention to tangible asset value. The faux value investors out there create opportunities for those of us who actually practice it.

Ben Graham, Chris Browne , Walter Schloss and all the other greats who paved the way.

Florida.  Can’t manage an election or field a decent professional football team to save their lives but this is a great place to live.

Did I mention my incredible wife?

Zombies, Bikers and Insane Asylums.

Newspapers. I still love an old fashioned actual ink and paper newspaper. My extraordinary wife actually got me subscription to the daily paper here in Orlando. That never would have occurred to me.

Twitter. I freaking love Twitter. If you set your feed up right its better than a news ticker most days. It’s also a lot of und to trade barbs and quips with people like @tangletrade,@byrneTSCM, @Brian Sozzi and others.

Greed. No matter how much my liberal friends deny it greed has been the source of much of human advancement. Rather it be greed for money, achievement or knowledge greed moves us forward.

Sunsets. I am sure sunrises are awesome too but I don’t get up that early if I can avoid it. With a 9 yr old who thinks 7 is late I see more of them these days.

Sleeping in. Its rare these days so I appreciate it even more

Naps. I love naps. You can never take enough naps.

Travis McGee, Doc Ford, Spenser, Hawk, Tomlinson, Agent Prendergast, John Cory, Thorn, Jesse Stone, Stone Barrington, Lucas Davenport, Horatio Hornnblower, Cletus Frade, Harry Dresden and all the other boon companions of the written word.

Baseball my life friend and obsession. The Orioles in the playoffs just makes the year better. The Red Sox sucking is just sublime

Football because who doesn’t like barely controlled violence with half naked dancing girls?

Beethoven Bach, Miles Davis, Wilson Pickett, Handel, Springsteen, Waylon Jennings Jerry Jeff Walker, the Grateful Dead and everyone else who plays the soundtrack of my life.

My wife. My kids. My life. I am a lucky man and I know it. I have much to be thankful for again this year.

Now lets get the bird in the oven. Uncork the wine and get this party started. Happy Thanksgiving.

Monday, November 19, 2012

Convert and Prosper

The last few weeks have been strangely peaceful.  For the first time in months we could turn on the television without a constant barrage of campaign ads and misinformation. Although I am sure the networks and local stations will miss the revenue I am glad to see it end. I will be equally glad to see the end of the barrage of how to invest now columns and presentations that are flooding the media. It happens every election cycle and it is equally silly every time. However you pick stocks or investments keep doing what works. All these predictions will or will not play out but all the information will show up in the financials. If you like growth stocks buy the stocks that are growing revenue, earnings and margins. If you are a value type buy those stocks that are worth far less than their intrinsic or asset value. I think you make more money and sleep better by reacting to what does happen rather than trying to predict what will happen.

I had a before conversation with my friends at FJ Capital the other day. As always once the niceties were out of the way the conversation focused on bank stocks. Andrew Jose, one of the partners of the banks stock hedge fund, was kind enough to forward a copy of their latest presentation and thinking. It was chock full of information about small banks stocks but one section really caught my attention. It focused on mutual thrift conversions, an investment strategy that has been successful no matter who resides at 1600 Pennsylvania Avenue for more than three decades now. I see no reason it will not continue to be successful.

Mutual thrifts were formed decades ago to serve local communities. They are owned by depositors not stockholders. Over time these institutions generated solid earnings but they were limited by the nature of the institution and it was difficult to deploy the capital and grown the thrift. Many decided to convert to state chartered banks and issue stock to the public. It is a tightly regulated process that involves an appraisal and IPO offering to the public. These are small banks that come public at a steep discount to their asset value compared to larger institutions and they have been a steady source of profits for astute investors.

Andrew sent a table along that had some useful information about thrift conversions over the past 22 years. It seems that because the post IPO banks are trading at a discount to book value, have plenty of excess capital and have very clean loan portfolios the stocks have done very well. They also become very attractive takeover candidates. The average life span of a mutual thrift is pretty short. In the past two decades more than 75% of mutual conversions were taken over within less than 5 years. In the past few years I have had former conversion taken over at a pretty good clip with banks like Abington and Danvers taken over at large premiums to our purchase price.

Here where it gets interesting. If you look at conversion deals that have been done since 2006 the takeover rate declines sharply. Looking at the information Andrew provided it looks like there have been 80 conversions since 2006 and just 5 take overs. The credit crisis hit all segments of the banking industry and thrift conversions were not exempt. They withstood the storm better than most because of their more conservative approach to lending and high levels of capital but they still took some hits. In addition takeover activities slowed down to a near coma as the focus for many banks was to simply survive not grow. That will change over the next five years.

There are still substantial headwinds for the smaller banks. Regulatory costs and capital requirements will constrain top and bottom line growth. Real estate markets are still struggling in many areas of the country. Small business, an important small bank customer, is still reluctant o expand in an uncertain environment.  This all is more of a positive than a negative for our thrift conversion stocks. Although the world is not back to 2006 levels there are signs it is stabilizing. As banking’s focus is again turned towards growth the easiest path will be to acquire smaller institutions with excess capital and clean loan portfolios. Given that high regulatory costs make it difficult to operate and profit many of these former thrifts will find it easier to sell. Since the officers and directors tend to be large shareholders post conversion these deals will be done at solid premiums to book value and the current stock price.

The opportunity for the last 6 years’ worth of thrift conversion stocks is a huge subset of the trade of the decade. This is an investment strategy that has worked regardless of who was in the White House, which party controlled the congress or what condition the economy was in at the time. The inevitable market dips and declines were merely inventory creation events that allowed investors to buy at sale prices. The conversion process itself creates bargain issues adding capital to an already strong balance sheet. Most of these are smaller local institutions that are extremely well run in the first place and would be attractive without the extra capital. As the good folks at FJ Capital pointed out most of them get taken over in a few years.
The banking crisis has bought mergers to a standstill in all sectors of the banking industry including conversion. We now have an excess inventory of converted thrifts that are still public and trading at attractive prices. Most of them fit comfortably with my trade of the decade strategy of buying banks with high levels of capital, low loan losses and trade below tangible book value.

One such institution is Home Bancorp of Lafayette Louisiana (HBCP). The bank entered the conversion process in late 2008 just as the credit criis began to boil over. In spite of this they have done a great job since that time. They have seen deposit growth for 13 consecutive quarters as consumers favor a relationship with a strong small bank with strong local ties. The bank has been able to acquire other banks in the area with FDIC assistance. The organic nonperforming assets ratio is below 2. The total NPL ratio is over 3 but much of that is acquired loans that have FDIC assistance and guarantees. The stock trades at just 90% of tangible book value and the equity to assets ratio is over 14. Home Bancorp has been buying back shares and intends to continue doing so. During the third quarter they bought back 162,629 shares and more than 220,969 shares remain under the current buyback authorization.

The 2007 crop of 2007 has already given us several cheap stocks. I currently own shares of ESSA Bancorp (ESSA), First Financial Northwest (FFNW) and Westfield Financial (WFD) all of which engaged in conversion transaction just before the crisis struck. They are all still cheap and have decent fundamentals. First financial Northwest has had some difficulties with troubled loans and real estate owned but conditions are improving and they have plenty of excess capital. Very few of the 2007 crop have been taken over so far and I expect this to change over the next few years.

 The 2010 crop has given us some solid portfolio holdings as well. I wrote recently about Fox Chase Bancorp (FXCB). I own the shares and have a nice gain in the position. The shares now trade right at tangible book value and I would wait for a sell off to add or initiate a position in the stock. I also own Capital Federal Financial (CFFN) and am up slightly on the position.  The bank is in the Midwest and has one of the healthiest loan portfolios in the industry. The equity to assets ratio is a little over 20 and they have been using the capital to buy back shares and pay dividends. Neither of them is exciting or sexy but I expect to make enormous profits over the next decade as these banks grow or are taken over at large premiums.

The 2011 conversions included one of my favorite little bank stocks. BSB Bancorp (BLMT) is a four branch bank in Massachusetts that has incredibly attractive numbers. The stock trades at just 84% of tangible book value and the equity to assets ratio is over 16. Nonperforming loans are just .34% of total assets. Unlike many banks the past few years BSB is growing. They have seen solid growth in both deposits and loans over the past year. The bank has seen asset growth of more than 22% so far in 2012. Insiders like what they see in the future as they have been steady buyers of the stock so far this year.

The thrifts that converted to stock ownership since 2007 have not seen anywhere near the level of takeover and merger activity experienced in the past. I expect that to change and conversions will be a source of large profits for those that invest in these safe and cheap financial institutions. Most of them are way too small to write about on Real Money but it will be worth the time and effort to uncover these gems for your portfolio.

Monday, November 12, 2012

After the election: My America

I waited for the smoke to clear and the dust to settle before commenting on the recent election. My first thought is that the nation almost universally decries the incompetence of its government and then elects the same professional politicians, buffoons, idiots and outright scoundrels to office. We all say how concerned and involved we are but virtually no one can actually tell you what their candidate believes, how he has voted on key issues in the past or how we can expect them to behave in office. We vote for carefully crafted images formed by PR flacks and make decisions based on sound bites and yard signs. It  was another election of least bad choices and we all went along with it again.We have no one to blame for this mess but our own ignorance and apathy. 

My overriding thought is that with every election cycle we move further and further away from my America. The America I believed in and was taught as a boy is disappearing from the landscape.  My America was a land of opportunity and freedom. It was populated by cowboys, astronauts, heroes and pioneers. The good guys always beat the bad guys and you could be anything you wanted when you grew up. It was a vision as much as a landmass. It was our heritage, a gift given by those who came before and in my lifetime I have seen it thrown away in some ways and fade due to neglect in others.

My America is a land of opportunity. There are jobs for those who want them and the chance to chase your dreams for others. Business flourish because of innovation, hard work and creativity. They make products and services that make the populaces life better and are rewarded for it. Business push back frontiers with new discoveries and innovative propositions and the founders were generously rewarded for such. Taking risks is encouraged and those with the physical or intellectual bravery to do so could earn riches beyond imagination. This is as it should be.

However in my America business not only pursues profit and riches they understood that the general public and the workforce were a huge part of that success. They don’t get so focused on the short term that they lose sight of the fact that capital and labor is an interdependent relationship. The do not fall so in love with Wall Street and their own stock price that they lose sight of the long term. In my America founders and creators can earn vast amounts of wealth but caretaker CEOs do not earn 300 times their average employees wage. Corporations do not sit on billions on cash and lay off employees to make their quarterly number. The look to the long term and consider the human capital at risk as well as the cash. Their loyalty to those who toil may not be rewarded in this quarter’s stock price but it will be in the long run.

Labor does not off the hook here. In my America labor is not so greedy as to think they deserve more of the pie than those with their money at risk. They understand that to have good jobs there has to be a sufficient profit earned. Look at what has happened in union intensive industries like autos and airlines and you can see that when labor demands more than their share everyone fails. They understand that profit is necessary for commerce.

My America believes in free markets where each is free to trade with each other. They also understand that a free market comes with personal responsibility. If you don’t like Wal-Mart pushing out the little guy spend the extra money and shop at the little guys store. Don’t cry foul and expect the government to do something. If you are pissed off that Citigroup and Bank of America helped push us to the brink of financial ruin you don’t keep your accounts with them because they have lots of ATMs. If BP dumps oil into the Gulf and this upsets you quit buying gas there. The free market solves its own problems and does not rely on government intervention so that we may maintain our personal convenience. A free market rewards good products and good behavior and punishes the opposite. In case you dint know YOU are the market.

In My America we do not rely on the government for everything. In fact we don’t rely on them for much at all. We ask that they provide for the common defense and create an environment where commerce and the resulting prosperity can flow. Help provide the infrastructure that we may live well and do well, keep us safe and then stay the hell out of our way. We do not ask government to take money from our friends and neighbors at gunpoint to pay for our retirement, healthcare or day to day needs. We recognize that not one person on this earth owes another one damn thing as a result of the accident of birth and it is up to us to take care of us and live our lives in the best possible manner.

In my America we all know that sometimes someone may need a hand up. We are generous and not afraid to of our own free will help our friends and neighbors along the road of life. We know that some, such as the disabled and handicapped may need us to care for them and we are quick to do so. We do so because we are human and we care. We do it of our own free will and not because the tax collector has a gun in our face. As hedge fund manager and free markets supporter Roy Niederhoffer, capitalist extraordinaire Omid Malekan and others showed us in the aftermath of Hurricane Sandy individuals can accomplish faster than any government agency. We take of our kids and make sure they have what they need. We take care of our parents when they get old. We do not need the government and their good intentions and guns to do this because we care enough to do it ourselves.

In my America we care deeply and passionately about Education. In fact we care so much we don’t let the federal government get involved. We do not spend money on bureaucracies or special assistants to the deputy secretary of social studies. We spent it on teachers and books. We do not teach to the lowest common denominator, we teach to lift up all the kids and get special help for those who need it.We do not adjust our tests to fit special racial or demographic lines but treat all children as if they have equal potential.  We fill students with facts and figures not opinions. We do not teach self-esteem or diversity we teach reading, writing and arithmetic. We teach science and history, not religious theories and PC rewrites.  We focus on keeping schools safe for students as well as teachers. We teach them the basics and then how to use technology as a tool and not a crutch. We turn out graduates who can read, calculate and think not just pass a test.

My America is not an Imperialist presence on the world’s stage. We do not feel the need to keep troops all over the globe. We do not send out soldiers, sailors and marines to try and solve every problem caused by some crackpot dictator or tinhorn warlord. We cannot solve all the world’s problems or act as protector and policeman for the globe. If the UN wants to try let them form their own version of the French Foreign Legion but we are not participating. We practice a version of Teddy Roosevelts speak softly but carry a big sticks. We want peace prosperity and trade with all. We will stay out of your internal affairs and problems. But be aware that we are big and we are powerful. If you fuck with us or cause us harm we will declare war and destroy you. There will be no consideration to PC warfare and it will be your asses we are after not your hearts and minds. We want peace but if you force our hand you will get war as you have never seen it. More importantly our children will no longer die in far off lands for no good fucking reason or someone’s misguided good intentions.

In my America we do not celebrate diversity because we do not give a shit about it. We are a melting pot and no matter how we got here we judge each other by who we are and what we do. The color of your skin or the history of your ethnic or nationality no longer matters. You can celebrate if you so choose much as I do each St. Patricks Day but at the end of the day we are all Americans and hyphens are neither needed nor wanted. Racism goes way when we quit focusing on endlessly and treat each other as individuals rather than part of some group or another. You skin color grants you no special rights or privileges nor does it grant you any special claim on society. You are owned only opportunity and in my America we all have that.

In my America we do not let religious whack jobs or bigots hold important positions or attempt to dictate their beliefs to others. The government does not interfere in who does what to their own body, who sleeps with whom or who is married to whom. Our personal lives, our sexuality and our life choices are our own business. As long as we do not harm others we are free to worship as choose or not choose and to live our lives as we see fit with judgment of punishment.

In my America we do not have more than 2 million people in prison.  We sure as hell do not have 100,000 kids in juvenile facilities. We do not have a prison population that is almost half locked up for nonviolent crimes. We do not put people in prison to fight some unwinnable war on drugs. We find more productive ways to punish nonviolent criminals that provides a benefit to society instead of an enormous cost.  Judges do not make an example of an offender with an overly harsh sentence. It does not deter anyone and you are guilty of ruining a life that may have been salvaged. We look to practice justice not mere retribution. Save the prisons for violent criminals. of course if we provide the education and opportunity we are capable of, the prison problem may just reduce itself over time.

 In my America we all pay a flat fixed income and sales tax. Corporations pay the same rate as individuals. There are no deductions meant to control or influence behavior. We all enjoy the benefits and opportunities of society so we all kick in the same percentage. The sales tax ensures that the national sales tax guarantees that those that consume more pay more. Investment and savings are not taxed thereby proving an enormous pool of capital to create jobs and provide opportunities. Along with import duties these are the only taxes. There are no thousands of pages of add on taxes, fees and charges. We all have more of our money and the budget is balanced.

In my America legislators typically have two motions each year. One motion to pass the balanced budget and one to adjourn the session. We have more than enough laws on the books and everything that should be illegal and much that shouldn't be is already against the law. Anything further is just an attempt to influence and control the behavior of your fellow citizens and that should be a crime. No matter how good your intentions you do not have the right to tell me how to live my life. I don’t need you to tell me how to behave or what kind of toy I can have in my damn happy meal.

In my America we elect people who share our vision, our dreams and our dreams. We elect people who have real jobs and own real businesses.  We elect people not parties. We pay no attention to slick commercials and passionate speeches. Instead we elect those who realize that the job of an elected official is to protect the American dream by not impeding opportunity. We ask from our government only opportunity, safety and infrastructure. Everything else is our responsibility. If we all take care of ourselves and our loved ones, and willingly help those who need a hand out we do not need to feed a self-sustaining and self-protecting government bureaucracy.

My America obviously is just a vision and pipe dream. We can’t really create this land of opportunity, equality and freedom can we? Actually we could. We almost had it but since 1913 we have done our level best to give it away. The ability to live your own life and making your own choices, judging others by who they are not what they are,  revering education as much as athletics, enjoying peace and prosperity, all of this is always within our reach. The cost is personal responsibility, tolerance and unforced generosity. It seems to me that as each year and each election goes by fewer are willing to pay that price.

Friday, November 09, 2012

Bank On It

As everyone is focusing on quarterly earnings reports, political comments and Central bank spokespersons from around the globe, I am doing my best to enjoy some relative serenity away from the fray. The mad rush of earnings reports and resulting trading frenzy has always struck me as ridiculous herd like behavior and I want no part of it. Instead I have kept my focus on researching solid undervalued opportunities in the hopes that the misguided short term activities of other will create opportunities for long term value types like me.

In the aftermath of the Annapolis National Bank (ANNB) deal announced earlier this week my attention is really narrowing into small banks. I have talked often about what I call the trade of the decade and Annapolis National is typical of what I think will happen. FNB Corp (FNB) made an all-stock offer for the bank of a little more than $12 a share. That’s about 240% above where I recommended Annapolis national back in April and about 160% of tangible book value. Smaller banks are going to be acquired at a pretty good pace over the next few years and there is an enormous amount of money to be made.

I have my own screening and search tools for small banks but sometimes I take a more casual approach and surf around the web looking for interesting articles and comments on community banks. I am glad I did because I stumbled across a recent presentation from PL Capital, the mangers of the Financial Edge hedge fund, that makes a strong case for the banks and contains information that can help us all make money. The firm invests in smaller banks and is not afraid to take an activist approach.

They point out that there are more than 700 banks in the United States with less than $10 billion in assets. Compliance and regulatory costs are going higher and these impacts small banks far more than the large banks. It will make sense for smaller institutions to be acquired by larger concerns to reduce the expenses as a percentage of income. The firm points out that the banking sector is healthier than the general perception. Over 80% of banks are profitable now. Loan losses have improved dramatically form the depths of the crisis. The banking industry still has plenty of room to grow according to the presentation. US Bank assets are a percentage of GDP are one of the lowest in the developed world.

Bank stocks have been hit hard over the past five years and are deeply undervalued. The NASDAQ Bank Index is down almost 50% since the end of 2006. The SNL Thrift Index is down more than 70% over the same time period. The last two times bank stocks sold off to these levels investors made enormous profits. Following the RTC crisis of the late 80s and early 90s the NASDAQ Bank Index rose by more than tenfold in less than a decade. In the aftermath of  the Long term capital debacle bank stocks rose by more than 300% in a little over five years. Banks have now been hit by the financial Crisis and a follow up blow from the European bank issues and offer substantial recovery potential over the next five to ten years.

Unlike most of these presentationsI see PL capital actually gives a stock pick as an example if their activist positions. HFC Financial (HFFC) is a $1.2 billion in assets bank where the firm has fought for and won a board seat. The shares trade at about 90% of tangible book value and have less than 25 in non-performing assets. The tangible equity to asset ratio is a little lower than I like to see at 7.78% but I think this is offset to some degree by the high quality loan portfolio.  The bank operates in one of my favorite regions, the upper Midwest with location in Minnesota and South Dakota. Pl Capital is not the only activist in the shares as Jacobs Asset management recently disclosed a 9.8% stake in the bank. This is a solid bank trading below book value that should return substantial value for long term investors.

Most of PL Capitals positions are too small to write about on Real Money with market caps well under $50 million. It is instructive for investors to dig through their SEC filings in search of the stocks they have been buying. There are some gems on the list worth buying.This was a great discovery from my bank based web searching. I am going to troll the net some more to see what else I can uncover that might lead to profitable Trade of the Decade ideas.

This morning I ran across the most recent commentary form the managers of the John Hancock Regional Bank Fund (FRBCX). Back in the 1990s this was my favorite mutual fund for small investors who wanted to participate in the opportunities created by the savings and loan crisis. The fund has struggled with the collapse of the sector for the past decade but is improving dramatically as banks are restored to profitability and viability in the past year. I am not much of a mutual fund guy these days but if I had access to this fund in my 401k program I would not hesitate to put some money in regional banks via a fund.

The fund manager’s commentary runs pretty much in line with my thinking. Regional and community banks are undervalued on both an asset and earnings power basis. Credit costs are declining rapidly and that should lead to fairly strong earnings growth over the next few years. The banks are building capital and growing book value and the stock prices are not improving at the same pace. As nice as the commentary is to read the fund also publishes a list of holdings every month. By doing a little comparison work we can see what the fund has been buying of late and that is valuable information.

One of the fund’s largest buys in September was East West Bancorp (EWBC). Investors were concerned that earnings growth was slowing at the West Coast institution and the shares pulled back a bit. Those fears appear to be overdone as the bank just reported a solid quarter with earnings up 17%. East West has a unique niche as it focuses on the Chinese American community and other Southeast Asian immigrants. In addition to its offices in the United States the bank has branches and representative offices in China. Non-Performing loans are just 1.04% of total loans and reserves are almost twice the total bad loan exposure. At 1.5 times tangible book  and 11 times earnings the shares are not “Tim” cheap but they are worth considering if the shares sell off to nearer tangible book or a single digit earnings multiple.

They also increased their position in BSCB Bancorp (BLMT) a Massachusetts holding company for a five branch savings bank that underwent a mutual to stock conversion just about a year ago. This is a classic cheap bank stock after the conversion. The shares are trading at 88% of tangible book value and have a tangible equity to asset ratio of 17. Loan losses are just .44% of assets and the loan loss reserves are more than 160% of nonperforming assets. The company is seeing strong growth in core deposits and management indicated that loan demand is starting to pick up in its service area. Insiders like the value and direction of the bank as they have been steady buyer s of the stock since the conversion a year ago. This stock is a buy at current levels and I would look to scale into more should the shares drop in a market related sell off.
Bank stocks are dominating the market related conversation around Chez Melvin these days. I know that I am supposed to be running around like a crazed chicken over earnings season but I  prefer watching the World Series and reading reports from banks and bank investment funds. I suspect that my path will not only be more relaxing but far more profitable.

originally published as a series of articles on

Monday, November 05, 2012


Today we will try to get back to business as usual in the markets. The earnings reports will begin to dominate the news once again. The bulls will look for any positive sign to be buyers as we head into year end and the bears will celebrate any signs of weakness. I will simply sit back and apply my usual sense of cynicism to the whole show. I confess that at this point I am most cynical about the bull case for the market. Earnings are following the same revenue light pattern with lowered guidance we have seen all year.  The economy is still solidly in better but not good mode and Europe is still a mess. The only real bullish case is low interest rates and as powerful as that has been I am not sure it is enough to keep moving the market higher.

My opinion on market direction does not matter that much as I am not a trader and evaluate stocks on a case by case basis. Once I was done updating my infrastructure and banking files this week I spent some time playing around with Piotroksi F-scores. They have been found to be very predictive of future stock price movements when combined with valuation and I used them in several ways the past few days to uncover opportunities. My cynical side also led me to use them to find some stocks that are best avoided by investors right now as a result of low scores and high valuations.

One thing I found interesting was how many of the growth darlings actually have a Piotroski score of 5 which is the line in the sand for using F-scores. Above 5 indicates potential outperformance and below that level is negative. 5 is just lukewarm market tracking stocks according to my research. Stocks that score a 5 but have been over loved include Chipotle (CMG), Intuitive Surgical (ISRG), Baidu (BIDU) and Broadcom (BRCM). Given their high valuation and middling scores I see no reason to own these stocks right now.

The other thing I note is that almost all of the large cap Real Estate Investment Trusts have a score fo 5 or lower. This group is overbought, overvalued and over loved by asset allocators. As much as I love real estate as an asset class for the next decade the large cap REITs are priced for perfection and beyond. Some of the REITs with scores below 5 include Equity Residential (EQR), Prologis (PLD) and SL Green (SLG). Given the high valuation and low F-scores I would not be willing to own the group and would consider shorting them if they continue to rise.

Telecom companies do not fare much better. Both AT&T (T) and Verizon have f scores of 5 and is highly unlikely in my mind that these stocks do any better than the broad market for the next year or so. Both have had a great run the past few years but there is no solid reason to buy them here. Century Link (CTL) has also done very well but now has an F-score of indicating strong possibility it lags the market over the market going forward.

One of the biggest stocks out there with very high valuation and an F-score indicating underperformance is Facebook (FB). I like the service and have a fairly active Facebook account to keep in touch and share ideas with friends and family all over the world. In spite of that I have been skeptical and bearish ion the stock since days one. I do not think they will be able to figure out how to monetize the user base using the current model. I do not know anyone who clicks ads on the site or buys products based on Facebook pages. I don’t think they ever convert to a subscriber model either. Facebook will be with us for a long time I suspect but it won’t be the wild growth stock some expect. With very high earnings and asset valuation and an F-score of just 4 I would avoid the stock and short strength in Facebook.

Now that I have embraced my inner cynic I will get back to my bread and butter and spend the rest of the week sharing some F-score based discoveries of safe and cheap stocks as well as longshots with a high probability of hitting the jackpot in the years ahead.

During our unscheduled market holiday I spent a lot of time doing research using Piotroksi scores. The F-score model has been a valuable tool in my arsenal for uncovering value stocks with high appreciation potential and I am looking at new ways to use the model. As we all know however, there is certain amounts of validity to the concept of its not broken do not try to fix it. The original research paper that introduced the model by Professor Joseph Piotroski was focused on stocks trading below book value ranked by F-score. Those with high scores outperformed the overall market by a wide margin.

With that thought in mind I sat down and ran a basic screen using the model I looked for stocks with scores over 6 that traded below book value. In my first version of the screen I added some financial strength criteria and only included those companies with a current ratio over 2 that owned as much as they owed. This should give us a list of financially strong companies that were cheap and had improving fundamentals and prospects.
My first observation is a familiar one. The list of companies that make the cut is shrinking rapidly as the market as churned higher.  There are only 134 companies listed on US exchanges that fit the bill. Only 31 of those are over $100 million in total market capitalization. Only 7 are larger than $1 billion in market cap. There simply are not that many solid companies with good fundamental prospects that trade below tangible book value right now. That is something of a red flag to me in terms of overall stock market potential over the next several months.

The largest company that is attractive to me is an old friend. I have owned Rowan Companies (RDC) before and think the company is well positioned for the future. The company has divested its non-core land drilling and manufacturing division Rowan is now focused on offshore drilling rigs. The company built three ultra deep-water rigs without contracts and it looks like the gamble is going to pay off for Rowan and its shareholders. The first of the new rigs is now under a three year contract with strong day rates.
The stock has been down this week after missing the always highly accurate analyst estimates.  The stock now trades at just 90% of tangible book value and has a Piotrokis score of 6. Given the offshore and deep water focus of the company the cheaper the stock gets the more likely a takeover becomes in my opinion. They have very little debt and a solid balance sheet. Given the growth prospects of deep water drilling an acquisition would make sense for several larger competitors. Given the lack of leverage on the books I would not rule a potential financial buyer such as a private equity fund either.

Dawson Geophysical (DWSN) is energy related company that is cheap based on asset value and has a high F-score. The company acquires and processes seismic data for the oil and gas industry. Lower utilization and reimbursement rates put pressure on revenues in the third quarter but management has said they expect conditions to improve for the rest of the year. We will find out this week when the company reports earnings.

The company has done a good job of transitioning form natural gas research to more oil related seismic services. They are also expanding into Canada and expect operations to begin in the great white north next year. Dawson spent a lot of money expanding its equipment portfolio as well as adding new crews last year and 2013 looks like it may be the start of a solid payoff for the company. The stock trades a little bit below tangible book value and has an F score of 8 so the fundamentals are already beginning to improve. The company has minuscule debt and a strong cash position so they are well positioned to grow as the economy recovers and oil and gas demand picks up.

The current list of cheap stocks with solid balance sheets and high f scores is very limited right now. Energy names dominate the list of larger market cap stocks which makes sense since this is one of the cheapest sectors right now. As we have increasingly found the last two years the really interesting companies are microcaps that are not in the tradable indexes or ETFs.

 The F-score is a useful tool in all steps and stages of stock selection process but it really shines in finding investments with a little more of a long shot flavor to them. These are companies that are carry more debt that n I would usually consider and traded at steep discounts to their asset value. A high F-score indicates to me that the fundamental s of the company are improving and they are generating sufficient cash to carry the debt load and there is a high probability the two edged sword of leverage cuts in our favor.

Once again in running the screen for leveraged companies trading below tangible book with high scores I note an unusually short list of candidates. Just 24 US listed names make the final cut. Only 8 of these have a market cap in excess of $100 million. There is only one stock with a market cap over the billion dollar mark. The list of opportunities for cheap stocks is getting shorter and smaller as the market has worked higher this year.

It is still a pretty interesting list of long shot cheap stocks. One my favorite REIT investments made the list. Arbor Realty (ABR) is higher than out original purchase price by a comfortable margin but fundamentals keep improving and the stock is still a solid buy in my opinion. The shares trade at 80% of the $7.58 tangible book value and management estimates that total asset value after adjusting for swaps is over $11 a share. Arbor has been making loans and originated more than $80 million of new loans during the quarter. They also purchased $30 million of residential mortgage securities in the quarter. After a solid quarter Arbor management raised the quarterly payout by 10%. The company has an F-score of 7 indicating a substantial chance of strong appreciation in addition to the dividend payout.

The aircraft leasing business is well represented on the list as well. I recently highlighted AerCap Holdings (AER) as a cheap stock with a high ranking from S&P. The stock still trades at less than 70% of tangible book value and has an F-score of 6. Aircastle Limited (AYR) also has an F0score of 6 and trades at less than 60% of tangible book value. Aircastle has a portfolio of 155 jet aircraft that are leased to 64 different airlines around the world. The fleet is 98% leased with more than 4 years of average lease life so cash flows should be relatively stable for the company. The shares currently yield 5.4% at the current price.

Another one of those pesky shipping companies makes the list as well. I am gun shy due to past poor results from shipping stocks but they are constantly showing up on my lists of cheap stocks with high long term appreciation potential. Global Ship Leasing (GSL) is a container leasing company with 17 ships on long term leases to CMA CGM S.A, the world’s third largest liner company in the world, with an average lease life of more than 7 years. Unlike many shipping companies Global has been generating operating profits throughout the global recession with operating profits every quarter since the start of 2008. They have been using their cash flows to de-lever the balance sheet and paid off almost $140 million of debt in the past three years. The shares trade at around 50% of tangible book value and the improving fundamentals are reflected in the F-score of 7.

Using asset value and F-scores has helped me uncover some great opportunities over my career. Right now the list is small and most of the candidates are in industries such as aircraft leasing, shipping and commercial real estate, as reflected by the three companies mentioned, that have been hit hard by the economic weakness. As long as the world does not really end these should return to prosperity over the next decade and shareholders in these stocks should do very well.