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Thursday, April 25, 2013

Mechanical Value

Although my base approach to the markets should be pretty well known to all by now I am constantly investigating, testing and evaluating other approaches. Most are modifications and variations on a value theme as I am intellectually incapable of abandoning my value beliefs and vulture tendencies. I have no intention of missing a baseball game or my afternoon nap to stay peeled to screen trading all day and I am just not capable of paying of paying enormous multiples for hopes and dreams as many growth and momentum investors do on a regular basis. Almost all of my research involves at its buying core stocks that are beaten down contrarian ideas or buying cheap assets.

One idea that I have been working with of late involves buying stocks that trade for less than 90% of book value and have a reasonable capital structure. Most back testing uses the idea of holding over various time periods and reformatting the portfolio. In this case I have adjusted the approach to sell based on the variable itself. The stocks in the system are sold when the price crosses above book value or debt levels exceed certain thresholds. If book value grows faster than price you will hold the stock for a long period of time. If the price pops above book in a month or two then the stock is sold right away.

I began thinking about this approach after watching several stocks like Kimball International trade form a deep discount to book value, run up over book and then sell off once again to a discounted price. Some stocks continually improve and you get a long run as book value grows but others trade between cheap and fairly valued on a regular basis and selling based on variables rather than time helps catch these profits. It has a combination of long term core holdings and shorter term profit taking based on fundamentals that might allow us to catch the best of both worlds. It is also purely mechanical so it over rides some of my less than brilliant over rides.

It is instructive to spend some time looking at the stocks that currently qualify for this approach. The firs stock is one that I have applied my brilliant over rides to over the past two years and it has cost me money. Genworth Financial (GNW)is an insurance and financial services firm that has been struggling back from the depths of near failure and the stock has done well. It is still the cheapest stock in the system with the shares trading at just 30% of tangible book value. The mortgage insurance unit that caused most of the problems is now fueling the recovery of Genworth and has now been organized as a spate unit under the braider corporate umbrella. They plan to sell the Australian mortgage unit later this year in an IPO and are also selling the wealth management business. They will use the proceeds from both deals to reduce debt. The life insurance and long term care businesses will recover at a slow rate as it takes time for the economy to fully recover but the company as a whole should see decent earnings growth this year and next. The stock has to triple to hit book value and will be a huge winner for the system if it reaches that level over the next few years.

I haven’t purchased shares of Hutchinson Technology (HTCH) in the past couple of years either and the stock has performed well since a better than expected earnings report late last year. In spite of the price improvement the stock is still the second cheapest stock in our systems portfolio trading at just 50% of tangible book value. The company is the leading manufacturer of suspension assemblies for hard drives and is slowly recovering along with the computer business. They will probably continue to report losses for the next few quarters but could see a significant recovery as storage demand is going to increase at a strong pace and the PC business will eventually see pent up demand hit the marketplace.

These are the two cheapest stocks in the system. . The quick and dirty back tests of this approach show a long term return substantially better than the market and more than 10 times the markets feeble returns over the past decade. It seems to me that this is worth further research and consideration.

. I am fascinated by this approach and am planning to dedicate more research time and effort in this direction. It removes emotions and second guessing from the process and the early quick and dirty results are promising. My programming and data skills are sadly lacking but I think I can torture the data long enough to see how well this works over time As a bonus it also helps identify some cheap stocks I might have otherwise overlooked.

One of the benefits of a mechanical system is that it over rides the human element and buys stocks I might have avoided. This is certainly the case with shares of Career Education (CECO). Although I never shorted this particular stock I have been betting against the education stocks for the better part of three years and am still not excited about the industry. However this stock is uber cheap at 30% of tangible book value and management is attempting to right the ship amidst the storm. They are closing campuses and cutting jobs. The cost cutting measures should save them about %50 million a year. That is about a third of what they lost last year so the business will have to get better as well for the stock to recover. The for profit education business in the United States will continue to decline but the company is seeing growth in its international schools. The system doesn’t address profit or potential yet and the stock qualifies so into the portfolio it goes.

The same “probably not” characteristics apply to at least two other stocks in the portfolio. I have made money with Imation (IMN) in the past as it has been a perennial net-net and book value stock. As cheap as the shares are at 60% of tangible book value the business is terrible and they are selling the audio and video accessories business.  The tape storage business is in decline and the company’s attempts to enter the data security and mobile storage markets are going to be an uphill climb. However it qualifies so into the portfolio it goes.

Neutral Tandem (IQNT) would not have made it into my discretionary portfolio either as I tend to avoid the network services companies as it is a fiercely competitive field that I simply do not understand that well. However they do provide Internet Protocol (IP) transfer services and I am told that is a promising market. The have 120 Ethernet hubs on 4 continents and do business in 80 countries around the world. A large customer just revised its contract for voice services at much lower rates and that is going to pressure sales and profits this year. Analysts seem to expect the data business to improve next year and see the new EtherCloud connection product gaining greater acceptance. They have no long term debt and the shares are trading hands at 50% of tangible book value so we are mechanical buyers of the stock.

Tellabs (TLAB) is a stock I have owned for some time and often suspect I will own if forever as the company has struggled to remain profitable much less grow. Their relationship with AT&T for its telecommunication s voice and data equipment has been lessened over the past few years and the European markets will be slow for several more quarters at least. The stock rallied a bit last year when the company paid a special $1 a share dividend but the operating results have caused steady selling since the beginning of 2013. As is the case with many cheap stocks there is nothing going on expect the valuation itself. The stock trades at 70% of tangible book value, has no debt and trades for a little less than the cash per share on the balance sheet. I own it and so does our mechanical value portfolio.

Now lets examine a few of the models picks about which I am more enthusiastic and would be happy to include in discretionary accounts.

Hartford Financial Services (HIG) is one of the stocks that I hope misses’ earnings horribly and the stock takes a whacking. The restructuring is ahead of schedule, they have disposed of several wealth management divisions and the annuity run off appears to be going as expected. The individual life insurance business is gone and they are concentrating on the property and casualty business. They are one of the largest P&C companies in the United States and they have a robust commercial lines business. Most of their personal lines business comes from a relationship with AARP. The stock is cheap at 50% of tangible book value and the upside in the stock is enormous. Here is where a mechanical approach would serve me better as the stock is trading near 52 week highs and that makes it very hard psychologically for me to pull the trigger. I own a lot less of this stock than I should at this point.

I have a similar problem with Lincoln National (LNC). The stock is very cheap at 70% of tangible book and I was a buyer of the shares last year so I have a nice gain and I just have a natural repulsion to buying near the highs of the year. The company has managed its way through the very difficult few years of the credit crisis and business is picking up in their life insurance and retirement plans operations.  They have a heavy exposure to the stock market as many of their products are equity linked which could make the shares more volatile abut it is a solid company and the stock is cheap.

I owned shares of Real Network  (RNWK)back in 2010and did fairly well with them. The stock is now trading back down near the net cash levels and is worth adding to a long term value portfolio again. The company is searching for an identity and needs new products to reinvigorate any hope of growth but the parts here are worth more than the sum the stock market is attaching to the company. If you read the last years headlines carefully you will see that the makeup of the board has been changing and they have added experienced entrepreneurs and finance types as they try to remake the company. If they succeed the stock could be a huge winner. If they fail the company can be liquidated for about 30% more than the current stock price.

We had a solid winner last year with shares of Kimball International (KBALB) as I sold the stock after an incredibly fast double during the year. As series of unfortunate events including a large purchase of raw materials for an order that was never fulfilled and a slowdown in government sales in the furniture division have pushed the shares back down to 80% of tangible book value. The electronics manufacturing segment is seeing strong demand from several sectors most notably the auto industry and this could well be the driver of growth for now. The furniture division is probably going to see more weakness as result of sequester and budget changes. They have plenty of cash on hand and the balance sheet is solid. I like the stock and will be a buyer once again if and when the stock market finally has a pullback.

The mechanical quantitative approach to value investing is intriguing and I will be doing more research along these lines in the upcoming months. As a bonus researching the model is producing some stock picks that can be used even in the most discretionary of accounts.

originally published as series on Real Money 4-9 to 4_11

Sunday, April 21, 2013

Baseball, Books and Guns

Our last few free form forays here have been thought and writing exercises based on famous quotations. They have been fun to do and I will be revisiting them in the near future. They are entertaining and put some much needed grease on the old brain gears at times. However much has happened in the world since I last updated my thoughts, ruminations and ramblings on the world, markets, life books and baseball so I shall devote some time today to catching up.

I will start with the events of the past week or so and get the madness out of the way as quickly as possible. The events in Boston have been covered at great length so I shall just share some random thoughts on this. First, the reaction of “I hope its an angry white guy” response we saw from some media outlets was as puzzling as it is disgusting. The politically based divide and hatred in this country is reaching dangerous extremes.  I am further amazed that a population of roughly a million people in the immediate Boston area shut down in an unprecedented act of sheepish civil obedience. I get that there may have been some risk to going out until they were captured but can you imagine NYC or say, Tel Aviv shutting down because some armed nutballs were on the loose? Keep in mind that it was an eagle eyed citizen who found the guy once the lock down was lifted.  In addition civil liberties were just trampled during the search. Before you chastise me about how necessary it was keep in mind the words of the esteemed Mr. Franklin. They that can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety.

Moving onto a related measure I keep asking any of my friends form either side of the aisle to tell me just what was in the recently failed gun control bill that would have done one darn thing about illegal gun ownership and use. There was nothing. It just made it more difficult to legally buy a gun. It was political grandstanding to show the world that they were in fact doing something about this awful gun problem. They were by god acting to protect the people from all these bad people with guns. They really weren't doing one damn thing except passing another law restricting the right of the citizenry.

Here something to chew over while you are calling a right wing fascist SOB who doesn't care about the children of America. We have lots of gun laws. It’s illegal to carry a gun without a permit. In most states you need a background check to buy a gun. In many you have to register your gun with the proper authorities. It is illegal to discharge a gun inside most city limits in the United States. It is illegal to threaten someone with a gun. It is illegal to smuggle guns or distribute them without a license. It is most certainly illegal to possess a firearm while committing a crime. It is illegal to shoot someone, or even just in the general direction of someone. I could go on but you get the general point. We have lots of gun laws. We do not need more gun laws. If more gun laws were the answer than strict gun control cities like Chicago and Baltimore would not have such high violent crime rates. Boston never would have happened but those kids could have never got their hands on the arsenal they obtained.

Here is my plan for gun control. Let’s end the war on drugs and use the money and manpower to go after ILLEGAL guns. We have over 500,000 people in prison in the US for violating a drug law. Let them out to make room for gun smugglers, illegal dealers and those who possess firearms illegally. Use all these alphabet agencies to get killers and violent criminals with guns off the streets and leave the potheads alone for a change. Let’s enforce the gun laws we have to the maximum extent possible and leave legal gun owners alone as well. Stop the political posturing about gun control and actually do something for a change.

It’s not just gun control. Common sense has been removed from the political process by the presence of the two parties. People take black and white stances based on the R or D on their voting registration card. If you have a D you are pro-choice so you do not even want to consider that what the guy in Pittsburgh was doing is murder. If you have an R you are pro-business so it’s impossible to admit that what we have done with the big banks is immoral crony capitalism. If you have a D you want to help the poor even if it means taking someone else’s money at the point of a gun in the name of “fairness.” If you have an R you are pro family so you insist it is okay to tell others who they can love and marry. Nobody thinks, they just vote.

George Washington nailed it when he said “However political parties may now and then answer popular ends, they are likely in the course of time and things, to become potent engines, by which cunning, ambitious, and unprincipled men will be enabled to subvert the power of the people and to usurp for themselves the reins of government, destroying afterwards the very engines which have lifted them to unjust dominion.”

John Adams foresaw the problem as well saying “There is nothing which I dread so much as a division of the republic into two great parties, each arranged under its leader, and concerting measures in opposition to each other. This, in my humble apprehension, is to be dreaded as the greatest political evil under our Constitution.”

We should join our founding fathers in the distrust of political parties. Doing away with political parties would force candidates to say who they are and what they believe and not just regurgitate the platform. Voters would actually have to take the measure of the man or woman in front of them instead of just pulling a lever passed on the initial next to the name. It is of the people, by the people for the people not for the party. Removing or at least ignoring political parties would go a long way to putting some common sense back into the political discussion and just maybe the practice of governing.

Now onto to something more interesting like baseball. There been some early season surprises most notably the New York Yankees. The Bronx geriatric squad is making an impressive early showing for themselves and winning games no one thought they would. They are 9th in the majors in total hits, 4th in batting average and 7thin runs scored. With so many bats on the DL this is unexpected. The pitching staff has been luckier than they should be as they are holding onto a sub 4 ERA with a WHIP that is 20th in MLB.  They are 9th in hits allowed but 22nd in runs allowed so they are catching some breaks in the early part of the season. I’m not sure the offense  can bail them out forever but they have a much better than expected start.

The other surprise is Los Angeles. There must be some anti baseball stuff in the water supply because both LA teams are goo to terrible starts. The Angels lead the league in batting average and are 5th in total hits but they runners are not scoring early on they are just 15th in runs scored. They have to get better at driving runners across because the pitching staff with a WHIP of 1.50 and a staff ERA of 4.81 is not helping the cause. The Dodgers are just middle of the pack in hitting and pitching and seem to have a bad case of overpaid locker room disease.

Then Orioles are about where I expected them to be but I have to admit they are a much better ball club with Brian Roberts than without him at 2nd base. Still they have more total hits than anyone in the division and trial only they lucky boys in the Bronx in total runs. The pitching needs to get better as a WHIP of 1.26 and ERA of 3.96 will make it a battle to win the division. With the exception of Pedro Strop the bullpen is doing very well but they need to replace Strop and get more quality starts to stay in the thick of things all year.

I replace fantasy baseball this year with fantasy baseball betting at Its more fun for me than playing manager as I am much more of a degenerate gambler type than manager type. I have always said that the two greatest jobs in the world would be a baseball writer or a bookie and this has elements of both. My official record right now is 43-41 although in my defense there are 4 games where form lack of coffee, inattention, stupidity or some combination of the three resulted in hitting the wrong button. Naturally all 4 went my way so I am a little better than that at actually picking but I am unaware of a bookie that lets you cancel a mistaken bet after the fact so the record stands. Given the nature of the money line I estimate you need to pick about 65% winners to be a winning baseball bettor so I have a long way to go to perfect the art.

I find it interesting from a psychological point of view that all the bad habits I have drilled out of myself in picking stocks show up in my early betting patterns. I am using pitching stats and hit run totals to make my picks allegedly but I have let expectations get in my way. I have taken a beating on the aforementioned LA teams because I expected them to be good and bet accordingly no matter what the line said. Favoritism gets in the way as well. I find it impossible to bet against the Orioles or Nationals. If Samardzjia is pitching I take the Cubs. Same with the kid Fernandez in Miami. I find it very easy to bet against Boston no matter what the stats say and the line looks like. I bet too many games and try to force an edge where none exists. It will be an interesting exercise to see if I can bring my market discipline over to betting and if that improves results as the year goes on.

As for market this weekend reading has scared the living crap out of me. In Barrons the number of bullish money managers leapt up to 74% the highest reading in some time. In fact it’s a record level . That much optimism should scare the living crap out of you. Then we have Mark Hulbert’s Piece on the Value Line Median Appreciation Potential reading. This is simply the services estimate of the average 3 to five year appreciation potential on average in the universe. It is at just 50%, very near the 5 year lows. Combine that with what is a weak revenue showing in earnings reports so far and there are red flags all over the place.

I am not a market timer but this does look like a time for increased caution to me. There are not many cheap stocks showing up when I run my screens outside of energy and materials. I have long said that either these names have to rally or the broader market has to come back to reflect the economic reality reflected in miners and materials. There are some cheap stocks around which I discuss both on Real Money and in other posts on this blog but the list is thinning.  Forget discount double check, it is a good time for portfolio triple check.

There have been some decent things to read of late as well. My first suggestion is that is worth your time to read Glen Duncan’s The Last Werewolf and the follow up Tallulah. I know the werewolf vampire thing has been down to death of late but these books stand out. I stumbled on them when the first one was named a top 100 of 2012 by the NYT and it is a great read. The book has all the werewolf stuff you expect nut it weaves in history, literature, philosophy and a host of other subjects in way that is entertaining and even somewhat thought provoking. The second does as well but not to the degree or quality of the first. However any book that contains the quote “The modern adult has really only one thing to say to its inner child : I am sorry . I am so (bleeping) sorry." is automatically a worthwhile read.

I picked up the Mickey Rawlings baseball mysteries again recently and they are a smuch fun as I recall. I never read them all but they are now available on Kindle so I am going to fill in the holes in the series. The adventures of the journey man baseball player as he travels around the league in the early part of the 20th century make for fun easy reading.

If you like adventure, the civil war and naval yarns in any combination you will probably become as addicted to the Honor Series of books by Robert MaComber as I am. They follow the career of one Peter Wake form his start in the navy during the civil war up through the turn of the century. I am halfway through and highly recommend the books.

The writers carrying on Robert Parkers characters are doing as well for him as he did for Chandler. Ace Atkins is doing a bag up job with Spenser and Robert Knott has the western characters of Virgil Cole and Everett Hitch nailed. No one can ever be as good as the master but they are still great reading. Atkins novels are solid material on their own by the way and good reading for hard boiled mystery lovers looking to escape into a good book.

Of course there is baseball related material to consume as well. Clay Snellgroves The Ballplayer is an excellent novel  that is as much a love story as a baseball yarn. It does both well and is a good read.
Joe Peta’s Trading places is a must read for fans of baseball, math and/or gambling and markets. Just a fantastic book.

Randy Wayne Whites Night Moves is the best offering in the Doc Ford series in some time. Gone, his book introducing a new character Hannah Storm, is also a solid read.

Paul Varnes is a retired professor with a fascination for Florida history and it results in tow read worthy novels for history buffs. Black Creek and Confederate Money are not a threat to Shakespeare but they are great yarns about the days of the Seminole and Civil War in Florida.

You will note that there are no finance books on the list. I have reproduced a recent column on market books in the past immediately prior to this one for that subject. Of the newer tomes only Quantitative Value by Wesley Grey and Tobias Carlisle has been of merit and worth your (or my) time.

And so life goes on and the world gets weirder. Bad stuff happens and will continue to do so. Politics will continue to be an immoral abyss and the apathy of the average American will allow it to do so. We shall quantitatively ease our way into eternity or oblivion and no has a clue which it shall be.Markets will do what they will do and those who insist they know what will happen will continue to lose money.

However there will be new books out this week and everyone thereafter.  My West Coast and French friends inform me that the vineyards are still making and shipping wine. My wife still says she loves me and proves it every day by not killing me in my sleep. I still have a wide circle of friends with whom to discuss, debate, curse, vent and fume. The kids are all doing great and on their way to a solid happy life (although the daughter and boyfriend are apartment hunting and that gives one a kind of “oh crap” mental tingle). They are playing baseball today and everyday though the end of September .If you learn to embrace life and all it offers there will usually be more good stuff than bad.

You may note that the complete absence of a certain grouping of words and phrases. A certain stock picking mountain climber form the land of grunge and coffee challenged me to done of these with the usual profanity laced tirades that tend to slip in my ramblings.. Now that this is accomplished I am sure we be back to our regular (bleeping) program in no (bleeping) time.

Reading to Profit

One of the more frequent questions I am asked by readers is what to read that can help make them a better investor. My stock answer is everything. I am in the Charlie Unger camp on this on and think that one of the keys to a successful life is to read often and always. I read at least two newspapers every day to gain a sense of what is going on in town and around the world. On weekends I plow though the daily papers as well as the Weekend Journal, The Sunday NY Times and Barrons. I read several magazines relating to the banking and real estate industries since these two areas influence so much of what happens in the rest of the financial world. Of course I also am a voracious reader of fiction and all things baseball as well. I keep up with what’s being released in business and finance books but most of the newer ones seem to be a rehash of the good old stuff. With that in mind here is my list of books that should help make you a better investor and can even improve your trading.

I do not care how you approach the markets everyone everywhere should read Ben Grahams The Intelligent Investor. In addition to the basics of value investing Graham teaches how to differentiate between speculation and investment, something all too few seem to recognize today. The book also outlines both the defensive and enterprising approach to investing and help you determine which classification into which you fall. We are also introduced to the critical concept of margin of safety and introduced to the maniac Mr. Market who can be your worst enemy or best friend.

Martin Whitman’s Aggressive Conservative Investor also makes the grade as a must read. The concept of maximizing returns through minimizing risk through security evaluation in selection has been at the heart to of my career. This was the first book on investing I ever read and the concepts and techniques have served me well over the decades. Although the book was released in 1979 be sure to get the edition released in 2006 as Whitman updated the text to adjust for changes in the financial world. Whitman’s Distressed investing Principles and techniques should also be read be serious investors adopting the value approach to the markets.

The Little Book of Value Investing by Chris Browne is also a must read in my opinion. I must issue the disclaimer that I had a hand in the writing of this book and Chris Browne is one of my favorite people in the history of Wall Street. He was intelligent, witty, articulate and a real gentleman. I learned more from Chris than anyone else in the course of my investing career. The book teaches the basics of the game, how to find cheap stocks, analyze them and manage a portfolio of them.

As an aside I have always felt that it is critically important to understand all approaches to the market and not just the one you favor. The Wiley Little book series is a Phd course in market approaches that allows you to quickly learn the various schools of thought from the best practitioners. Serious investors and anyone offering financial services to the public should  buy, read, and keep the entire series.

This will come as a surprise to a lot of people but I think everyone involved in the markets in any fashion should read the Education of a Speculator by Victor Niederhoffer. The book gives insights into the successful speculative mind that simply cannot be obtained elsewhere. The life lessons derived from sports, gambling and board games can be applied to both life as well as the markets. Investors and traders alike who have not done so should read it sooner rather than later.

James Montier is an articulate insightful writer whose letters and article have been a must read for year. So is his book Value Investing: Tools and Techniques for Intelligent Investing. This book give insights not just into picking stocks but how to think about stocks and market to increase your chances of success. Any book recommended by Seth Klarman has to be on your reading list.

Speaking of Mr. Klarman if you can get your and on a copy of his Margin of Safety you should do so. The only problem here is that used copies can fetch upwards of $1000 and is out of print. Klarman has refused entreaties to republish the tome but you can sometimes find a copy by digging around the interwebs.
If you do not understand arbitrage at some point in your life you will lose a bunch of money to someone who does. Keith Morre and Guy Wyser Pratte have written fabulous books on risk arb that will give you a deeper understand of this complex corner of the market. You need to read them.

I rarely suggest new books but I am impressed by the wealth of information in Quantitative Value the new book by Tobias Carlisle and Wesley Gray. They do a great job of testing and explaining various approaches to the market and using quant model to pick value stocks.

That’s my starter list of things you must read to make you a better investor but my best advice is to read everything.

Monday, April 15, 2013

California Dreaming

When I was a kid the image of California was almost magical to those of us who lived on the East Coast. California was palm trees, cable cars and movie stars. When I first made it to the Golden State in my late teens I was enthralled by the entire state and eventually moved there for a few years. The reason I left in the early 1990s were a foreshadowing of what is happening there today. The rapidly rising taxes and ridiculous government policies were among the chief reason I fled the state and that has all gotten worse not better over the next two decades

Today when we think of California we tend to think of bankrupt cities like Stockton, fallen real estate values in the aftermath of the crisis. The state and local governments seem to make the news almost daily for some ridiculous new proposal or proposition and the external view of the state is one of poor government and a failing economy. The unemployment rate is close to 10% and the state is viewed as outright hostile to business with its heavy tax burden.

However it is important to keep in mind there is a lot to like about the state. There wouldn't be so many people there if it was not a great place to live. California has a strong agricultural economy and Silicon Valley remains as robust as ever. They have enormous shale oil and gas resources that could add millions of jobs if the legislature doesn't screw it up too badly. They have two of the best baseball teams in the country right now, and most importantly they have banks. California has a lot of banks that are still very cheap as a result of the disastrous real estate markets during the crisis and the economic situation. Separating the winners from the losers in the state can be an enormously profitable exercise.

I will start with an observation that seems to pop up every time we look at the community bank stocks, Many of the larger ones have traded up and are at a premium to tangible book value. Most of these premiums are small in the range of 1 to 1.25 times TBV but they are still too high to chase at the moment. A strong market pullback could change this but for now resist the urge to chase banks stocks trading above book value. Most of the value right now is the smaller institutions.

The larger banks in the state have already recovered while few were watching. The two larger institutions associated with the Asian markets have soared off the bottom. East West Bancorp (EWBC) has risen by more than 5 fold off its lows while Cathy Bancorp (CATY) has merely doubled. SVB Financial has ridden its high tech relations hips to a gain of more than 5 times the lows in a few short years as well. All of the California banks with more than $10 billion in assets now trade at a premium to book value.

When we away from the larger metropolitan area banks however the picture begins to change and its worth investigation to find some bargain banks for our Trade of the Decade portfolio. When we look at the thrifts we stumble across one of my favorite financial institutions right now First Pactrust Bancorp (BANC).  I have mentioned the bank several times in recent article and I am a big fan of the stock. They are transitioning into a full service commercial bank; the shares are cheap at 72% of book value and the stock yield more than 4% so it qualifies as an income story as well as a candidate for large long term appreciation.

Another thrift trading at a bargain valuation is Simplicity Bancorp (SMPR) of Covina.  The bank started as a credit union to serve employees of Kaiser Foundation Hospital, grew into a mutual thrift savings and in 2010 completed the second step of the conversion process to become a stockholder owned saving bank in 2010. In 2012 the name was changed from Kaiser federal Financial to Simplicity as part of rebranding effort. Simplicity has 9 locations currently with $890 million in assets.

This is simply a well-run community bank with a solid balance sheet. Nonperforming assets are 2.8% of total assets. 85% of the loan portfolio is single or multifamily housing with almost all of them first mortgages so they have no real exposure to the riskier home equity and second mortgage loans that have plagued other California institutions. The bank has completed two 5% buyback programs and just announced a third repurchase plan. Although the dividend yield is modest right now at 2.1% the equity to asset ratio of 14 leaves plenty of capital for future increases. The shares trade at just 85% of tangible book value and represent a solid value for long term bank stock investors.

One that catches my eye and seems worth investigation and investment is Pacific Mercantile Bank (PMBC). The bank just sold an additional $14 million worth of stock to their largest shareholder< carpenter and Company. Carpenter runs a specialty fund that is registered as a bank holding company and makes private equity like investments. The funds were transferred to a new asset management division and will be used to buy nonperforming loans and foreclosed real estate from the parent company. This will help with the continued efforts to clean up the bank’s portfolio and improve operating performance going forward.

The efforts have been working as nonperforming assets have declined steadily over the past two years. The bank I positioning is itself to participate in the economic recovery of California with an continued focus on commercial lending and SBA lending.68% of the bank’s loan portfolio is in commercial real estate and C&I loans so the Costa mesa based bank in the right spot to profit as business conditions improve. The company has seven branches on the LA area with over $1 billion in assets. The stock is cheap at less than 90% of tangible book value and is a fantastic way to participate in the eventual recovery and growth of the Golden State.

One of the intriguing banks in the region is United Security Bancshares (UBFO) of Fresno. Fresno is in the San Joaquin valley which was one of the hardest hit regions in the country during the real estate collapse and prices are just now showing signs of stabilizing at much lower levels. Shares of the bank have shot forward this year as the bank turned a profit in the fourth quarter but are still cheap at 84% of tangible book value.
This is definitely a long shot bank as they have some problems. Nonperforming assets are falling but are still quite high at more than 5% according the latest FDIC call report. The bank has been solidifying its loan loss reserves and working off its large supply of real estate acquitted through foreclosure and restructuring and this should continue as housing in the region stabilizes. Most of the real estate was acquired through the construction loan portfolio and should be easily sold when development activity sees renewed activity. To preserve capital the bank has halted cash dividends and has been paying a stock dividend since 2008.
The bank faces a potentially difficult turnaround but the officers and directors seem to feel that it can be accomplished. More importantly they are backing their convictions with cash. In the last six months insiders have purchased more than 175,000 shares of the bank. I wouldn’t bet the farm on United Security but it is worth owning a few shares as an asymmetric payoff potential bet on a California recovery.

Since the  credit crisis began I have been watching and eventually buying the smaller banks as I believe that they will recover as they did in the aftermath of the savings and loan crisis. The valuation, especially of the smaller community banks, represents solid values with enormous potential returns. This is especially true of those banks in the hardest hit regions that survive, recover and eventually either thrive or get acquired.

Thursday, April 11, 2013

No Need To Complicate Matters

Those of us that toil in the market and on the Street are really fond of making what we do seem more important and difficult than it really is in practice. No one is stock broker anymore. They are financial advisors and consultants. We are not looking at markets we are engaging in intermarket analysis. We do not buy options, we get long volatility. No is a corporate raider anymore. They have all become activist investors and Private Equity manager. I didn’t sell options, I got short gamma. I’m not betting on potential takeovers I am an event driven investor.  This weekend it seemed I could not turn around without hearing the newest,    and for my money ,dumbest phrase of self-importance so far. No one is a contrarian value investor anymore it seems. They are engaging in time arbitrage.

Time arbitrage is described as buying stocks that have disappointed investor and sold off and then holding until they recover. Now, I have trade a lot of arbitrage over the years. I have, and still do, engaged in risk arbitrage. I have done pairs trading to exploit discrepancies.  I used to do a and b share arbitrage on a regular basis. In arbitrage I was always trying to lock in an apparent price discrepancy by buying one thing and selling the other. In the case of so called time arbitrage I am long the asset and long time. It’s not arbitrage. I just bought something I think is cheap and plan to old it until it’s not cheap.

I am a much more plain spoken guy. I was never a financial consultant but for 25 years I was a decent stock broker. I do not engage in time arbitrage but I do like to buy out of favor cheap assets and hold them for a long time. Right now there are several candidates that contrarian investors might like as long term buying opportunities but let’s avoid the fancy terms and just be long term patient value investors.

Arcelor Mittal (MT) is a classic undervalued unpopular stock that no one loves but the long term prospects are actually fairly bright. Arcelor has two strikes against it. One it is a steel company, ad of course it is based in Europe. The steel business is bad right now and Europe is careening from fiscal disaster to banking crisis’ on an almost daily basis. The long term truth is that at some point Europe gets its act together and a t least stabilizes. The economy will eventually recover around the world and steel demand will increase again and the current excess supply will go away. The company is making all the right moves, selling some assets, closing marginal plants and expanding in emerging markets.  The stock may go lower before it goes higher but I suspect that in 10 years the stock will trade at many multiples of the current quote.

We can apply the same logic to Cliffs Natural Resources (CLF) right now. This is one of the ugliest stocks on the board for the past few months as fears of a weak economy and sliding iron ore prices have not just weighed on the stock but crushed it. Metallurgical coal is tied to steel demand so that’s not exactly a robust business at the moment either. Wall Street analysts are tripping over each other to downgrade the shares and the funds are selling shares as fast as they can hit the sell button. The company has whacked the dividend and is still losing money. However as with Arcelor, someday the world gets back on its feet, the economy grows, emerging markets expand and the business recovers. It will be a long bumpy ride but I would not be shocked to look up in six or seven years and see the stock back over $100 a share giving patient investors a spectacular return from today’s price.

I buy cheap assets and own them until they are no longer cheap. This usually takes a long time and my average holding period is somewhere around the 5 year mark. I could give it a fancy title but the truth s there is nothing that fancy about it. Although I will be the first to admit that Time Arbitrageur would look pretty cool on a business card it’s just asset based value investing and patience. 

Wednesday, April 10, 2013

Individual Advantage

One noticeable aspect of the stock market the past few years is the absence of the retail investor. Although we get an occasional surge of retail inflows like we saw in January for the most part individuals have avoided the stock market. They may have some exposure through retirement plans but after seeing two devastating losses in less than a decade many people have just gotten scared and stayed away. Many fell, with some justification, that the market is rigged against them by high speed and high frequency traders that exploit their order flow. The brokerage firms have not really been a friend of the individual over the years either. A lot of potential investors feel like the stock market is simply a game they cannot win and therefore do not play.

It is important to recognize that much of the pain inflicted on retail investors is done by retail investors. Numerous studies indicate that the average investor does not perform as well as the averages. There is a tendency to over trade and allow fees and commissions to eat into their margins. Rather than exploiting the fear and greed cycle they usually are the cycle selling in a panic at the bottom and worst of all buying into the excited frenzy as prices have nearing the end of a bull run. We tend to buy stories and sales pitches and ignore fundamentals and often fail to do the homework needed to be a successful investor.

The truth is that the biggest mistake investors make is not exploiting the significant advantages we have over the large institutional investors. Wed can do things they cannot and can adopt a mindset that has proven profitable but the large hedge and mutual funds simply cannot adopt.

First, and perhaps most importantly, we do not have to play the short term return game. Measuring the performance of a business or an investment fund by quarterly results is ludicrous but that is exactly what happens in the investment arena. Fund managers have to keep up with the indexes and their competitors and this leads to adopting a herd like mentality and doing what everyone else does to keep up. You and I do not have to do that and can adopt a longer term more business like view of our investments.

We have no institutional mandates or style box concerns to consider. We can own as high or small a percentage of stocks compared to bonds as we choose. We can hold as much cash as we want to as well. Odds are we will not fire ourselves for buying a stock that doesn’t pay a dividend as mandated by the prospectus or account agreement. If one of our stocks does not fit into the large cap socially conscious growth classification we do not have to resign from our account. It is our money and we can mix it up with value stocks, special situations and even growth stocks as we see fit.

We have an enormous size advantage as well. One of my favorite stocks right now is an aerospace company with a market cap of about $70 million. A fund with a $1 billion under management cannot buy a 1% position of the stock without moving the price and triggering a 13G filing with the SEC. You and I do not have that problem and can venture into areas the big guys simply cannot.

We have a huge time advantage as well. If we consider one of our stocks to be a solid business with a margin of safety we can hold it for as long as need to for the price to reflect the value. We can view put portfolio as a collection of businesses and allow time to unlock the value. The institution cannot do that as they have to keep up with the Dow Joneses and do not have the luxury of time. My best results have come from stock held for many years but most of the big funds have a turnover rate of close to 100%.

One of our biggest advantages comes from not having to play just because the casino is open. Getting caught up in the action is usually disastrous for individuals with careers or a business to run, a family and other time-consuming obligations. Trading is hard work and the simple truth is not that many people are really good at it. When you get the urge to swing trade that 100 shares of a high flyer keep in mind that the guy on the other side probably has twin Phds in math and econ and needs special air conditioning units to cool his computers he uses to trade. He is a shark and he views you as lunch. Don’t be lunch.

The most powerful stock market story ever was told by John train many years ago in Forbes magazine. He introduced to us to the pig farmer Mr. Womack who always made money in the stock market. When Mr. Womack saw on the news that Wall Street was in disarray and in full disaster made he would drive into town and buy some stocks that had fallen precipitously, had sound balance sheets and paid dividends. He then forgot about the stock market for the most part until after a period of few years he noticed that the papers were full of talks of new market highs and wildly optimistic prediction. He would then drive back into town and sell his stocks. On balance the man never lost money in the stock markets and enjoyed significant gains and a steady flow of dividends.

You have significant advantages over the big funds and large traders. Use them to make you investing more business-like and more profitable.