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Tuesday, August 27, 2013

Invest Like a Pelican

 My daughter was in town this past weekend for a semiannual visit so we schlepped her down to Islamorada in the northern Florida Keys. Given my aversion to frolicking I spent a lot of time on the shore just watching the collection of birds and other wildlife that are so prolific in that part of the world. I confess to a particular admiration for the noble pelican. This bird spends a great deal of its time just hanging around relaxing and observing the world. When it is hungry it flies out to where it knows there are fish, picks off the easy ones and heads back to a nice piling or tree to renewing the observation process. If a fat tasty fish should swim by his perch he will react but he is content to sit and watch the world go by for long periods of time.

Now consider the seagull. This bird seems to spend its entire life flitting form potential foods source to food source. It circles in a mad screaming frenzy looking for an opportunity to eat. It will leave one food source if it thinks the flock has found a better one. One kid on the beach with a hot dog can attract 100 birds  fighting over scraps. Once one seagull finds a potential easy source of scraps the entire flock and every flock within screeching distance heads to it with a great deal of enthusiasm. The late arrivals expend a lot of energy for very little food. It does not strike me a very productive approach to finding food.

There is a great metaphor here for the investing process. Most investors are seagulls. They flock from stock to stock, sector to sector in search of the hottest and brightest ideas. There have been numerous studies showing that individual investors do not earn as much as they statistically should because of this heart seeking behavior. They trade too much and hold for way too short a time to make a decent return on their investing dollars. All too often they follow the squawking flock into areas that are picked over and ready to fall.
We can improve our results by taking more of a bird’s eye view of the market. If you look at stock right now the flock is swarming around stocks like Tesla (TSLA) and Netflix (NFLX) that are popular and priced like lottery tickets instead of corporations. Big dividend paying blue chips have bid up to the point where it looks to me like they are trading for about twice what the business is worth in a slow growth global economy. Large REITs are priced like 2008 never happened and REITs are lining up to come public or do secondary offerings.  Restaurant stocks have shrunk portion sizes and laid off employees so successfully that investors are beating down the doors to buy the shares. When you step back and take a bird’s eye view of the markets it is easy to see the pockets of excess where the flock is fighting over scraps.

It is also easy to see where the easy pickings for long term investors are in the current market. Every stocks are priced fossil fuels will never be used again and we have found some magic solution tour energy problems. Many of them are priced at discounts to net asset. All these companies have to do is survive and their tocks price should rise sharply over the next few years. Energy demand may be relatively sluggish right now but it will pick up in the future. Like it or not natural gas and domestic oil is the path to energy independence for the United Sates and will be for several decades.

Materials and resource stocks are priced like the world is going to end. I do think it may take a while for the natural human desire to improve their lives overwhelms the incompetence of our politicians but it will eventually and there will be strong demand for things like iron Ore, pulp, paper and steel. . Again these companies just need to survive until demand pick sup to pay off handsomely for patient investors.

Net net and near net stocks are the fat fish of the stock market. When stocks trade at levels close to or less that what the entire company could be liquidated for its makes sense to pick up a few shares. They are simply too cheap not to own and history shows us that buying these stocks is usually a profitable endeavor.

Investors would do well to emulate the pelican and avoid the squawking flock of gulls fighting over scraps in their approach to investing.

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Wednesday, August 21, 2013

The Right Minded Investor

With all the traveling and distraction this week I didn’t get around to reading Barron’s all the way through until last night. The highlight was the interview with David Rubenstein the co-CEO of Carlysle Group (CG) the giant private equity firm. He made several interesting points in the article including the fact that one of the best opportunities is in the energy space. He told the magazine that carbon based fuels are the most efficient and inexpensive energy source we have and as long as that’s true we will burn the stuff. He doesn’t expect renewables to be a viable source in his lifetime and neither do I. Companies that explore for, produce, transport and store oil and natural gas have not really participated in the market rally of the past few years and are very cheap. Long term investors should be focusing on the group.

He also talked about opening private equity up to the general public by creating vehicles for investors along the lines of limited liquidity closed end funds with monthly or quarterly redemptions. He correctly points out that private equity usually has higher returns than public markets over time for a variety of reason. I have to say I think this is a horrid idea. Investors have proven that they will earn less than they should because they trade too much and are too vulnerable to news, emotion and price action. Private equity vehicle may return more than equity mutual funds but investors will probably enter at the wrong time and exit at an even worse time as they have done with other investments and strategies.

Investor’s do not need a private equity investment vehicle as much as they do a private equity mindset. Private equity earns higher returns because they investor for an average 6 year holding period. They buy companies no one else wants and focus on industries that are out of favor. They buy companies rather than trading electronic betting slips day in and day out. They also sell when the markets are moving up and investors are looking for merchandise to buy. The private equity mind knows that they get more than the company is worth by selling into a happy stock market.

I pay a lot of attention to what’s going on in the private equity world because we tend to be looking at the same types of stocks most of the time. Their activities also usually set a benchmark for buyout prices and that is part of our intrinsic value calculation. If you have a private equity mindset and are paying attention right no you will see that most private equity firms are selling with both hands. In fact Leon Black of industry leader Apollo (APO) recently said that his funds were “selling everything that is not nailed down.” Mr. Rubenstein’s co-CEO at Carlisle recently told the Wall Street Journal “With the world awash in liquidity, interest rates at rock bottom levels and asset prices being bid up, it has become increasingly difficult for us to compete when underwriting our investments, particularly in the U.S., to a 20% to 25% internal rate of return."

A look at recent and pending IPO activity shows that a lot of the deals are private equity cash outs. We have Hilton Hotels coming public soon as Blackstone sells back part of one of the 10 largest PE buyout deals in history. TPG and Warburg Pincus are preparing to unload some of their stake in Neiman Marcus in an initial offering. Blackstone has already unloaded part of Sea World (SEAS) and Pinnacle Foods (PF) in earlier offerings. So far this year there have been 18 private equity backed deals and the IPO calendar is crowded with PE exit offerings. The ZIRP fueled market wants to buy and the PE mindset is happy to oblige.

Individual investors should consider adopting a private equity mindset. Take a look at the market objectively and sell the stocks and sectors that have been strong the past several years and now carry premium valuations. Dividend paying blue chip stocks have been pushed beyond the boundaries of reasonable valuations and are not worth chasing here. Homebuilders have rebounded nicely and now trade above any reasonable calculation of corporate worth. Barring an economic miracle in the next six months many retailers are selling premium valuation in spite of non-premium prospects. High multiple hot story stocks have a had a good run but the time to take the money and run is before momentum shifts not after large selling wipes out your gains in a short period of time.

A private equity mindset is looking where no one else wants to go right now and considering the 5 to 7 return potential for industries like oil and gas, coal, mining and small banks. They are not chasing hot deals or market indexes and are doing far more selling than buying. There are reasons PE returns more than public equity and patience and discipline are a big part of that equation.

Sunday, August 18, 2013

Bank Stocks and Alligators

This weekend my daughter was in town and we took a trip down to the Keys though the Everglades. I have never driven the entire length of Highway 41, the Tamiami Trail, and was fascinated by the idea. Along the way we took the mandatory airboat ride back up into the glades and it was quite an experience. I confess to an admiration and fascination of alligators and although I see them all the time walking the dog here in Windermere, this was alligator heaven. They were everywhere and they were enormous. I do not know if you have spent any time watching gators but they are pretty opportunistic creatures. They do not hunt as much as wait for something to be foolish enough to get closer and then they pounce. They tend to eat a lot of smaller animals that wander by but will occasionally take down bigger prey like a deer that makes a crucial mistake. If nothing comes close they are content to float around the lake or take a nice nap in the sun.
Being small bank stock investor is a lot like being an alligator. It is an opportunistic approach as we tend to wait for banks to come to us in price and value and not force the issues. We are looking for the smaller banks most of the time but in environments like 2009 and 2010 larger regionals will also get cheap enough to buy. We wait for perfect little banks with strong loan portfolios and balance sheets to be cheap enough to buy at a large discount to book value or for an activist on other influential investor to take a stake in a special situation bank that has less than perfect loan portfolios or needs capital. If nothing comes by today that is cheap enough we are quite content to just hold what we have and wait. Days and even weeks can go by without a trade. I have owned banks for years that steadily appreciated but at a slower pace than the book value grew so they never became overpriced. I have gone months without adding a new name to the portfolio.  When prey is rich on the ground in periods like 2003 to 2005 and 2008 to 2010 I can become fully invested in an instant. It is a very opportunistic and patient approach to the markets. A good friend once described small regional and community investing on a value basis as the most productive and boring way he ever found to make money in the stock market.
Perusing the bank call reports for the second quarter shows a drop in total banking assets for the second quarter in a row. The biggest drops are in trading assets and real estate owned as banks continue to dispose of troubled assets and cut back on riskier activities. Net loans and leases increased slightly in the quarter with farm loans and car loans leading the way. 1-4 family mortgage and junior lien lending continues to decline as does home equity loans. Commercial and industrial loans as a percentage of total loans are at a very high level of 20.1%. Big banks are rushing to make these loans while ignoring mortgage loans to the greatest degree possible. This bears watching. So does smaller banks exposure to muni bonds in the aftermath of the Detroit bankruptcy as they have long been a safe haven for smaller banks looking for safer investment securities.
Small banks really are the trade of the decade. These quiet little almost boring  stocks can make you a fortune. In the aftermath of the S&L crisis the bank stock indexes rose roughly 10 fold over the next decade and I see no reason the same won't happen this time as banks are ripe for consolidation at current levels.

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Saturday, August 17, 2013

Tropical Islands and Value Investing

My daughter was in in town last week for the first time since Christmas so we took a little jaunt around Florida. We ended up down in Islamorada in the Upper End of the Keys and spent a fantastic weekend taking in sun and seafood. As the weekend wound down we found ourselves discussing the age old question of why more people do not just chuck it all in and live the island life in the Keys or somewhere similar. After all there are tropical breezes, fresh seafood, sunsets, frozen cocktails and other symptoms of paradise galore and it strikes me a pleasant unrushed place and way to live.
Lots of people talk about doing it. Some even visit for a while and day dream of living there. The truth is that very, very few people ever give it all up and move to a tropical paradise or mountain hideaway town. There are jobs and schools to think about after all. You have to be prepared to basically thumb your nose at conventional thinking, separate yourself from the herd, trade in your dress shoes for flip flops and turn your back on the community at large. You have to be ready to give up the bright lights and big city life, or the comforts of suburbia, to become an island dweller and the simple truth is most people cannot do it. This makes life a little less crowded for those that do make the trade from ties to  tiki  and live a life of which most people can only daydream. The idea either makes complete and total actionable sense to you or it is just a pipe dream.
Deep value investing is a lot like that. Lots of people talk about and only a very small handful ever actually engage in the practice. Everyone can quote Ben Graham but very few people invest like him. Lip service is paid in the form of relative value and other such schemes but there are not too many investors who ignore the income account almost in its entirety to focus on the balance sheet. It flies in the face of conventional wisdom about EPS growth and hot stocks and is in defiance of almost every academic theory about markets ever taught in our colleges and universities. You have to be willing to separate from the herd and buy stocks no one else wants.  Deep value investing makes for bad television and poor tweeting most of the time. You have to practice patience beyond 4:00, and even beyond the next quarterly earnings report. You are buying companies, not tradable electronic blips in the night. It either makes absolute actionable sense to you from the very start or it does not. I see more deep value investors on the list of those with long lasting success and profits, but most cannot resist the psychological pull of the open casino of Wall Street and hot stocks.

Deep value is not for everyone. Not everybody has the discipline and patience to earn the outsize profits history shows us can be earned through business like investing practices such as buying assets for less than their full value. For those that can there is a lot of money to be made. 

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Tuesday, August 13, 2013

Scary Markets, Solid Stocks

Okay kids. It is time to have the talk. Last night during a discussion of markets I gave my usual I am more of a bottom up guy and try not to pay too much attention to the stock market quote. That is how I run my day to day activities for the most part but my friends were a little pushier than usual and got me to talk about the current state of the stock market. I have hinted at this before with talks of portfolio pruning and caution but in reality this is the scariest stock market I have seen in my career. I worry more about the market now that I did in the late 1990s. At least that market had a story and life changing technology to fuel the excess. This one has nothing but a blind faith in the Fed.

One of the biggest lessons I have learned in the past three decades is that fortunes are made in the stock market buying into a collapse. If you look at some of the most successful investors of all time, that’s how they made their money. John Templeton talked about buying at the point of maximum pessimism. Walter Schloss liked to buy stocks trading at 4 or 5 year lows. Warren Buffet has a knack for getting into companies like Goldman Sachs (GS) when things go bad. Sam Zell has made a fortune buying real estate when no one else was interested and prices had collapsed. Wilbur Ross buys stuff that would freeze the innards of a less disciplined patient investor.

US stocks are nowhere near a point of maximum pessimism and are at 4 to five year highs not lows for the most part. We have gone straight up since the lows of 2009 and are more than 2.5 times the low. The only driver of the gains has been zero interest rates. Earnings have not been fantastic. Revenues of late have been flat. Much of the earnings gains are driven by cost cutting and financial engineering such as buybacks. The economy is just drifting along in a better but no good mode. It has been a great run and I have benefitted enormously but the overriding question has to be how long can money printing and financial shenanigans support stock prices?

Some of the smarter guys in the investment world are getting as nervous as I am. Sam Zell flatly said that stocks remind him of 2007 real estate markets and its time to sell. In April Leon Black of Apollo management said they were selling everything that wasn’t nailed down after the markets rise. At the same Milken Conference as Mr. Black Wilbur Ross warned of a bubble in junk bonds and said sometimes it is just better to hide. Seth Klarman’s recent comments to a private business group have been widely quoted and are the stuff of sleepless nights. He calls the current economy is a house of cards that will eventually implode.

One thing all of these men have in common is that they agree with my basic premise that things are dangerously over inflated and the markets and the economy are running on an addiction to cheap money and quantitative easing. I have no idea when this silliness will end of what may happen between now and then but I do know that when it does I do want to be caught massively long a bunch of overpriced stocks or 5% junk bonds. This is a time for extreme caution in my opinion.

I put together two new money portfolios the a few weeks, one concentrating on just plain of ordinary cheap stocks. I ended up finding enough opportunities to become about 35% invested buying names like MultiFine Electronics (MFLX). Arcelor Mittal (MT), Pericom Semiconductor (PSEM) and Volt Scientific (VISI).  The rest is in cash and staying there for now. The same held true of small banks where we are able to find enough stocks to get close to 50% invested based on my strict criteria. Most were well below %50 million in market cap. I have no idea what will happen in the market and the economy but I do know that the red flags are flying if you take your eyes off the screen long enough to look at the window.

What if I am wrong? What if all this financial chicanery and money pumping actually works and reignites the economy? Here the beauty of the deep value investing approach.  If you look back at the archives we own things like steel companies, iron ore producers, coal companies, silver miners and banks bought at fractions of book value. We have been buyers of energy companies at a fraction of their net worth. Even with new portfolios at less than 50% invested and older ones at something around 70% we are going to have a monster return from those stocks. I want making a macro call but just buying what is too cheap not to own but the process has left me well positioned even if I am dead wrong with my cautious approach. If things do blow up in the next few years existing positions will feel some pain but I will have a lot of cash to take advantage of the point of maximum pessimism.

If you are concerned about the markets and the economy right now I suspect you just aren’t paying attention. Rely on caution and value to protect yourself no matter what happens out there.

I will get a lot of questions once this is published. Many will want to know if I am really that concerned about the market. Of course I am. If you are not you are not looking deep enough. There are some structural problems with the market and the economy and it could be a disastrous. I hope it never happens but I intend to be prepared if the cracks expand. The next question of course is exactly which stocks I was buying to get 35% invested in this market. I would be less than fair if I didn’t answer that question so I will devote some time to highlighting the stocks I would buy today with new money.

First lets understand that this is a new money portfolio. The fact that I stock I bought last year is not in it does not mean you should sell it. It just means its moved up enough that I am not putting any new money in the stock. Feel free to email me with questions on a particular stock I suggested that is not listed here. Second this is a domestic non-bank portfolio invested on strict asset based criteria. There are no longshots, foreign maximum pessimism stocks or small banks in this portfolio nor are there any of the Graham growth type stocks I occasionally suggested for younger investors like my kids. This is a classic Tim Portfolio. Also be aware most of them are tiny so I am only going to be able to cover those large and liquid enough to discuss here.

I have talked a lot about Richardson Electronics (RELL) and it definitely goes into a new portfolio. The stock trades right around the value of its net current assets. They are not setting the world on fire by any stretch of the imagination but the company is profitable and pays a 2% dividend. Business is just going to slog along until we see a stronger global economy. The stock is trading at 90% of tangible book value and they have more than 80% of the share price in cash.

Alpha and Omega Semiconductor (AOSL) is struggling along with the economy as well. The company makes chips used in batteries, smart phones, computers and gaming systems. The shares fetch just 70% of tangible book value and also have more than half the share price in cash.  The company has done a solid job of increasing shareholder equity over the past few years and should see strong results in a better economic backdrop.

I included all the resource and mining stocks we have talked about in the past few months. If we ever do have an economic recovery, and I am confident that at some point in the next few years that will happen, then companies that dig stuff out of the ground and provide the basic materials. I included shares of Resolute Forest Products (RFP), Pan American Silver (PAAS), Cliffs Natural Resources (CLF) and Arcelor Mittal (MT) in the group. While some of those are foreign they are not part of a maximum pessimism trade such as I have suggested in Brazil and European banks. All of them are very cheap on a price to tangible book value basis. I am aware that if the economy does collapse so will these stocks but I am more than willing to buy more at a deeper discount.

I still like Brookfield Properties (BPO) as well. It is rare to be able to pay a portfolio of global world class real estate at this type of valuation and I feel like this could be a huge winner for over time. The market is too focused on the space they have to lease in lower Manhattan and not looking at the quality of the portfolio of premier office space around the worlds. In spite of the space available in New York the overall portfolio is 91% leased and they are renewing many of their leases at higher rates. Trading at 70% of tangible book value this REIT is too cheap not to own in my opinion. They should close on their acquisition of MPG Office trust in this quarter giving them a nice chunk of the LA skyline at a very good price.

I will conclude this portfolio wrap up tomorrow. Even in a market that has serious long term concerns that are stocks that are just too cheap not to own. The key to making this all work is that I have a very long time frame and have no problem buying any of these stocks down 50% from the current price in a market pullback, decline or crash.

Today I want to finish up my review of stocks I consider cheap enough to own regardless of your view of market conditions. As I said earlier this week I find the current market and economic conditions more than a little scary and am as cautious as I have ever been, however I follow a discipline of buying stocks at the too cheap not to own level regardless of market conditions and opinions. Given the run in the market the last few years there are not a lot of them and I am keeping positions sizes fairly small so there is plenty of room to buy on a scale if needed. Again these are stocks that I would be buying right now and not those that may have been purchased over the past few years and still hold.

Pericom Semiconductor (PSEM) make integrated circuits and frequency control products used to transfer route and time signals between computers, networks and telecom systems. Their products are used in laptops, notebook, smart phones and a wide range of other electronics devices.  Revenues and earnings were basically flat in the second quarter and I expect they will be pretty much the same when the company reports second quarter results. Computer sales are still weak and Pericom is in the early stages of expanding into higher growth markets such as networking and crowd computing. The stock is cheap at a little under 90% of tangible book value and more than 70% of the stock price in cash and securities at the end of the first quarter.

Cowen Groups (COWN) stock price has moved up a bit but the stock is still cheap enough to buy at just 80% of tangible book value. The brokerage and asset management firm has a strong asset management and alternative investment arm and the investment bank is well represented in key industries. Cowen has invested its capital well and since 1999 has earned over 16% annually on their proprietary investment accounts. If the markets did collapse I would be a big buyer of this stock as they would likely make a fortune in the aftermath form activist investment strategies and merger activity.

 I also like Calamos (CLMS) in the asset management space selling just over book value and at less than 3 times free cash flow. The have a strong presence in their markets and are a leader in convertible bond funds. The stock pays a decent yield of more than 4% so you get paid pretty well while you own the stock.

There are still some energy names that I think investors can buy at current levels. WPX Energy (WPX) is off slightly this morning after missing the always highly accurate analyst estimates. The stock trades at just 70% of tangible book value and even after adjusting for the loss of value in their Argentinian holders the actual asset value of the company is probably higher than book at this point. Swift Energy (SFY) is still transitioning from conventional shallow water oil and gas company to an unconventional production company. The product mix has not shifter away from gas to oil and liquids as fast as Wall street would like to see but they are making progress. In the meantime you can buy the stock at just 50% of tangible book value.

Tellab (TLAB) is still seeing weakness in its business lines as telecom spending remains very weak right now. The company is taking steps to refocus their business and I like the fact that Third Avenue was able to put a representative in the board last year.  The stock trades at $2.28 and they have $2.18 a share in cash as of the end of the first quarter. They report earnings later today so it will be interesting to see how the cash balances held up in the quarter. In the meantime the stock is just too cheap not to own.

These are the stocks that have enough liquidity to mention here on Real Money. About a dozen other non-bank stocks qualify but they are tiny with market caps between $25 and $50 million and trade pretty much by appointment. Given my concerns about the world and the markets I am focusing only on those names that I consider safe and cheap enough to own through a period of high volatility. I am willing ot add to all of them at lower prices if necessary. Should the economy surprise me and catch fire I think they would explode higher and more than offset my cautious positioning.

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