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Thursday, October 31, 2013

Updates and Offers

I have mentioned before that I really am not a huge fan of all the marketing and promotion stuff that goes along with offering a newsletter service. Left to my own devices I would prefer to just hunker down in my little office and focus on research and managing the portfolios. I am something of a geek and   think that a day of finding and researching stocks followed by an evening with a good book, a bottle of wine and a ball game on in the background is pretty much a perfect day. But apparently all this comes with the territory so I want to take a minute to remind you of some things that are going on with the Tim Melvin portfolios.

Since June 6th of this year when we introduced the newsletters and bought the first stock the S&P 500 is up about 9.44%. That’s pretty impressive in and of itself for a five month period. However our stocks are doing even better than that. 16 of our 26 stocks in the Deep Value Portfolio are up more than that.  We have had two companies receive takeover offers at higher than market prices and 6 or our stocks are up more than 25% already. We have also already had a takeover offer at more than a 50% premium in our bank stock portfolio already this year. Buying stocks at a significant discount to book value works and it works very well. The Deep value Portfolio currently averages about 70% of tangible book value and the Banking on Profits portfolio averages right around 80% of tangible book value.

We have been sending you some examples of past picks that have generated 50, 100 and even 200% gains over the past couple of years. My method does not involve trading in and out of stocks all day and trying to balance watching the markets while working or spending time with your family. It is based on buying business at good prices with a large margin of safety and letting time and economics take care of the rest. You have things that you need to do and want to do during the week and a bunch of time chasing electronic dots across the screen with some trading system might not be the best use of your time. Let me pick the best stocks for you to profit from as a long term investor and spend your time doing what is important to you.

I also have a strong focus on margin of safety. It is not enough to be cheap the business has to be safe with a strong credit and fundamental profile. We believe that to thrive you first have to survive. That spills over into my approach to the overall market as well. I am not a market timer but when times are bad and most folks are scared and selling there lots of bargains and I trend to be a buyer. When markets are strong as they are now opportunities are scarce and we tend to hold a lot of cash. Right now we have 40% cash in our Bank Stock portfolio and close to 70% in the Deep Value Portfolio.

Here is an example of how this non market timing approach has worked in anticipating past market corrections and crashes. Both of these comments come from the blog I kept at the time and are a matter of public record:

December 5, 2006

                “You might be able to sell me the fact that this market is fairly priced, providing I’ve been drinking heavily, but undervalued, I can’t see it. The bond market and the dollar are telling you it’s just not that good out there right now. We have rallied almost 12% since August without a real pause of any length and anybody who is not cautious now pretty much deserves what they get.”

April 1, 2008
                “Even if I am dead wrong here I think the risk of being fully committed to stocks carries too many risks for the idea of a margin of safety to exist. I am willing to miss this run up to protect capital. There appears to be very little common sense being used on Wall Street these days when it comes to the overall economic and financial matters, as well as a total lack of fear. Bottoms are accompanied by fear and loathing not cheerleading and bottom predictions. The bullish arguments are laughable.

By the way we got back in pretty much at the lows because even though it looked like the world was ending stocks were cheap.

As for the market itself there is a fortune to be made over the next several years. I see companies that are profitable trading for less than 3 times E/EBITDA. I see an ever growing list of companies that sell for less than cash in the bank. We are fast approaching the depths of an ugly bear market and there is money to be made.
March 14, 2009
                You can buy stocks like ADPT, TECD, and ESIO for less than the value of the company’s liquid assets. You can literally build a portfolio of 40-50 of these that have a good credit scores, viable businesses and excellent recovery prospects. That’s enough to make me salivate at the possibilities for gains over the next several years.

                DIS trade for about two thirds of my appraisal value. That is provided we give no value at all to the film library or character rights and price the parks as raw land and put a 5 multiple on after tax earnings .DELL trade for less than two cash. HTH is a pile of cash in the hands of a proven investor in distressed banks and other financials. As a bonus the company landed a back door bank charter and will be able to bid on distressed assets and institutions. Southwest Airlines is stupid cheap, trading below tangible book value. Oil service companies like RDC and PTEN trade below net asset value at these levels. I like the idea of buying the Forest City senior debentures at a 30% YTM and what looks to be more than adequate asset coverage.

Using my value approach can help you find stocks with outstanding long term returns. It will also help you avoid overheated markets that present the chance of a permanent loss of capital and have cash on hand to buy when we get to that point of maximum pessimism that offers the very best long term opportunities.
Thats my whole pitch folks. No fantastic claims just hard evidence that this works and can help you accomplish the two most important goals of a long term investors. First service and avoid grievous and permanent losses of capital. Second to find those stocks that offer the potential for returns measured in multiples rather than percentages of your initial purchase price.

I had my partners at put together a couple of offers for you to start putting deep value investing to work for you. Check them out and pick the one that works best for you. I look forward to having you as part of the Deep Value family.

Cheers  !

Tim Melvin

Tuesday, October 29, 2013

Betting Longshots and Turnarounds

I have frequently confessed a strong attraction for longshot stocks in the past. I like these stocks that are ridiculously out of favor and struggling to execute a turnaround. Most of my efforts are focused on safe and cheap stocks with the potential for high returns but I confess to having a few longshots around most of the time. I have advised my son and daughter that they should have an even higher percentage of these stocks in their portfolio than their old man does as the math is just too compelling.

Consider a portfolio of carefully selected long shots with the potential to triple in price over the next three to five years. If you are right about 40% of you selections and just average break even on the rest of the bundle you end up handily beating the markets historical returns. If it takes three years you end up averaging 21% and if stretched out to five you still have a compound annual return a little over 12%. A 30% win rate gives you a  return of between 8 and 14% depending on the time it takes to play out. With the application of a hardy dose of common sense and strong stomach for volatility the 40% win rate should not be difficult to achieve. It is the same mindset that makes private equity and distressed investing so successful.

If you look at the stock I identified as longshots in the second half of 2011 and all of 2012 there were 25 names on the list. 22 of the stock are higher although admittedly with a boost form a strong stock market. The biggest loser is my old nemesis Hampton Roads Bancorp (HMPR) with a nice loss of almost 80%. The biggest winner is Cemex (CX) with a tidy 200% return already. More importantly taken as a group the package of stock is up more than 80% over just an 18 month time frame. I have not graded out 2013s long shots yet but we have already seen some big winners in stocks like Cumulus Media (CMLS) and Cowen Group (COWN) that were long shot portfolio suggestions.

One way of searching for long shots is to set some of my traditional metrics aside and simply look for companies with higher leverage that I normally accept that also have high Piotroski F scores indicating improving fundamentals. I then cut that list down to companies that have tumbled into single digits and have a long way to climb if management is successful in turning the business around.

Skilled Healthcare Group (SKH) operates skilled nursing facilities, assisted living facilities, hospices, home health providers, and a rehabilitation therapy business. This used to be a $14 stock but now fetches less than $5. The stock was over $7 back in July but missed analyst forecasts for earnings and revenue and investors dumped the stock aggressively. The debt to equity ratio is a a daunting 400% but the company does have an F-score of 7 indicating fundamental improvements are taking place and not being recognized by Wall Street just yet. At the first sign of good news this stock could begin a climb back in the direction of the old highs.

Alaska Communications Group Company (ALSK) provides integrated communications services to consumer and business customers in and out of Alaska. The Company's wireline and wireless communications networks extend throughout Alaska. The company recently announced new broadband capabilities for businesses that should help drive future growth. The new service will be rolled out shortly in the Anchorage area and introduced to the rest of the state over the next few years.  Five years ago this stock traded for more than $10 a share and just halfway back to that level would be a huge return. They carry a high debt load with a debt to equity ratio of 500% but the F-score is an impressive 8 indicating better times ahead for the company and hopefully the stock.

Although I do run screens looking for long shots my favorite way is to simply sit down with the new issue of Value Line and electronically thumb through the issue looking for stock with enormous upside potential over the three to five year time frame I find most effective. The list of stock that have performed poorly in the last quarter and those with the highest three to five year appreciation potential as calculated by the research service have been particularly fertile hunting grounds over the years. The longshot and turnaround portfolio break form some of my basic valuation tenets and are more of a distressed/private equity view of certain stocks. This approach suits my son more than it does me at this point in my life but I have an affinity for having a few of these in my personal accounts.

Looking at the list today I see that a few of my recent longshot picks from earlier this year still make the grade. I am a huge fan of both McDermott (MDR) ACCO Brands (ACCO) and Amkor Technologies (AMKR) still make the grade. I am big fan of all three of these issues and am very hopeful that the politicians will gum things up for a few more days and panic the market. I would love to have all three of these in my classic value portfolios and they don’t need to fall that far to trade at a healthy discount to book value.

Central Pet and Garden (CENT) makes the grade as a turnaround as well. The company has seen its share price plummet from over $18 pre-crisis to a little over $7 today. The company has been struggling to get its act together and saw earnings fall again last quarter and the stock was further punished by disappointed investors. The company has turned its attention to cost controls and that should help improve the bottom line. They have already reduced headcount once and may have to do so again before its all said and done.
Unless suburbs suddenly disappear the company will have a market place for their lawn and garden supplies, seeds and insecticides. Most of their revenue actually comes from the pet side of the business with products like treats, toys and animal health products. Many people I know, including my wife, would take care of their pets before themselves so that should remain a solid market for the company as well. With a little attention to costs and margins this stock should have no trouble getting back near the highs in a stronger economy.

Golar LNG (GLNG) is a little higher priced than y usual longshot picks but this stock appears to have enormous upside.I t is involved in the acquisition, ownership, operation, and chartering of LNG carriers and floating storage regasification units and the development of LNG projects. Currently the company owns six LNG carriers and operates Golar LNG Partner LP's fleet of seven LNG carriers and floating units. LNG rates have slipped this year as a result of delays and plant outages and the company actually took two vessels out of service in the second quarter rather than pay the costs of operation. The company is expanding their fleet and other shippers are rushing to get into the LNG business so there may be some excess LNG shipping capacity next year but this is eventually going to be a rapidly growing industry and Golar is positioned to be a leader.

The outlook for the floating storage and regasification units is strong right now. Golar commences a new contract in Jordan during 2015 and is considering converting older vessels to FSRU platforms to meet the growing demand. This stock could easily triple as the LNG industry continues to expand. You get paid to wait with this stock as the shares are yield 5.1% at the current price.

Before moving on from Value Line and the search for longshots with an above average chance of success over the 3 to 5 year time frame these investments usually need to work I like to go to amore familiar section of the weekly edition. Each week the venerable research service publishes a list of stock trading with the widest discounts from book value. While they use sated book and not my preferred tangible book value I find that the list has been an excellent source of stock ideas with longshot potential for a return of several times the initial purchase amount over time. This week’s list did not disappoint and there were several stocks worthy of further consideration.

FUJIFILM Holdings  (FUJIY)has suffered over the past few years as the film and camera business became a buggy whip business. No matter how good the products might be the demand for regular photographic supplies is disappearing as photography moves into the digital world. The company has taken steps to diversify the business and now offers products for the medical imaging markets, optical devices and office equipment. They own 75% of Fuji Xerox and have been developing export markets in other Asian nations for these products. They have restructured their basic photography related businesses and are migrating more towards higher end digital cameras in an effort to slow losses from that product line. It will take some time to get the ship fully righted but there is more than enough potential upside in the stock to justify waiting. The shares trade at just 50% of book value and cold easily double or more over the next few years.

Atlantic Power (AT) is a stock that will either be a big hero or a large zero. The stock trades at about 25% of its 2011 after a weak economy pressured the highly leverage power generator and they were forced ot cut the dividend payout. Even after slashing the payout by 66% the yield at the much lower price is still fairly enticing as the stock yields 8% at todays price. They were able to turn a profit in the second quarter to the surprise of many analysts and the stock has moved op off the lows but us still very cheap. Management is committed to paying down debt and reduced its debt load by $172 million in the second quarter. They are also looking to sell assets considered noncore operation and will use the cash form these efforts to further reduce the debt burden. If the restructuring and turnaround plans are successful this stock could easily double or more over the next few years.

Aircastle Limited (AYR) is in the aircraft leasing business and currently y has a fleet of 158 aircraft. The fleet has a utilization rate of 98% with a portfolio yield of more than 13% so business is pretty good for the company right now. They have been disposing of older aircraft and upgrading he fleet in in 2013. They have sold 11 aircraft so far and spent more than $960 million on new planes. The comonay also recently sold a little more than 15% of the company to Marubeni , Japanese trading company. Aircastle CEO Ron Wainshal said of the deal that “We're extremely pleased to welcome Marubeni as an important new strategic shareholder. Marubeni brings a long-term, globally minded perspective to our business and we believe there are exciting business opportunities for us as we work together."   The stock is cheap at just 81% of book value and the shares sport a yield of 3.7% at the current price. This was the 29th consecutive quarter of dividend payments by the firm. The company is also buying back stock and since 2011 have repurchased 11.7 million shares and still have $30 million to spend under the current buyback plan. Patient investors could collect a nice yield and see the stock double over the next five years.

Investors should spend more time looking for longshots and turnarounds that they do trying to trade the news or predict market direction. Both strike me a futile exercises and are a significant part of the reasons individuals tend to under perform the market.Investing in turnarounds and longshots may not be for many investors but it probably should be. Although the short term volatility of the share prices can be daunting investing in these stocks forces investors to adopt what I call a private equity mind set. By viewing the potential return five years out and not worrying so much about the daily trading of the companies they own most investors would see a substantial increase in their portfolio value Not all longshots work out. However it has been my experience that if you use a little common sense and look for decent companies simply dealing with a rough patch more than you might think work out very nicely indeed. Patient aggressive investing in stocks with significant upside potential should prove to be a far more profitable exercise.

Tuesday, October 08, 2013

Uncommon Common Sense

If you are like me your email inbox gets a lot of those oh so enticing offers promising instant stock trading profits in just 15 minutes a day and endless stock promotions. I spend a lot of time visiting financial sits on the web kicking over rocks in search of ides so it is no surprise that I end up on many of these mailing lists. What is surprising to me is that many of these firms have been in business for some time so apparently people are spending money to become the next Stevie Cohen or George Soros between dinner and dessert.  Folks must be buying those stocks that will benefit from the looming crisis or loading up on those $.10 stocks with breakthrough technology that will change the world.

It must seem silly for me to say this since write for a subscription service but there is a huge difference between advice and hucksterism. The guys and gals on Real Money share their thoughts, ideas and the trades they make with their own money which is light years away from Five Stocks to Buy if the Government Shuts Down , or Six Stocks to Sell If The President Trips On The Way to the Podium.

We need to see a healthy dose of common sense applied when it comes to trading and investing our money. There is no magical system that will make you risk free millions in just minutes a day. When you open the account and decide you will make your living trading stocks or forex in your spare time you are stepping into someone else’s arena and odds are you are mere lunch money. I have done a lot of work on trader survival rates and returns of late and you have a better chance of beating Lebron James in a one on one basketball game than you do of being a consistently profitable trader in your spare time. When I talk to successful traders like Tim Collins, Bob Lang or Bob Bryne they are always working to define and refine their edge. You are up against the best minds armed with the best technology and you have a better chance of earning outsized profits betting a hard 8 every roll at the craps table.

The other area where I see any illusion of common sense thrown out the window is this idea that we can somehow predict where the market is going and book huge profits in the process. Predicting the market sis an absolute waste of time and the lucky ones who get a call right are then usually wrong for the next several dozen predictions. We make stars out of folks like Elaine Garzarelli and the Joe Granville for a lucky coin flip and spent a long time paying for that mistake. The economic, financial and psychological stews that are the financial markets are impossible for anyone to predict with any sustained accuracy.

Big money is made in the stock market by reacting to what the markets do, not in predicting their future movements. If you look at the most successful investors they made their biggest returns by buying when markets were ridiculously undervalued or hopele4ssly overpriced. Investors like Jon Paulson and Michael Burry didn’t sell subprime mortgages because of a chart pattern or trading system. They made billions because they correctly recognized that the securities traded at price will beyond their true value. The markets went against them for a while but they held on until the process inevitably corrected themselves.

Investors like Wilber Ross, Warren Buffett and Howard marks did not get rich by predicting the direction of the stock market. They did it by buying assets they were egregiously undervalued and held them until the market entered another euphoric stage and selling them to over excited traders and investors. They are far more active when the markets are crashing down around our ears and everyone else was panicking. They bought assets and earnings cheaply by acting as the buyer of last resort for scared sellers. They got rich by applying common sense to the markets and waiting for a chance to react rather than predict.

I have no idea what the market will do in a reaction to a government shutdown. I do know that the best way to lose some serious coin here is to try and predict the outcome and the market’s reaction. Common sense tells me that if the markets react negatively we could sell some bargains created. In the long term the shutdown has no real impact on the future of my small bank and cheap stock so I would be foolish to rush to sell.

As investors we need to apply common sense to the markets and quit chasing impossible pipe dreams. Charlie Munger once attributed his success to the fact that he acted rationally when other did not. We need to do the same.

Friday, October 04, 2013

Investing Michigan Style

As I have mentioned in the past I am something of a geek. Once I finished running stock screens and checking the stocks in my portfolio for any important fundamental changes I turned to serving business school websites for interesting new papers or research article that might contain significant information that would help us as investors. I found a few on interest and will report back on them after I have digested them but at the University Of Michigan Webster School Of Business I found something that interested me greatly and should you as well. They are running two portfolios that are posted on the website identifying stocks that are undervalued and another one that lists what they call earnings torpedoes.

Earnings torpedoes are stocks that the students have identified as having the potential to blow up as a result of poor earnings. They use academic theories such as earnings quality, cash flows, momentum and valuation to identify stocks that could be set to sink your portfolio.  I checked through the historical lists they keep on the site and the theory actually worked very well at finding potential disasters and torpedoes underperform the market much of the time. I have mentioned more than few times I am cautious about the markets and sometimes the best way to make money is to lose it so the list is worth a review to see where danger may lurk.
The list is littered with energy related Mater Limited Partnerships (MLPs). Many of these oil and gas collection, transmission and storage partnerships have been bid up to very high levels as a result of strong oil prices and indiscriminate yield seeking by investors. Billions of dollars have flooded into the sector as ETFs and funds were formed to take advantage of the higher yields offered by these vehicles. Some of the better known MLPs that are potential torpedo stocks include Atlas Resource Partners (ARP),Atlas Energy (ATLS),  Cheniere Energy Partners (CQP) and Eagle Rock Energy Partner (EROC). Investors who own these names may want to review their holdings and consider lightening up on the shares.

The list is absolutely dominated by small cap biotech stocks.  50% of the list is biotech’s like ARIAD(ARIA), VIVVUS (VVUS) and  Idenix Pharmaceuticals (IDIX). Biotech has been red hot this year with the industry indexes and ETFs up more than 30% but investors might want to get some money off the table. I have ling maintained that this is an incredibly specialized filed and if you don’t possess, or have an advisor who possesses, a medical degree with a biotech concentration, small biotech’s are a danger zone for individual investors. Using traditional fundamental or technical analysis techniques on these stocks is a game of financial Russian Roulette in my opinion. If you own individual small biotech’s it is worth your time to go the schools website and see if you are hanging on to a potential torpedo stocks.

There are some big market darlings on the list that momentum investors need to be aware of before you take a torpedo amidships to your net worth. has shown up on several of my red flag lists in recent weeks even as the stock has run higher in recent weeks. With a forward earnings estimate multiple of 100 times the slightest disappointment form this company is going to cause an implosion in the share price and all but the most nimble of traders should probably avoid the stock at this level. Zillow (Z) is another trader favorite that has had a nice run as housing markets have recovered somewhat but it is now on the danger list. At more than 150 times estimated profits it would not take much bad news to explode the stock and your portfolio along with it.

It is worth your time to check out the torpedo list on the Webster Business school site. Even if you decide you do not agree with them on certain stocks or sectors it is thought provoking and educational. Next I will take a look at the stocks the students have identified as undervalued and see if we can find any potential gems to buy.

. The folks at University of Michigan Webster School of Business not only has a list of stocks you should avoid they have one that gives you 40 stocks they think are undervalued. They do not reveal exactly which metrics they use but the website says they use Value, Momentum, Quality and Predictability. It is a combination of several of the more successful academic theories and it producers a really interesting list of stocks that might appeal to ling term investors. According to the site the screen has beaten the market handily in 8 of the last 10 years.

It is easy to see that momentum and value are heavily weighted in the 40 stock list as many of them are former deep value stocks where the price has begun to improve. It was no that long ago that basset Furniture traded at a fraction of book value and was wildly out of favor on Wall Street. The company is firing on all cylinders now with three quarters in a row of strong sales growth and the stock is now at a small premium to book value. Insiders have been buying stock outright and exercising options and keeping the stock so that’s another academic theory at work in this stock. The company has plenty of cash and little debt and seems to have put the recession in the rear view window. Basset is doing much better than many other consumer related companies right now.

They have a few little banks as well which comes as no surprise to me at all. I will highlight two from opposite ends of the bank spectrum. Monarch  Financial Holdings (MNRK) is a little bank  with 11 banking offices, 15 residential mortgage offices, and 1 investment services office in the Norfolk /Virginia Beach area. It also operates 2 full-service banking offices and 2 residential mortgage offices in the Outer Banks of North Carolina, as well as 28 additional residential mortgage offices outside of its primary banking market area, The bank is in great shape with  nonperforming assets of .29% of all assets and an equity to assets ratio of more than 10. The stock trades at 1.2 times book value and has momentum on its side with the share up almost 40% this year.

Parke Bancorp (PKBK) is on the other end of the spectrum. The New Jersey bank has 6 offices in in its home state and one if the greater Philadelphia area and about $740 million of assets. The stock is much cheaper than Monarch at 75% of book value and there is a good reason. The loan portfolio is a mess with non-performing loans at more than 7% of total loans and nonperforming assets at a staggering 9% of total assets. They do have excess capital with equity to assets ratio of a little over 13 but asset quality has been slow to improve. This one has more a long shot feel to it but if they do succeed in getting their house in order the upside could be huge.

There are also lots of small insurance stocks on the list including one, Eastern Insurance Holdings (EIHI) that announced a takeover bid yesterday at a pretty big premium. This stock was one of my top picks for 2011 and has more than doubled thanks to the acquisition offer. This is going to be repeated throughout the industry over the next few years as smaller life and property and casualty insurance companies are very cheap compared to historical valuation level. It is worth your time to go to the schools site and run through the insurance picks stock by stock.

For fans of sin stocks Ricks Cabaret (RICK) makes the grade as a University of Michigan cheap stock. The only publicly traded operator of Gentleman’s Clubs. The stock trades at 12 times earnings and 1.27 times book value and business is apparently pretty good. The CEO and CFO like what they see as much as the customers as they have been buyers of the stock over the past few months.

Star Gas (SGU) makes the grade as well as this remains one of my favorite little long term income stocks. The propane company is not going to set anyone’s portfolio on fire but it will continue to roll up Mom and Pop propane dealers and pay a strong dividend. The stock yields 6.75% and is a good fit for most income investors in addition to the schools value stock list.

Tracking the academics makes a lot of sense to me. When they have proven they can outperform and are willing to publish their stock lists as Michigan has it makes even more sense to check the page regularly.