Week 45: The Trouble with Value Traps
Where are the gains?
What is really frustrating about my portfolio performance is how well I have done on individual stocks while making so little money overall. Its been such a wasted opportunity.
Here is a short list of some of my winners since the beginning of this year:
The obvious question that occured to me was how is it that these stocks that make up a substantial part of my portfolio (PHH Corp and Newcastle are two of my three largest holdings) can be up an average of 42% and my portfolio as a whole is only up about 10% since the beginning of the year.
When I went back through the history of my performance for the year so far it became clear that really, most of the problems are the result of two mistakes.
- I bought the stocks of two oil companies and oil company stocks have been pummelled
- I compounded that mistake by averaging down in each case
Averaging down is such a dangerous game. In the long run it can work out for you at times, but at other times it can really stick you into some tough spots. I averaged down on Equal Energy, which I originally bought at $5.50, when it got to $4.00. It proceeds to go down to $3.00 before finally recovering recently to $3.40 where I have perhaps compounded my potential for a mistake by averaging down again.
I also averaged down on Pan Orient. I bought an initial position in Pan Orient at $4.00. The stock collapsed on poor results in Thailand and I averaged down at $2.75. The stock is now $2.30.
Averaging down is the symptom, but the cause that underlies both of these situations is that both are value traps. Both stocks are really quite cheap. Of course they were really quite cheap when I initially bought them and they were really quite cheap when I averaged down. They just got cheaper. In the case of Pan Orient, the company has $1 per share of cash on hand, is able to generate $1 per share of cash from their current level of oil production, and have some upside to be realized from the new discoveries in Thailand. In the case of Equal, they generated $2 per share of cash flow last year and continued that trend in the first quarter by generating another 50 cents. At $3 they are trading at 1.5x their cash flow generation.
The problem is that the wisdom or folly of averaging down is not a clear cut case. If I look back on the times that I have been trapped by value, I can name just as many cases where I ended up a big winner as I can cases where the value was never realized. I sat underwater some 40% with Tembec at one point before the market recognized the turn in the pulp cycle and the stock tripled from where I bought it. Had I not doubled down with Western Canadian Coal in early 2009 I would never had had the truly phenomenal gains that came from the stock going from 50 cents to nearly 10 dollars. To site a recent example, I tripled my position in Community Bankers Trust when the stock hit $1, which was down 30% from my original $1.30 purchase. Now its $2.25.
I appreciate the wisdom of the Gartman axoim that you should never add to a losing position. And in many cases I follow this axoim and I walk away from a stock simply because its not working out. But there are cases where the value appears to me to be so clear that to walk away from it just because the market acknowledges even less seems foolish. Such is the case right now with Equal and Pan Orient. The same sort of scenario could quite easily be in the process of developing with Atna.
So what do you do? What I do is I sit down every weekend or two and review these two holdings and the thesis behind them and generally I end up drawing the same conclusion that I originally did. In the cases of Equal and Pan Orient I remain convinced that both stocks have to trade higher at some point. So I hold and wait. And I hope that Europe doesn’t completely implode in the mean time (see my last post on cat and mouse).
Out of Shore Bancshares
I sold out of Shore Bancshares on Friday as I warned that I might. Here is a case of a stock just not working out the way I anticipated. Over the long run the bank is probably going to be just fine, but as I have already pointed out the non-performing assets are not trending down and so it is perhaps going to be a while before the market gives shore the “just fine” green light. In the mean time I have been looking at some other names that are perhaps better banks to be in right now.
Out of Atlantic Coast Financial
I really wanted to hold onto my small position of Atlantic Coast Financial. Its a lottery ticket to be sure, but its not very often you find a bank with a book value of almost $20 per share trading at a share price of $2. Nevertheless, when I read the news earlier this week that the Chairman of the Board was resigning from his position because he felt the board and management were not working hard enough to put the bank back on its feet, I felt I had no choice but to sell. I was somewhat surprised that the fall out since then has been minimal. The stock is essentially trading at the same price it was at the time of the announcement. That may actually be the best sign the company has given that they are turning around. It remains on my radar screen, and on my google alerts.
Maybe not a Gold Stock reversal
I thought that we had a classic reversal in gold stocks on Wednesday. But now, not so much. As I pointed out at the time, I am not a technical trader and generally pay no attention to such things and perhaps I should continue in that vein rather than trying to pick points that clearly aren’t working out.
I wouldn’t say that my theory that Wednesday was the gold stock bottom is dead, but its certainly on life support. I sold some Golden Minerals that I had bought and in an account I don’t track here I sold the Newmont I had added.