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May 20

Its a Shitty Time to be a Stock Picker

I find picking stocks to be a lot of fun. I run through numbers and sleuth out scenarios and wrap my head around business models, all in an attempt to predict the future and find that golden opportunity. I enjoy making spreadsheets and flow diagrams and all the other tools that I use to figure out how a business works.

There are few things as exhilarating as when you find an oportunity. When you run through a 10-K or an MD&A and the light goes on and you are like, holy crap, hasn’t anyone else figured this out? So you run the numbers again and read through all the releases again and you sit back in your chair and stare at the screen and say to yourself, “this is a gift.”

That’s good stuff and that is what makes the work worthwhile.

What is frustrating is when you do all the work, have confidence in what stocks should work well in the future, and none of it matters.

And that is where we are today.

On Friday I spent a few hours pouring over the Nationstar Mortgage Holding 10-Q filing. The company is a no-brainer. They are going to earn $3+ this year, maybe much more than that. Being a recent IPO offering, the market has only started to realize they exist, and so they trade at $17, when if you ask me they are worth $25+.

Earlier in the week I looked at Xerox. A beaten down situation, trading near the 52-week low, at a multiple of less than 8x forward earnings. Perfect stock to sock away and wait for it to get back into double digits.

This morning I listened to the Atna Resources conference call. They are on target with Pinson. The operational efficiencies they introduced at Briggs have started to pay dividends in the way of lower costs, and I think we will see further cost reductions going forward. The stock is trading at less than 2x what they will cash flow next year once Pinson is up and running.

Three great opportunities. Each would be solid bet.

But because of Europe, I feel foolish to bet too much on anything. I have to get smaller and smaller because no one really knows what is coming next.

I listened and read everything I could find on Europe last week. No one really knows how it will play out. Not Dalio, not Mauldin, not Novogratz, not Coxe, not Saut, and on and on. If you really listen carefully to each of the experts, they all hedge their bets in one way or another.

What do you do?

I raised cash on Wednesday, Thursday and Friday. My current cash level is about 25%. I raised cash by selling out of Gramercy Capital Corp and Bank of Commerce Holdings, reducing my position in Pan Orient Resources and Equal Energy (finally succumbing to the philosophy of doing less of what isn’t working), and taking 10-15% haircuts from most of the other stocks in my portfolio, including PHH Corp, Newcastle Investments, Atna Resources, and Golden Standard.

I hated to do it. The market right now is very oversold. The Dow has been down 12 out of 13 days. One would expect a market rally here at some point. Greece is still over a month off and its hard to imagine we only go down from here to there. Still, many of the stocks I own had held up well, had not yet broken down, and so I felt the necessity to act while I could. As I wrote on Thursday, the Novogratz interview spooked me into action. As it turns out, I was barely able to lighten up before the bottom began to fall out of stocks like PHH Corp and Newcastle.

The only stock I have not sold any of is Nationstar Mortgage Holding. I am watching it carefully. It has a lot of strength, and I think it may be under accumulation by larger funds. Being a recent IPO, its underweighted by everyone.

But even with Nationstar, I make no promises that I will continue to hold my position at its current size. In this environment I have to protect capital. You have to live to fight another days.

Its helpful to review this quote from Peter Berstein, during times like this:

After 28 years at this post, and 22 years before this in money management, I can sum up whatever wisdom I have accumulated this way: The trick is not to be the hottest stock-picker, the winning forecaster, or the developer of the neatest model; such victories are transient. The trick is to survive. Performing that trick requires a strong stomach for being wrong, because we are all going to be wrong more often than we expect. The future is not ours to know. But it helps to know that being wrong is inevitable and normal, not some terrible tragedy, not some awful failing in reasoning, not even bad luck in most instances. Being wrong comes with the franchise of an activity whose outcome depends on an unknown future (maybe the real trick is persuading clients of that inexorable truth). Look around at the long-term survivors at this business and think of the much larger number of colorful characters who were once in the headlines, but who have since disappeared from the scene.

There will be stocks to pick on another day.

May 18

A Light Goes On (understanding why Greece matters again)

I’m can be slow to understand the implications of things. I don’t immediately see what in retrospect should be obvious. Instead I have to get people to spell things out for me before I get it.

I think this is partially a consequence of not being able to spend as much time thinking about the world as I need to. I have a job, I have a family and so I really don’t get a chance to sit down and work out all the potential impacts on a regular basis.

I’ve been looking at some private equity stocks lately, trying to understand them better and determine whether they are buys. As part of this research I stumbled upon a market commentary from Michael Novogratz, a principle at Fortress Investment Group. He crystallized for me why we are seeing the carnage we are in the markets (you have to wait until about 4 minutes in).

The key moment in the interview for me was when Novogratz spelled out that the Greek election was a game changer. If Greece leaves the Euro it is, in his words, a Lehman moment. If they leave, we don’t know for sure who owes who what or whether they can pay it back or if the assets and liabilities of any particular entity are going to balance out. Novogratz is saying that Greece could breed the sort of counter-party uncertainty that could cause credit markets to seize.

That’s when I suddenly got it. Its not that anyone can say with certainty that its going to end well or end badly. Novogratz himself said that the ECB and the Europeans governments have been preparing for a Greek exit for months. Its possible that they have worked out all the contingencies. But at the end of the day no one really knows. If Greece leaves it all goes out the window. You are really just guessing to bet what happens next.

Just to throw out some of the uncertainties, there is the effect of funds and banks with mixed liabilities of Euro’s and Drachmas’. There are the TARGET2 balances between Greece and other Eurozone countries that now become debt. There is the strange consequence that a Greek exit destroys all the capital of the ECB. There are the cross-border balances of companies that trade across the Eurozone. There is the deep recession in Greece that results. There is the investor response to Portugal, Italy and Spain sovereign debt. There are simply a lot of moving parts and it is perhaps impossible to estimate how they all play out.

It has the same flavour of uncertainty as Lehman did. And one thing that I learned from Lehman is that the decision makers know far less about the consequences then I thought they did. They aren’t that much smarter than the rest of us. Nobody knew what was going to happen when they let Lehman go until stuff started to happen after they let it go. I think its the same thing with Greece.

Today I raised 20% cash. I just sold a bit of everything, and I sold all of Gramercy Capital (GKK) because I wasn’t sure about it anyways. It helped that gold stocks rallied. It hurt that PHH and Newcastle had bad days. Maybe this is a terrible time for it. We could rally because we are so oversold. But I feel like I have no choice. Now that it makes sense to me it seems like too much risk. I want to get back to at least 50% cash by the Greek election or until there is a resolution that makes it clear Greece is staying.

May 15

Was this why Atna was down yesterday?

In the last few months I have sold off most of my gold holdings, but I decided to stick it out with Atna Resources. That hasn’t looked like a terribly good decision these last couple of days, as the stock has been clobbered down to well below a buck.

Yesterday I looked at the stock thirty minutes before the market closed. It was at 94 cents. I was rather shocked to see later on that it had closed at 84 cents.

It being an earnings release day, I had already scoured the news release and determined it looked mostly benign. However I also know that Canadian regulations call for a filing of the Management Discussion and Analysis report on Sedar. The thing about Sedar is that these reports become available to paying subscribers a little bit before they do for the general public. When I saw the stock drop I wondered whether there was something in the MD&A that insited it.

This morning the MD&A was made publically available. Though I don’t think it is worthy of a 10% drop, I suspect that the following may have contributed to the drop:

The principal requirement within the next 12 months is expected to be funding development of the Pinson underground mine at a cost of $18 to $22 million. This range of costs is likely to increase when a new Technical Report is completed. Atna is considering additional sources of financing to address any potential contingent risk of having inadequate capital to complete the Pinson underground development in 2012, possibly to accelerate the development of Reward, and to ensure funding for the aforementioned projects.

Normally this might be seen as being fairly benign. In the current environment, where even good news is sold and investors are skittish that all gold stocks will soon be worthless, it carries a particular bite.

I always have known that Atna is skating on relatively thin ice with respect to the development costs of Pinson and the available cash on hand. The current report merely confirms that. I have to suspect that the reason the company has not released the technical report on Pinson (that they had originally said would be released at the beginning of May) is because they are trying to line up some financing to give the wiggle room they need. With the current share price depressed, I hope the financing is of the debt sort.

However before I concede yesterdays losses to this buried nugget of coal, it must be said that most gold stocks were down significantly. In fact it looked like a day where the larger institutions were throwing in the towel, with companies like Detour Gold and Osisko Mining down more than 10%.

It simply is a terribly time to own any gold stock. I had thought that the growth profile of Atna might overcome that gravity. Unfortunately that has not been the case.

The good news is that Atna is back to a level where it has completely unpriced Pinson from the share price. In other words, how much lower could it possibly go? You also have to wonder whether there are intermediates looking at the company. A company like Aurizon for example, with $200M in cash, could buy Atna, develop Pinson and have a growth platform for the future, all of which could likely be had for less than what they have in the bank.

I remain committed to my shares. The company has the potential to generate cash flow from Reward and Pinson next year that will match or exceed the current share price. Its too bad that the company hasn’t been a bit more prudent in managing cash levels and taking advantage of the $1.50 share price to raise a buffer of cash but that is what it is. The stock, like so many gold stocks, remains deeply depressed and it seems foolish to me to sell my shares at these levels.

May 14

Week 45: The Trouble with Value Traps

Portfolio Performance

Portfolio Composition:

Trades

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.