Week 115: On Purges and Renaissance

Portfolio Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades.

Recent Developments

I ended the month on a high note, at a new all-time high after gains this week from Gastar, Tronox, and Entrec, and notable gains over the last month from Axia, Novus, Ainsworth, Equal and Monarch Financial.

Gastar’s rise took place after the company announced a major asset purchase in the Hunton I wasn’t as enthused about the purchase as the market because I didn’t see the purchase price, which worked out to a little under $100,000 per flowing boe, as particularly cheap, but I understand that the move further consolidates Gastar’s position in the Hunton, and that the news that the company’s fifth well was producing 160 bopd on 1/3 of the well lateral was another positive datapoint to the field’s potential.

In the case of Tronox, apparently there is some speculation that Huntsman may be about to make a play on the company. This was reported on SeekingAlpha.

I’m not really sure what drove the share price of Entrec on Friday though I think its more of a sector move. The stock had been floating down on low volume for a couple of weeks. It was anything but low volume on the move up on Friday, trading over 1.6 million shares.

The Purge

The recent good times were preceded by bad. In my last portfolio update I talked about how things weren’t working and how when that happens I had no choice but to sell. I also warned that if my portfolio continued to flounder, I would sell more. True to my word, within the next couple of days I found myself further down, and in response I sold out of a number of positions. In the following two weeks I exited Lin Media, PennyMac Mortgage, Vitran, Institutional Financial, Niko (which I will discuss more below) and Ambac, and also cut my positions in Arbor Realty and IDT Corp (I did however buy back what I sold in IDT after news of the Fabrix spin-off).

A lot of these deletions were done on August 19th, it being kind of a day of purging that is typical for me. I can be an extremely patient investor when things are working out, but I have no patience for being wrong. I believe that two of the great advantages of being an individual investor are that I can be in and out of most names with little or no market reaction and that I answer to no one but myself. I take advantage of these

The Renaissance

I cannot tell you the number of times that such purging has been followed by an appreciation of my portfolio. I’m not really sure if you can reason out the cause and effect relationship, I mean the specific circumstances that led to the sale of OpenNet and extension of the Supernet contract by Axia NetMedia, a SeekingAlpha pump of Monarch Financial, a takeover of Novus, a takeover of Ainsworth Lumber, a break-out of Gastar on news of asset purchases in the Hunton, a raised bid on Equal by Montclair and a takeover rumor on Tronox have absolutely nothing to do with any of the stocks I sold. Nevertheless…. It is utterly uncanny how much this sort of thing happens. If I were to extend myself to make an unverifiable observation, I would suggest that you are rewarded for doing the right thing. There is a lesson from Napolean Hill there somewhere.

A few Adds that I will talk about later

Most of the stocks that I added in the last month have already been discussed in prior posts. However there are three that I haven’t gotten around to talking about yet, and so I just want to make note of them here. I added starter positions in Radcom (RDCM), DSP Group (DSPG) and G Willi Foods (WILC) at various times in the last month. I would refer you to the tweets I’ve made about each name for some of the background. I will try to get around to saying more about each name in the coming couple of weeks.

My Mistakes with Niko Resources

Every once in a while I make a really bad decision. Usually this comes after a particularly good stretch because of overconfidence. And usually the situation arises in part because of a flaw in the idea, and in part because of my reaction to it.

Such is the case study of Niko Resources (NKO.to), which I want to spend a few minutes on here. Below is the trading history from my practice account that I track on this blog. My actual trades of the stock followed the pattern shown here is fairly close fashion.

At the beginning of June I took a small initial position in Niko, which reflected the uncertainty of the balance sheet and the possibility that the gas price decision (for domestic contracts in India beginning in April 2014) would be unfavourable, but that allowed me to participate if the decision was favorable. The position was a little over 1%, which is actually a little on the small side for me.

When the first news came out that the gas price was going to be set based on a formula which would likely mean $8.40/mcf for Niko (around June 27th), I added to my position, making it about 4%. When that news was confirmed by the government (July 4th), I added again, making it about a 5.5% position.

So far, every move that I had made was reasonably consistent with the methodology I try to follow. Start small with a thesis in mind, watch developments closely, and wait for confirmation in the news and/or in the stock price. When evidence arises to suggest that I am on the right track, add to that position.

It was the gap between my last purchase (July 4th), and my first sale (July 29th), where I made my errors. During this time there was news that could be clearly interpreted as negative; that the previously agreed upon gas price was being contested by some elements of government. First there were negative comments asking for further review from one of the opposition parties, then there were similar comments from the Finance Minister, then the case was made to bring the matter to the Supreme Court, who agreed to review the decision in September.

All of this evidence should have caused me to reduce my position. Not sell it entirely, because much of what was being said was circumstantial or political, and therefore the outcome was not necessarily going to be negative, but it was nevertheless increasing the uncertainty beyond that with which I had established my position, and thus it should have been reduced to reflect this.

Unfortunately I didn’t do this. At least I didn’t until I had to, when I was about to pass the 20% loss threshold at which I always sell. I followed this up with further selling once I was down 25%, and a capitulation at a little under $5. In between, as you can see, there was quite a bit of flip-flopping, buying back to sell later that day and the like. This just demonstrates the degree to which I had become emotionally involved in the stock, that I could not easily part with it.

At the end of it all, I racked up a 34% loss on the position, which works out to about a 1.5% drawdown on my portfolio. It’s a set-back. But it’s also a good, if not expensive, lesson to be reminded of. First, I have to act upon the facts and the uncertainty they suggest. My reaction to the negative developments in the gas price was “it will likely all end up ok”. That may be a valid statement, but if getting from here to there is going to take you through unacceptable volatility, it’s irrelevant. My reaction should have been, “this isn’t what I signed up for”, followed by a commensurate reduction of risk.

Second, I have to really watch becoming emotionally attached to a position. To say that another way: I can’t allow myself to really want to be right. The streets are littered with the empty wallets of investors who held on because they just knew that they would eventually be proven right. I’ve done a really good job of this over the last couple of years, I showed no remorse in dumping oil stocks, gold stocks, mortgage originators, and REITs on various occasions when the idea appeared to be going south. But I did a poor job of it with Niko. I saw the opportunity for a big score and I was riding on the heels of some pretty impressive past months performance, and so I held on a conviction that was being betrayed by the evidence. You just can’t do that. Not if your goal is to actually make money, and not just to get airtime or sell subscriptions.

Portfolio Composition

Click here for the last four weeks of trades.