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SINLetter – July 2010
Welcome to edition 53 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.
It has been an interesting few months and I took a short unannounced hiatus from publishing these newsletters to concentrate on a few things including a new blog category called Insider Weekends, another blog series called Merger Arbitrage Mondays and its accompanying Merger Arbitrage Tool, and building a quant model that assigns a score to individual stocks based on 16 different criteria. This model will be eventually used for automated algorithm based trading. In case you don’t subscribe to the blog and were not aware of these new features, check out the following blog posts that explain them in more detail. I have also included a few other noteworthy posts from the last couple of months.
- Special Reports 5: Going Bananas and the Short Case for AIMCO (AIV) (subscription required)
- Special Report Update: Coca-cola Enterprises (CCE) (subscription required)
If you do not receive blog entries by email, you can subscribe to receive them by email here.
The SINLetter model portfolio outperformed all the major indices in the first quarter of 2010 with a gain of 7.06% but the second quarter was not so kind to us. For the month of June, the SINLetter model portfolio posted a loss of 4.61%, marginally worse than the Dow’s 3.58% loss but much better than the 6.55% drop in the Nasdaq. The S&P 500 posted a loss of 5.39% as you can see below. On a year-to-date basis, we are still outperforming all the indices, albeit with a smaller loss. I plan on making significant changes to the portfolio as discussed in the Portfolio Readjustment section below that may help stem these losses and may even help us close the year in positive territory.
|Performance Metric||Dow||S&P 500||Nasdaq||SINLetter|
|Second Quarter 2010||-9.97%||-12.04%||-11.86%||-10.84%|
|Since Inception (Aug 2005)||-7.99%||-16.57%||-3.92%||88.35%|
At the start of the second quarter I wrote the following words in the April newsletter “I think the market has once again forgotten about risk and is becoming complacent. My enthusiasm for new stock positions is very low at the moment and besides holding on to the positions I already have on the long side, I am mostly looking at merger arbitrage opportunities and refining a strategy with strangles”.
Had I heeded my own advice and sold some of the positions from the model portfolio, I may have mitigated some of the losses we experienced in the second quarter. My opinion has not changed much over the last three months and I still think the downside risk is greater than upside potential in this market. A number of economic indicators, from the June unemployment report last Friday that showed a 125,000 decline in non-farm payrolls to the weaker than expected data from the ISM that showed manufacturing activity sliding to 56.2 in June from a reading of 59.7 in May, are pointing to a slowdown ahead. On the other hand, I am also seeing a lot of companies trading at very attractive valuations irrespective of the criteria you pick to analyze these companies. In anticipation of additional declines in the market, I am going to sell a number of positions in the SINLetter model portfolio in order to increase the cash portion of the portfolio and to create room for some new positions.
The companies I am going to sell from the model portfolio include Precision Castparts (PCP) for a gain of 114%, Companhia Siderurgica Nacional (SID) for a loss of 26%, PowerShares Water Resources ETF (PHO) for a loss of 30%, Unilever (UL) for a loss of 14%, Icon Plc (ICLR) for a gain of 45%, Alvarion (ALVR) for a loss of 74% and Suntech Power (STP) for a loss of 58%. We sold nearly 40% of our original position in Suntech Power back in November 2007 for a gain of 151% as discussed in the blog entry Scaling Back on Suntech Power (STP) and essentially ended up with a profit of 20.62% for the overall position. Looking back at what happened to oil prices and the high correlation between solar stocks and oil prices, I should have liquidated the entire position back in 2007. The closing price of the day on July 9, 2010 will be used as the selling price for these positions.
If you are familiar with book value, feel free to skip the next four paragraphs to the section about Umpqua Holdings (UMPQ) and Marcus (MCS).
Investors often have preferred valuation metrics that they look at to get the feel for a company before digging in for further research. One could compare this with a lender looking at your FICO score before requesting additional supporting documentation to see if you would qualify for a loan. One such metric I tend to use is the Book Value of a company. In very simple terms the book value is the sum of all assets of the company minus the liabilities. In more personal terms, book value could be compared to an individual’s net worth. To figure out your net worth, you would add up all your assets including your home, your car, your cash, your jewelry, etc and then subtract your liabilities such as credit card debt, student loans, the remaining loan amount on your home, the loan on your car if you financed it, etc. What is left over after you subtract your liabilities from your assets is your net worth. Similarly for companies when you add all the assets on the balance sheet (cash, investments, inventory, accounts receivables, etc.) and subtract the liabilities (debt, accounts payables), you get the book value.
While you could go through each line on the balance sheet and calculate the book value of a company, websites like Yahoo Finance and Reuters provide this information to you either as “Book value per share” or as the Price/Book ratio. If the company has a book value of $100 million and has 20 million shares outstanding, the book value per share would be 100/20 = $5. If the stock of that company is trading at $10, the Price/Book ratio will be $10/$5 = 2. Essentially you are paying 2 times the book value of the company when you purchase those shares for $10. If the stock of the company were to fall precipitously to $4, you would be paying less than the book value for the stock, as the Price/Book ratio will drop to 0.8. This may appear to be a great bargain because you are buying the business at less than the liquidation value of the company.
However just as you are relishing the thought of picking up a business for 80 cents on the dollar, you should keep in mind that the book value you see on Yahoo Finance also happens to include intangible assets. Wikipedia defines intangible assets as “identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset. There are two primary forms of intangibles – legal intangibles (such as trade secrets (e.g., customer lists), copyrights, patents, trademarks, and goodwill) and competitive intangibles (such as knowledge activities (know-how, knowledge), collaboration activities, leverage activities, and structural activities).” This presents a problem as you may not recover your investment if the company were to be liquidated and its intangible assets were substantial. Removing intangible assets from your calculation of book value will give you Tangible Book Value, which is a more useful metric. Once again, you can get the Price/Tangible Book Value ratio directly from Reuters without having to calculate it from the balance sheet.
It is important to keep in mind that companies that are selling below tangible book value are usually in trouble of some sort because the market is valuing those companies below their liquidation value and essentially assigning no value whatsoever to its ongoing business. These companies are usually unprofitable and it makes sense that the market is anticipating that the company will eventually burn through its liquid assets like cash, thereby reducing its book value.
Umpqua Holdings (UMPQ) $11.95
We have covered Oregon based regional bank Umpqua Holdings a number of times in the past including the April 2010 newsletter with its focus on regional banks as well as in a section of the February 2008 newsletter titled Umpqua Holdings: Can the free cookies last?. Following the April newsletter, I decided to keep Umpqua on our watch list instead of adding it to our portfolio due to the bleak macro environment but now think it is time to consider starting a position in the company.
Three events have transpired over the last three months that have made me look at Umpqua once again. The FDIC once again picked this Pacific Northwest bank to acquire the assets of Reno based Nevada Security Bank when the bank failed in mid-June, making this the third FDIC assisted acquisition for Umpqua this year. After taking over $492 million in assets and $480 million in deposits from Nevada Security Bank, Umpqua’s total assets have now increased to almost $11 billion.
Umpqua’s Troubled Asset Ratio or TAR has fallen to 20.1 from 23.1 even as the national median has gone up from 14.5 to 15. Finally Umpqua’s stock has dropped more than 9% from $13.14 in April to its current price of $11.95 and was much lower earlier this week before the sharp two day rally we just experienced. At current prices, the bank is trading at a Price/Book ratio of 0.79. The Price/Tangible Book Ratio according to Reuters is 1.39. Given this increase in assets, drop in TAR and drop in price, I think it is time to once again initiate a long-term position in Umpqua. I will be purchasing 1,000 shares of Umpqua for the SINLetter Model Portfolio. The closing price of the day on June 9 will be used as the purchase price. I will also purchase Umpqua for my personal portfolio after this newsletter goes out to subscribers.
Marcus (MCS) $9.02
Marcus is yet another stock that we have featured in the newsletters and SINLetter blog numerous times. If you are not familiar with this small-cap movie theater and hotel operator, check out this February 2010 blog entry titled Marcus Revisited: The Avatar Effect, which led us to picking the stock up when it had dropped below book value. We sold the stock less than a month later from the Special Reports Portfolio for a gain of 14% when the stock rose above book value.
With the recent market slump the stock has once again fallen below book value and currently trades at a Price/Book ratio of 0.80 and a Price/Tangible Book Ratio of just 0.93. Marcus is a profitable company with a dividend yield of 3.9%. Having written off its investment in an ill-timed Las Vegas condo development, the key risk the company faces is continued softness in its hotels segment. The movie theater business has held up well and has supported the overall company even as the hotels division has suffered through this downturn. I am going to purchase 1,000 shares of Marcus for the SINLetter Model Portfolio. The closing price of the day on July 9 will be used as the purchase price.
Voluntary Disclosure: I am long Marcus in my personal portfolio.
|Stock||Symbol||Number of Shares*||Cost||Current Value||Diff ($)||Diff (%)||Date Added|
|Chicago Bridge & Iron||CBIemail@example.com||$10,585||$9,405||$-1,180||-11.15%||1/05/10|
|Companhia Siderurgica Nacional||SIDfirstname.lastname@example.org||$8,630||$5,876||$-2,754||-31.91%||04/30/08|
|Powershares Water Resources||PHOemail@example.com||$8,840||$6,024||$-2,816||-31.86%||10/31/07|
|Procter & Gamble||PGfirstname.lastname@example.org||$10,008||$10,796||$788||7.88%||06/30/06|
Voluntary Disclosure: From the stocks that are currently in the model portfolio, I own shares of Chicago Bridge & Iron (CBI), Empolyers Holdings (EIG), Safeway (SWY), Activision Blizzard (ATVI), Lionsgate Entertainment (LGF), PowerShares Water Resources (PHO), Suntech Power (STP), Teva (TEVA), Alvarion (ALVR) and Unilever (UL).
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