JTX Follow-up

I previously posted on Jackson Hewitt (JTX) here: http://mevsemt.blogspot.com/search/label/zCurrent%20Holding%3A%20JTX%20Options.

Basically, my thesis was this tax season would either make or break JTX, and this would largely be driven by whether JTX could find a partner to fund their RAL (Refund Anticipation Loan) product.  Further, I knew JTX would need to have their RAL funding lined up before the end of the year, so IMO this made Jan 2011 $2 call options the way to go.  Basically, I likened this to betting on a coin flip where the payout is better than 1:1 (maybe much better).

So here's where we stand: JTX has lined up 90% of its RAL funding and things are looking up.  As a result JTX stock has gone from < $1 at the beginning of December to $1.71 today.  Now the stock needs to go above $2 for me to make any money, but I'm cautiously optimistic this could happen... wish me luck!

PS - this was a very small (and speculative) investment on my part, so it'll really need to pay off big to have a significant impact on my portfolio.  Nonetheless, it's fun to watch!

* As a bit of house keeping I've decided to turn off the "Comments" feature on my blog.  The reason for this is I'd like to try corresponding with my readers more directly - so, if you have any questions/comments/insights/disagreements (especially disagreements as I always like to hear why I might be wrong) about this or another investment please email me directly at mevsemt@gmail.com.

More Sears LEAPS... In Eddie we trust...

On Friday I purchased an additional 10 contracts of SHLD Jan 2013 $95 call options for $4.45 for a total outlay of $4,462.  I really hope Bruce Berkowitz* is right and (1) Sears is indeed cheap and/or (2) Eddie has something up his sleeve. 

* Bruce Berkowitz manages the Fairholme Fund, he was awarded Morningstar's domestic manager of the decade, and most importantly the Fairholme Fund is the largest single investment in my IRA(s).

** As a bit of house keeping I've decided to turn off the "Comments" feature on my blog.  The reason for this is I'd like to try corresponding with my readers more directly - so, if you have any questions/comments/insights/disagreements (especially disagreements as I always like to hear why I might be wrong) about this or another investment please email me directly at mevsemt@gmail.com.

SVU Analysis

Earlier this week I purchased SVU 2013 LEAPS with a strike price of $15, so I thought I'd follow up with a quick discussion on why I think this could be an attractive opportunity.

1. SVU is very highly leveraged.  As someone who comes from private equity, I'd say I have a healthy appreciation for how leverage can help OR hurt an investment.  For more on the "LBO" nature of SVU, check out this link: http://www.barelkarsan.com/2010/12/supervalu-leveraged-buy-out-for-retail.html
2. SVU is cheap on both an absolute and relative basis.  Granted, it's trading at low multiples because it's highly leveraged (creating increased risk of permanent capital loss) and operationally it's inferior to its peer group.  Read this link for an interesting comparison of SVU and Whole Foods (WFMI), http://seekingalpha.com/article/241435-supervalu-may-soon-have-its-day
3. A new CEO (Craig Herkert) was brought on to turn the company around.  Additionally, he's made it a priority to deleverage the company, nearly tripling the rate of debt repayment from a combination of increasing free cash flow and selling assets.  Here's another link with a general discussion of SVU as well as some more detail on Mr. Herkert, http://seekingalpha.com/article/242200-supervalu-should-reward-patient-investors-with-substantial-upside?source=yahoo

For illustrative purposes I put together a quick and dirty scenario analysis (click to enlarge) with all numbers taken from yahoo finance.  Since the options I purchased expire in 2 years I wanted my analysis to focus what SVU might look like then.

As you can see the key drivers here are debt repayment, EBITDA growth (or in this case shrinkage), and the EV/EBITDA trading multiple.  The next step was to figure out what strike price I wanted on my options, so to figure that out I've put together a simple tool that shows what a $1,000 investment will look like if the stock  is trading at various prices at expiration (click to enlarge).

* Lastly, as a bit of house keeping I've decided to turn off the "Comments" feature on my blog.  The reason for this is I'd like to try corresponding with my readers (I think I'm up to 5) more directly - so, if you have any questions/comments/insights/disagreements (especially disagreements as I always like to hear why I might be wrong) about this or another investment please email me directly at mevsemt@gmail.com.

SVU Part 2

I rounded out my SVU Jan 2013 $15 call options by purchasing an additional 42 contracts at $0.50 this morning, which now gives me a total of 75 contracts.  I hope to post my SVU analysis this weekend, stay tuned...

Super Valu?

Yesterday I placed a limit order (at $0.50) for 100 contracts of Jan 2013 $15 call options of SVU.  Unfortunately, with a limit of 50 cents my order was only partially executed - I now own 32 contracts which cost me $1,625 (including commissions). 

Over the coming days/weeks I'm going to try to buy the additional 68 contracts, but I'm not willing to pay too much more than $0.50, so who knows if I'll be able to do so.  Once/if this becomes a full position I'll do a more detailed write up on why I like this opportunity, but in the mean time wish me luck.

Transaction Alert, Sears Holdings 2013 Call Options

Sears is a difficult company to analyze IMO, and as result any fair value estimate I can come up with has a huge amount of uncertainty.  So, instead of spinning my wheels trying to value the company, I'll group my thoughts into 3 buckets and see if I can back into a non-valuation-centric investment thesis:

A. What do I KNOW?

1. Sears Holdings is controlled by Eddie Lampert (who is a legend in the world of value investing) through his hedge fund, ESL.  Mr. Lampert started ESL in 1988 at the ripe old age of 26, since then his returns have averaged somewhere between 25% to 30% returns per year... wow. 
2. Eddie's reputation, financial track record, and personal wealth are all heavily dependant on the success of Sears Holdings as an investment (SH represents something like +40% of ESL's portfolio).
3. SH's retail operations have thrown off considerable cash since Eddie took control in 2004, the vast majority of which has gone to share repurchases.  In fact, over the last three years SH has bought back almost $2B worth of shares at an average price around $77 (this is significant considering SH has a market cap around $7B)
4. SH has an interesting collection of assets including owned real estate, real estate controlled through ultra long term leases, a portfolio of brands (Craftsmen, Kenmore, Lands End, and DieHard), and a 90% stake in Sears Canada.

B. What do I THINK?

1. Eddie thinks the stock is significantly undervalued, which is why he's so aggressive with share buybacks (i.e. there's a ton of things he could've done with the cash like pay a dividend, modernize stores, acquire other companies, etc., BUT he has choosen to repurchase shares time and time again)
2. Eddie probably bought SH with the idea of turning around the retail operations, however my guess is several years ago he determined this would not generate the best returns.  As a result the retail operations are essentially in run-off with the goal of maximizing cash flow.
3. There is huge uncertainty over the value of SH's assets; and for shareholders this value is heavily dependent on HOW and WHEN these assets are monetized.  IMO the value of these assets could be quite a bit higher than the current EV of $9B.  For instance, the owned real estate of only the retail operations could easily be worth more than $4B (http://www.manualofideas.com/files/shld_moi_20081223.pdf). 
4. SH has already begun it's transformation from a retail company into something else.  For example, DieHard and Craftsmen are already being sold at non-Sears/Kmart stores and real estate is starting to be monetized (http://www.shcrealty.com/).  Additionally, SH is in the middle of a massive effort to beef up their online presence.  Given that SH's free cash flow is quickly dwindling, this transformation could happen sooner than most people expect.

What could go wrong?

1. Eddie could make a capital allocation or strategic mistake.  Truthfully there's a lot that could go wrong here - maybe the share buybacks were a mistake, maybe he'll try to revitalize the retail operations and be unsuccessful - just because Eddie has a lot riding on SH doesn't guarantee success.
2. Maybe Eddie is already looking for a way out - one of the worst things that could happen IMO is to wake up one day and see the press release "ESL sells stake in SH."
3. I could be flat out wrong.  The truth is my investment thesis is a lot of conjecture based around circumstantial evidence.  Additionally, I do not have any special insight into the value of SH's assets.  I think they're worth more than the current EV, and SH's share buybacks support this position, but that doesn't make it so...

Based on the 3 buckets above I'm actually more comfortable buying SHLD LEAPS, so today I purchased Jan 2013 $95 call options (10 contracts at $4.85).  Basically, I think something either really good or really bad is going to happen, and my guess is we'll find out what it is before the LEAPS expire in 2 years.  BTW, so you don't have to do the math, these 10 contracts (including commissions) cost $4,861.  At expiration, with SHLD trading at $95 these options will be worth $0, at $150 they'll be worth $55K, at $200 they'll be worth $105K... talk about an asymmetrical risk/reward!

PS: I've previously owned SHLD; in Feb 2008 I purchased 52 shares at $97, in June I purchased 28 shares at $82, in Sept I sold 15 shares at $105, in Oct I purchased 20 shares at $48, in Nov I purchased 30 shares at $34, in Feb 2009 I purchased 35 shares at $37, and then finally I sold out all 150 shares in March 2010 at $107.

Just Sold MYGN

Today I sold all my shares (650) of MYGN at a price of $21.25.  Initially I hesitated to do this for several reasons, the main one being that I think the stock is still undervalued (I think it's probably worth somewhere in the high 20's). 

However, the stock does have several things going against it.  First, there's been no insider or guru buying.  Second, while it's trading at a discount to my fair value estimate, there are a handful of other opportunities that I think are much more compelling.  Lastly, I try to be opportunistic when I buy and sell stock, and I think selling MYGN after the recent (and steap) run-up is consistent with this goal. 

Overall I'm quite happy with the way things worked out - I purchased MYGN in July for $15.05 and sold today for $21.25, giving me an IRR of 158%.  Now if only the rest of my portfolio was doing this well...

Adding to TTT... again.

See my previous post...

This time I added 360 shares at a price of $7.85, bringing my total share count to 2268. 

Adding to TTT...

On a whim today I purchased an additional 270 shares of TTT at $7.82.  The more I think about TTT, the more I think it's like LUK - basically a company run by a shred/talented capital allocator who is focused on creating shareholder wealth by compounding book value.  With these types of companies I'd prefer for the position size to be more than 10% of my portfolio, and with TTT spinning off one share of KHDHF for every 9 shares I wanted my position to be comfortably above the 10% threshold post spinoff. 

On a side note this puts my cash position at only $23K, which feels low and makes me a little nervous given the markets recent run-up. 

My Returns as of Oct. 12th 2010

When I posted my returns at the end of Q3 one reader correctly pointed out that I wasn't showing my cost basis for each holding.  At the time TradeKing was doing some sort of behind-the-scenes IT conversion and didn't display cost basis on their summary pages.  They've since finished the conversion, so I thought I'd post a quick update on my returns and update the "My Returns So Far..." and "My Current Holdings" pages. 

I started 2010 with $107,514 and as of 10/12/2010 my account balance is $108,885 (Note: as of Q3 when I last posted about my returns my balance was $104,494, so this is quite a jump in the last 2 weeks).  YTD I haven't made any deposits or withdrawals, so the increase in value was driven by an aggregate increase in my holdings.

• On an absolute basis, my portfolio gained 1.3% YTD while the S&P (w/ dividends reinvested) is up 6.1%.
• I've been tracking my returns for 4 years and 9+ months, during which time my annual rate of return is 14.6%. Over the same period the S&P returned 2.3% annually. In other words, over the last 4 years and 9+ months I've outperformed the S&P by about 12% per annum.

However, I'm still underperforming the S&P for 2010, but as I mentioned last time I have a very concentrated portfolio and I'm pretty optimistic about my holdings - so I'm not overly concerned that YTD I've been lagging the S&P.  Below are two pictures (click to enlarge), one for my current holdings (this is actually 2 displays b/c only the bottom grid shows my cash balance) and one for my 2010 realized gains & losses. 

Some more thoughts on TTT/MCFAF

In my previous post on TTT/MCFAF (click on "zCurrent Holding: TTT" under Labels) I mentioned how the recently announced merger made TTT an attractive investment, so I thought I'd elaborate a little here... 

MCFAF can be thought of as the original Michael Smith investment vehicle, and through countless mergers/acquisitions/divestitures/spinoffs it's been used to generate serious wealth over the last two decades.   Before the merger I thought TTT was cheap, but I never bought it b/c I was worried about any conflicts of interest.  Afterall, with Smith controlling both companies and with both companies dependant on acquisitions to create value, I was worried he would cherry-pick the best opportunities for MFCAF.  Additionally, TTT was basically a mining royalty company that paid MFCAF a fee for administration - perhaps this fee was slightly beneficial to the shareholders of MFCAF at the expense of TTT?   Lastly, from what I've been able to gather (from 3rd party sources, so I can't verify the accuracy), Michael Smith has a large ownership stake in MFCAF and a small stake in TTT, so financially he's much more aligned with MFCAF (and when I evaluate stocks, insider alignment is one of my primary considerations). 

So, my next thought was why the merger and why now?  Afterall, over the last 5-10 years Smith has gone through considerable lengths to put build the company that was basically the sum of TTT, MFCAF, and KHDHF*.  He then spun out MFCAF and a few years later he split up TTT and KHDHF, and now he's merging TTT and MFCAF!  Wouldn't it've been easier to just spin out KHDHF in the first place?  Ultimately there's no way for me to know why Smith has made these transactions so complex, BUT that doesn't matter b/c with the TTT/MFCAF merger I'm comfortable that now I'm directly aligned with him. 

So, all that being said, I do have a conspiracy theory about what might be up Smith's sleeve.  Recently, TTT issued stock to raise cash for the express purpose of pursuing an acquisition.  My blue-sky hope is Smith found an acquisition that's so attractive he, along with his MFCAF shareholders, wants a piece of the wealth it'll generate - and what better way to do this than by merging MFCAF into TTT before the acquisition becomes public?  Also, this is consistant with a nuance of the TTT/MFCAF merger that has a lot of people scratching their heads - Smith is financially aligned with MFCAF, but on the surface the TTT/MFCAF merger appears to benefit TTT shareholders at the expense of MFCAF.  Afterall, on a conference call Smith was very confident he has the necessary MFCAF shareholder support for the TTT merger - perhaps the pending acquisition was how he got it?  Of course this is just IDLE SPECULATION on my part, we'll see what happens...

*KHDHF is a cement/industrial company that trades on the Frankfurt exchange and here in the US on the pink sheets.  This company is being spun out of TTT in 4 phases, three of which are already complete.  After TTT and MFCAF merge, I'll get 1 share of KHDHF for every 9 shares of TTT/MFCAF I own (which is why I purchased such an odd number of shares - it's divisible by 9). 

Can a "Value" Investor Trade Options?

"Rule 1 is don't lose, your option holdings are not consistent with your strategy, unless you changed from value investing to gambling..."

A reader posted this comment, and as someone who considers himself a value investor it's something I wrestled with - afterall, in the world of value investing buying options basically amounts to heresy. 

So what is value investing?  IMHO it's simply buying something at a discount to it's real, or intrinsic, value.  Normally, when people think value investing they think stocks - but really value investing can be applied to real estate, private equity, bonds, commodities, etc.  However, options are a different story because, while a share of stock represents partial ownership of a business, an option has no such claim.  In the world of engineering an option would be akin to a 2nd derivative, i.e. the operations of a business drives the price of the stock, and the price of the stock drives the price of the option. 

So does it ever make sense for a value investor to buy options?  Obviously I think the answer is yes, but only in certain situations - maybe the underlying stock is highly leveraged, or maybe there's some future event that could dramatically change the value of the underlying company.  Rarely, an option is just plain cheap and the risk/reward profile is really attractive. 

Also, the world of options is quite interesting.  First, just about everyone is a trader and they view stocks as pieces of paper (not partial ownership of a business).  Second, just about everyone uses the Black-Scholes model to price options (B-S uses volatility, interest rates, time to expiration, etc. to price the option, but doesn't considers the real intrinsic value of the underlying stock b/c it assumes the market is efficient).   So in the world of common stocks there are plenty of value investors bidding up the prices on undervalued stocks, but in the world of options this simply isn't the case. 

Anyway, just off the top of my head I can name several value investors who've purchased options (or warrants) - Warren Buffet, Joel Greenblatt, and Francis Chou - so while I can pretty much guarantee I won't be as successful as them at least I'll be in good company!

My Returns as of Q3 2010

Well, the quarter's over so it's time to write a quick post on my returns - I started 2010 with $107,514 and finished the quarter with $104,494.  I didn't make any deposits or withdrawals, so the decrease in value was driven by a decline in aggregate of my stocks.

• On an absolute basis, my portfolio declined 2.8% during the first three quarters of 2010. Annualized, this rate of return is -3.7%.  YTD the S&P (w/ dividends reinvested) is up 3.5%.
• I've been tracking my returns for 4 years and 9 months, during which time my annual rate of return is 13.3%. Over the same period the S&P returned 1.5% annually. In other words, over 4 and half years I've been outperforming the S&P by about 11% per annum.

Unfortunately, YTD I've underperformed the S&P by a margin that can't be considered insignificant.  However, as I've mentioned before, my portfolio is quite concentrated and I'm optimistic about my holdings - so I'm not overly concerned about my recent underperformance... yet.  Anyway, you can see my current holdings below (click on the picture to zoom in).

Transaction Alert: Bought TTT

Over the weekend I posted about "uU" investing and mentioned I'd been watching TTT and MFCAF (see my previous post).  Ironically, less than 48 hours later these companies announced they'd merge, which IMHO makes them a very compelling investment.  So today I purchased 1638 shares of TTT at a price of $7.30, for a total outlay of $11,957. 

TTT/MFCAF is almost a pure "jockey" bet (at a reasonable price) - if everything works out perfectly (which there's a 99.9% chance it won't) this would be akin to buying Berkshire Hathaway in the 1960's or Leucadia in 1980's.  However, we don't need things to work out "perfectly" to make some real money here, we just need things to work out "OK". 

Both these companies are run by Michael Smith, who for the last 2+ decades has put together a case study on how to generate wealth - here's a fantastic article from SumZero on how he's done it: http://www.sumzero.com/postings/2985/guest_view.   Also, one of the Seeking Alpha contributors has put together a number of very good articles on the evolution of TTT/MFCAF, here's a link to his page: http://seekingalpha.com/author/george-fisher/articles.  Lastly, this guy has also done some excellent write-ups and owns the stock himself: http://longtermvalue.wordpress.com/.

In my previous "uU" post I said the following: 

I love it when I hear value folks talk about whipping out Excel, plugging in financial statements, explicitly projecting bull/bear cases for 7 years, trying to figure out the right cost of equity (BTW it's 12%, it's always 12%), and then passing b/c there's too much uncertainty.  Rather I'd argue, for some portion of their portfolio, investors should seek out uncertainty, try to quantify the downside (or like B. Berkowitz says, "Kill the company"), make sure you're not overpaying, and let the upside take care of itself.

In this case I'm doing just that (hopefully I won't end up with egg on my face...).

uU Investing

I just read a fascinating essay that really resonated with me, it's called "Investing in the Unknown and Unknowable," by Richard Zeckhauser. It can be found here: http://www.hks.harvard.edu/fs/rzeckhau/unknown_unknowable_PUP.pdf

Basically, the article asserts that by seeking out situations where the outcome is unknown and unknowable (uU) an investor can potentially make outsized returns. Now let's look at an example of what a uU investment is and what it isn't:

I don't know exactly what Coke's (KO) finances are going to look like in 5 years, but I know the company is still going to be selling sugar water and I can make a reasonable guess about their cash flow - this is NOT a uU investment.  IMO the large integrated banks, such as Citigroup, Bank of America, or JP Morgan, are great examples of uU investments. I have no insight into potential government regulation and capital requirements, and coming up with an estimate of their loan losses is quite difficult. In other words, these companies are "black boxes." Further, I have no idea what the economy will look like - will we be in the middle of a "lost decade" like Japan in the 90's, or will be experiencing devastating inflation, like the late 70's?

The problem with investing in the Coke's of the world is even though I can come up with a good estimate of their fair value, so can everyone else. In other words, even if I decide Coke is undervalued and therefore an attractive stock, there's someone on the opposite side of the trade who did the same analysis and decided Coke was overvalued - and she's probably smarter than me (having gone to Harvard or Wharton for her MBA).  And it's not just the Coke's of the world, there are very smart people EVERYWHERE in investing; and they're arb'ing away the pricing inefficiencies in small-caps, micro-caps, bonds, distressed debt, etc. - this is why it's so hard to beat the market consistantly and over long periods.

BUT if I decide to invest in a big bank I don't have this problem, i.e. everyone is having a huge degree of difficulty figuring out their fair value - so what type of environment does this create? Well, I think people in general have a natural aversion toward uncertainty, so a lot of current holders are dumping their stock. Additionally, our friend with her Wharton MBA isn't interested in buying these stocks - afterall if she's wrong she is subject to "Monday morning quarterback" risk, which in the investment world can get you fired.  In other words, uU investing sidesteps the normal mechanisms that generally keep securities priced efficiently.

If you already read the linked essay you'll notice the author makes a strong case for Warren Buffet being a uU investor.  You can also make the case that Mohnish Pabrai with his "low risk, high uncertainty" mantra fits in this camp.  Morningstar's fund manager of the decade Bruce Berkowitz is also a uU investor: he's investing in the banks right now, he invested in health care companies while (i.e. not after) the government was overhauling health care, he owns stocks like SHLD, JOE, LUK, and FUR - all of which are classic uU stocks.  And of course there are many other value investors who are also uU investors in disguise: David Tepper, Ian Cumming, Michael Burry, Prem Watsa, Seth Klarman, Carl Icahn, etc. etc. 

This brings me to my next point: I love it when I hear value folks talk about whipping out Excel, plugging in financial statements, explicitly projecting bull/bear cases for 7 years, trying to figure out the right cost of equity (BTW it's 12%, it's always 12%), and then passing b/c there's too much uncertainty.  Rather I'd argue, for some portion of their portfolio, investors should seek out uncertainty, try to quantify the downside (or like B. Berkowitz says, "Kill the company"), make sure you're not overpaying, and let the upside take care of itself. 

As for my portfolio, I consider LUK, SD, and HAWK to be uU stocks to one degree or another.  On my watch list I'd consider CHK, NRG, BH, FUR, SHLD, TTT, MFCAF, BAC, COF, and JPM to be uU's.  Of course it's tricky figuring out what to buy, but if you go several posts back I disguss my checklist, which is my starting point. 

My Returns?

I got a comment from a reader today with regards to my investment returns, here's what he/she had to say:

probably making a mistake somewhere...
in one place you claim a 19.5% AR as of Mar 2010 and in another place you claim 13.4% AR as of Jun 2010
- 2006-2010 19.5% beats the best of the best of the best, gurufocus shows one investors with double digit 5yr average returns (10%), you are go(o)d!
- a 6% drop in one quarter in AR could only be caused by massive losses, what happened?
regards

Well first let me say I appreciate the kind words!  Previously I've speculated that my out performance could simply be dumb luck, so for any readers who'd like to dive a little deeper the first thing you can do is go to the "My Returns So Far..." link to the right, which is under the "Pages" category.  I update this page quarterly, so it has my returns from 1/1/2006 through Q2 2010.  If you'd like to verify my calculations you can use your friendly XIRR function in Excel.  Further, under the "Labels" category there's a link called "Returns," if you click on this it will pull up all my previous posts where these have been discussed.

As this reader correctly points out, my returns fluctuate like crazy - this is simply a biproduct of having a concentrated portfolio.  If you check the "Transaction Alert" link under the "Labels" category you can see what I've bought/sold and get a feel for how I've generated my returns (or for this year, lackthereof)!

Leave a comment if you have any questions, or if you prefer you can email me at mevsemt@gmail.com

Investing Checklist

Like many people out there, investing is something I do on the side - I have a full time job, a rental property, and a 9 month old baby girl - so you could say my goal of outperforming the S&P is a bit audacious given that the vast majority of my time is spent on non-investing activities.

However, by using an investment checklist I save a ton of time. Basically, it enables me to pass on the majority of investments without doing any heavy lifting, and I can dedicate serious time to only what I perceive are the best opportunities. Anyway, here's the checklist:

1. Insider buying (http://www.gurufocus.com/) or insider ownership (http://www.morningstar.com/)
2. Near 52-week low
3. Significant discount to Morningstar's fair value estimate (yes, I subscribe to Morningstar)
4. "Guru" buying (http://www.gurufocus.com/)
5. For options only: high degree of leverage
6. Significant discount to my fair value estimate
7. Downside protection - i.e. low risk / high uncertainty profile
8. Asymmetric payoff

Items 1 to 5 can be done in less than 5 minutes, and based on the results I either pass on the investment or start working on 6 to 8, which take quite a bit of time. The nice thing about having a checklist is it really narrows my universe of possible investments - at any given time there are usually less than 10 stocks that meet enough of the criteria to be considered (right now there's less than 5) - and with so few stocks to pick from investing becomes a much simpler process.

All or Nothing...

Today I placed an order to purchase Jan 2011 $2.00 call options (the contract price is $0.05, my order is for 175 contracts but as of now only 92 have gone through) for Jackson Hewitt Tax Services (JTX). Assuming I get all 175 contracts, my total purchase price should be about $994 including commissions.

JTX is a company in a TON of trouble and is drowning in debt - there is a very real chance they could be bankrupt before the end of the year. The situation is complicated, and I'll try to elaborate in a future post, but ultimately I think there's about a 50/50 chance they'll survive. IF they do make it they're probably worth $3 to $5 per share - which means the options I purchase today could be worth quite a lot.

IMO I'm essentially betting on a coin flip - but I'm only paying $1 for a chance of winning $10.

Backing up the truck...

Given the precipitous decline in the stock price of AHS I thought now would be a good time for a second look. To recap, AHS reported decent results last quarter, BUT they also announced an acquisition which they’re completely funding with stock (thereby massively diluting existing shareholders). They’re also assuming 136 MM in additional debt in conjunction with the acquisition. IMHO it’s the dilution and debt burden that has caused the sell off, which may in turn be an opportunity to buy more shares.

So now that AHS has new operations, new cash flows, and a new capital structure, (and a new stock price!) let’s do a quick and dirty valuation analysis. Assuming a stock price of $5, the company has an EV of about 400MM and a market cap of 206MM. IF we also take management at their word and model 30MM in additional EBITDA from the acquisition, then we’ve got pro forma EBITDA of 71MM on revenue of 904MM – this means AHS is trading at an EV/EBITDA of 5.6x.

Now let’s run through a hypothetical (but very reasonable) 5-year scenario. First, we’ll assume that EBITDA will grow steadily to 90MM by the fifth year (btw this is a pretty conservative assumption given that EBITDA before the acquisition in 2008 was 95MM). Second, we’ll assume all EBITDA during our 5 year analysis goes toward paying down debt, paying interest, rebuilding working capital, and capex. Because AHS has low ongoing capital requirements, it’s not unreasonable to assume they can pay off all their debt within our 5 year window.

So, in our hypothetical situation, at year 5 AHS as a pretty simple company – it’s essentially cash free / debt free, it has EBITDA of 90MM (which we can assume is growing at a low single digit % going forward), and the majority of EBITDA converts to FCF. The question is, how much would you pay for this asset?

The answer, of course, is “it depends,” but I think it’s reasonable to assume the company could trade somewhere between 4x (very conservative) and 8x EV/EBITDA, giving us a market cap somewhere between 360MM and 720MM (or a stock price between $8.75 and $17.50). Now obviously I have no idea if this is how things will play out, but it feels like a high risk/high reward situation. Remember, AHS does have a lot of leverage and if the economy falls off a cliff AHS could be in real trouble. However, I think this is a risk worth taking, so I purchased an additional 550 shares (giving me a total of 1750) today at a price of $4.68.

Fool Me... Once?

In my previous post I mentioned the possibility of selling GMXR, and today I did just that (at a price of $4.13). I purchased GMXR on separate occasions in February and March at an average price of $9.57, so with my 1400 shares I ended up losing about $7,600... ouch!

Basically, GMXR has been killed recently along with a lot of other natural gas companies, and since my account is taxable I decided to lock in my losses (since I have significant gains from selling SHLD, USG, WTM, and DFS earlier in the year) and simultaneously buy Jan 2012 $5.00 CALL OPTIONS (50 contracts at $1.07) in a similarly punished E&P company that I've previously owned, SandRigde Energy (SD).

SandRidge is a company in flux, and IMO there's been quite a bit of selling pressure due to it's recent transformation. In fact, apparently the only people buying SD (other than me) are the company's insiders! Check out these two articles for a great introduction to the company: http://www.gurufocus.com/news.php?id=105087 and http://www.gurufocus.com/news.php?id=103990.

Anyway, I'll try to do a separate write up on my estimate of SD's fair value if time permits, but for the time being suffice it to say that I think SandRidge MIGHT be significantly undervalued. However, because SD is highly levered and because the price of gas & oil are huge drivers of the company's results, my fair value estimate has a large degree of uncertainty - I'm going keep my fingers crossed and hope for the best!

Current Holdings and Random Musings

Well so far it's been a very tough Q3, both in absolute and relative terms. After marginally outperforming the S&P through Q2 things have taken a turn for the worse, and YTD I'm underperforming the S&P by a wide margin. However, with a highly concentrated portfolio, big swings in performance are bound to happen, and hopefully recent history isn't indicative of things to come.

For my current holdings, AHS in particular has been a thorn in my side. The company recently reported results, which weren't bad by any means. HOWEVER, the company also announced an acquisition which will be completely paid for with newly issued stock, thereby materially diluting existing shareholders. My estimate is this will destroy about $2 to $4 in value for existing shareholders. Of course, the stock has gone from $8'ish to $4'ish, which I think is an example of a typical "Mr. Market" over reatcion. All things considered, I think this stock is worth $10 to $15 per share (assuming management doesn't make a habit of diluting shareholders).

GMXR has also been a big thorn in my side. Natural gas stocks in general have been hammered, and GMXR in particular has been killed because of its high level of debt. I think the risk/reward proposition at today's price is pretty compelling, and I'm considering doing one of two things; 1) doubling down 2) trading GMXR for a similarly punished E&P company. The logic behind #2 is that my account is taxable, and with significant gains from SHLD, USG, WTM, and DFS, I'm sitting on roughly 28K of capital gains for 2010 (ouch!).

Generally I try to stay away from making broad market predictions, I figure I'm better served by trolling for pockets of opportunity. HOWEVER, I do read the predictions and observations of other smart investors, and I try to incorporate any inferences/insight when I make high-level portfolio allocation decisions. IMHO the two best sources for this are John Hussman's weekly comments (www.hussmanfunds.com) and pretty much anything published on PIMCO's website (although I'm partial to Bill Gross's monthly commentary). Again, this is just my opinion, but if you read everything they've published over the last six months (which will probably take a day or so) you'll automatically become a better investor.

Anyhow, right now I've got about 40K (or 43%) of my portfolio in cash (obviously this is a huge %), so clearly I'm worried about downside risk. This is in the realm of gut feel, but personally I'd be much more surprised if the DOW goes to 12K than if it goes to 8K. And assuming it does go to 8K it'll be nice to have some cash on the sidelines waiting to be deployed.

Why'd I sell DFS?

This was the question I got after my previous 2 posts, which was a simple disclosure that I sold my stake in DFS where I didn't really provide any rationale (my apologies)...

My guess is DFS is worth about $20 to $25 dollars, so I don't see a huge potential upside. Additionally, given the current state of the economy, there is a relatively large amount of uncertainty in my guess of DFS's fair value - who knows, maybe its fair value is $10, or maybe it's $30... only time will tell.

Also, the stock has basically tripled from its March 2009 lows, and this type of run-up always makes me a little nervous. This is similar to when I sold USG and SHLD after their run-ups, see my previous posts on those former holdings for details (you can click on the "zzClosed Position..." labels on the right to easily navigate there).

Anyway, someone said that when it comes to investing the science is buying and the art is selling... and someone else said there's no rule that says you have to get 100% of the upside. So maybe DFS will continue higher and I'll end up kicking myself, or maybe it'll go back down to the single digits and I'll buy more...

Transaction Alert: Sold DFS Part 2

Today I sold my remaining 475 shares of DFS at a price of $15.49.

After this transaction my cash balance has increased to almost $40K, which is a bit higher than I'd like. Hopefully some new investment opportunities will present themselves, but I also think several of my portfolio holdings are very cheap, so I could always just add to those...

Transaction Alert: Sold DFS

The portfolio churn continues...

Today I sold 475 shares of DFS at $15.25. This was only half my position, so I still have 475 remaining shares. I originally purchased DFS in late 2008 and early 2009 for an average price of $10.34.

Transaction Alert: Bought MYGN, Sold WTM

This is a two part post. Last week was a busy one for me - in addition to buying Seahawk Drilling (HAWK), I also sold White Mountain (WTM) and purchased Myriad Genetics (MYGN).

I purchased 30 shares of WTM on 2/24/2009 for $203.58 and sold on 7/9/2010 for $331.17. While the returns on this investment were good, they weren't significantly different than the broad market, so I can't really call it a win. I still think WTM is undervalued and has a top notch management team, HOWEVER I think there are better opportunities elsewhere. Despite selling my shares, I'm going to keep this one on my watch list.

I purchased 650 shares MYGN on 7/9/2010 for $15.05, and as with most purchases this position is now approximately 10% of my portfolio. MYGN hit its 5-year high in early 2009 in the low 40's, so it's really been quite a fall since then (in fact, the stock hit its 52-week low the same day I bought it). Anyway, Myriad essentially does 2 things:

• It's predictive medicine products help determine the likelihood that a patient will get breast/ovarian/colon/skin cancer.
• It's personalized medicine tests allow doctors to customize the treatment received by cancer patients for the best possible results.

This is pretty heavy stuff - predictive and personalized medicine. So why has the stock been hammered?

• It's not growing as fast as the market predicted and priced. Obviously lowering growth forecasts has a significant impact on valuation, and my guess is many "growth" investors are dumping their shares.
• There is significant uncertainty around the company's patents, and weaker patent protection could make MYGN vulnerable to increased competition.

My guess is the market is overreacting to these negatives, and as a result the stock has been punished too harshly. Here's my thesis - I think MYGN can grow in the mid-teens for at least the next 5 years, but really it has the potential to grow at this clip for next couple of decades. It's trading at less than 8x EV/EBITDA and a PE ratio of 12x for the ttm - this is VERY cheap for a company with this kind of growth profile. Also, since capital requirements are low, free cash flow is quite strong.

So what are the expected returns? Well, if MYGN grows in the mid-teens for the next 5 years before leveling off, I'd expect the stock to be worth somewhere in the high 20's. If it grows in the mid-teens for the next couple decades then the stock's worth significantly more. Finally, if I'm wrong and the market is right, then the stock is probably fairly valued at today's prices. So, I guess we'll see what happens...

On a side note, my portfolio is now about 25% cash. This feels OK, but I may look to increase my cash allocation in the near future. Afterall, there's a lot wrong with the world - municipal/state/sovereign defaults are all a possibility, deflation could be around the corner, with inflation around the corner after that... As PIMCO's Gross/El-Erian say - we're driving down a bumpy dirt road in the dark without a spare tire...

Transaction Alert: Bought HAWK

This post is a couple days late, so my apologies. On 7/7/2010 I purchased 1000 shares of Seahawk Drilling, symbol HAWK, for $9.10 a share. As with most purchases, this new holding makes up about 10% of my portfolio.

By way of background, HAWK is a shallow water offshore drilling company in the Gulf of Mexico. They became a public company in August 2009 after being spunoff from Pride International. In addition to the typical market inefficiencies that can accompany a spinoff, the BP Gulf disaster has contributed to make the price of HAWK shares very very cheap IMO.

I've been following HAWK since it was spunoff almost a year ago, and as a result I stumbled upon an excellent blog, http://greenbackd.com/. Greenbackd's analysis of HAWK is perhaps the single best write up I've ever seen on a blog - this is serious stuff here, in fact it's more insightful and intelligent than just about any Wall Street report I've read (and I've read quite a few). So, rather than try to do my own write-up (which would pale in comparison), I'm just going to link to Greenback'd's.

• An introduction (September 2009): http://greenbackd.com/2009/09/08/guest-post-ben-bortner-on-seahawk-drilling-nasdaqhawk/
• Revisited (June 2010): http://greenbackd.com/2010/06/03/seahawk-drilling-nasdaqhawk-redux/
• Parallels between HAWK and Mohnish Pabrai's investment in FRO, very insightful (June 2010): http://greenbackd.com/2010/06/04/pabrai-on-frontline-ltd-usa-nysefro-hawk-template/
• HAWK liquidation value (June 2010): http://greenbackd.com/2010/06/30/hawk-liquidation-values/
• Rig value (July 2010): http://greenbackd.com/2010/07/06/hawk-rig-market-values/

The above links are a long read, so here is a summary of the most pertinent information I used to make my decision:

• HAWK is probably worth $154 MM in a forced liquidation scenario where it's rigs are sold as scrap. However, even in this type of scenario the rigs would probably be sold as operational, in which case the liquidation value is probably closer to $300 MM. (As of 7/9/2010, at a stock price of $10.71, HAWK had a market cap of $126.6 MM!!)
• In the good old days (2006 to 2008), HAWK generated a pro forma net income in the $150 MM range on an annual basis. It probably won't ever get back to those results, but given it's PE ratio is less than 1x peak earnings shows how cheap the stock has become.
• On July 29th, an 8K was filed that basically said the CEO and board members wouldn't receive a cash salary for the rest of 2010, but rather they would get an equivalent amount of restricted stock based on the June 25th closing price - so effectively they're "buying" a huge slug of stock. However, what's so interesting about this isn't the stock "purchase," but rather the timing - ALL of the stock is being awarded at the June 25th price (as opposed to a monthly price). If I were to read between the lines my guess would be management thinks the stock is CHEAP and it's NOT going to stay this cheap for long.

So, that's basically my investment thesis boiled down to a couple of bullet points. In a way, HAWK reminds me of my experience with USG. I purchased USG in March of 2009 when the outlook couldn't have been bleaker for the home builder supply industry. Things didn't get materially better, BUT the outlook went from bleak to slightly-less-bleak, and the stock went from a purchase price of <$5 to a selling price >$21 over my 13 month holding period. Will HAWK do the same? (Obviously I have no idea, but I've placed my bet!)

My Returns as of Q2 2010

I started 2010 with $107,514 in my portfolio and finished the quarter with $101,294. I didn't make any deposits or withdrawals, so the decrease in value was driven by a decline in aggregate of my stocks.

• On an absolute basis, my portfolio declined 5.8% during the first two quarters of 2010. Annualized, this rate of return is -11.3% (although negative, this is still slightly better than the S&P).
• I've been tracking my returns for 4 years and 6 months, during which time my annual rate of return is 13.4%. Over the same period the S&P returned -1.9% annually. In other words, over 4 and half years I've outperformed the S&P by over 15% annually.

Obviously, beating the S&P by 15% every year is quite good. HOWEVER, as I've said before, I have a very concentrated portfolio - a few good picks can make a huge difference in performance - so I still have no idea whether I'm just lucky or if I'm doing something right...

Sucker's Rally?

It's been awhile since my last post, so I apologize to my regular readers - I think there are 2 of you :)

Last week I read a fascinating article in the Huffington Post, entitled "Remember: In 1930, They Didn't Known It Was 'the Great Depression' Yet" (http://www.huffingtonpost.com/henry-blodget/remember-in-1930-they-did_b_605814.html). I highly recommend reading it in its entirety, but the basic gist is after the 1929 crash there was brief period defined by renewed optimism, speculation, IPO's, etc. which of course turned out to be a sucker's rally.

Basically, the market went from its 1929 peak of 381 to an initial bottom of 199. This was followed by a rally that pulled the market all the way to 294 over the next six months. Finally, after this "sucker's rally" the market once again turned negative and bottomed out at 42 eight months later (that's right, 42!).

The point of the article is to draw similarities between what's unfolding today and what happened back then - was it a sucker's rally when the DOW went from its March 2009 low of 6.5K to its May 2010 high of 11.2K? Should we expect the market to hit new lows over the coming months and years?

Obviously I have no clue.

Interestingly enough, George Soros recently gave a speech in which he elaborated on this very subject (http://www.gurufocus.com/forum/read.php?1,97265,97464#msg-97464). During this speech, he said such warm and fussy things like:

• The current situation in the world economy is “eerily” reminiscent of the 1930's with governments under pressure to narrow their budget deficits at a time when the economic recovery is weak.
• “The collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama.” (Act I is defined by replacing private debt with public debt, "thereby reinforce[ing] the excess credit and leverage that had caused the crisis in the first place." Act II began "when financial markets started losing confidence in the credibility of sovereign debt," with Greece and the Euro taking center stage.

So if the bear case I described above does indeed come to pass it could mean very bad news for the average Joe who invests in common stocks (i.e. me). The question is how should one position their portfolio if they believe there's a 10% chance it'll play out (or 25%, or 5%, etc.)? Remember, there's always a chance that we make it through this mess unscathed, and if you hold too much cash you could miss out on significant upside...

Personally, I've got about a third of my portfolio in cash. Not only does this act as a safety blanket should things head south, but it will also give me the opportunity to snatch up some bargains in this scenario. Conversely, the other 2/3rds of my portfolio is spread over a small handful of stocks that I feel are undervalued in aggregate, so should the market rally I feel these securities will do quite well.

Transaction Alert: Bought AHS

When I sold SandRidge Energy (SD) last Friday I used the proceeds to immediately buy AMN Healthcare Services (AHS). I purchased 1200 shares, for a total outlay of about $9,600. The stock is currently at $8 a share, but I think it's worth about $15 to $20.

AHS is a staffing company for nurses and other healthcare workers. They are somewhat economically sensitive, and as a result their revenue fell from $1.2B in 2008 to $760MM in 2009. However, AHS generally produces pretty stable EBITDA margins in the high single digits, for 2008 their margin was 7.9% and for 2009 it was 7.5%.

I expect their revenue to rebound to about $1B within a year or two and probably grow at 5% to 10% thereafter. At $1B in revenue I conservatively expect them to generate about $70MM of EBITDA. With this type of margin/growth profile I think a EV/EBITDA ratio of 10x is quite reasonable, which implies an EV (enterprise value) of $700MM. Their current EV is just over $300MM, so it's really not much of a leap to get to my fair value range of $15 to $20 a share.

From a high-level perspective this new purchase did not alter my portfolio very significantly. I made the AHS purchase with cash from the sale of SD, so I'm still about 30% cash.

Transaction Alert: Sold SD

On Friday (May 21st) I made the tough decision to sell my shares of SandRidge Energy. I still think the stock is significantly undervalued BUT I'm also concerned there's a lot of downside risk, specifically:

1. A lower outlook for oil prices.
2. High leverage and a diluted shareholder base due to an ill-timed acquisition.
3. My portfolio already has significant exposure to the energy sector.

The SandRidge acquisition of Arena Resources will shift the company's focus to oil and away from natural gas in a significant way. Unfortunately, SandRidge made its bid when the price and outlook for oil was significantly higher - if the price of oil stays at its current level there's a very real possibility this merger will destroy shareholder value. If the price of oil falls further SandRidge could experience financial distress.

SandRidge is a very hard company to value - when I initially purchased the stock my estimate of the fair value was somewhere from $10 to $20 per share. Currently I think it's more like $5 to $15, but there's also a very real chance it could be worth even less. Ultimately, the risk/reward isn't as attractive as it used to be, but I'm going to keep an eye on SD b/c there are still a number of attributes that could make it a good investment.

Random Musings

A little over a month ago I wrote a post entitled "Feeling Fearful" (which can be found here http://mevsemt.blogspot.com/2010/04/feeling-fearful.html). During this time I sold several stocks (SHLD and USG) and allocated about 30% of my portfolio to cash - in retrospect, it looks like my timing couldn't have been more lucky. Since then, the market has turned decidedly more fearful as the Eurozone mess has drawn an increasing amount of investor attention and oil gushes into the gulf.

Ironically, the oil spill disaster could prove beneficial for some of the stocks I own. A likely consequence of this mess is increased government regulation and decreased offshore drilling in the short to medium term. This in turn could lead to an increase in the price of oil and natural gas (natural gas in particular, b/c it can't be imported from overseas nearly as easily). IF this does indeed play out I'd expect SD, GMXR, and EXC to reap the benefit (SD and GMXR have onshore operations and EXC would benefit from an environment with higher energy prices in general).

On a negative note I expect the call options for FAF to expire worthless. In my initial post I wrote that a broad market sell off could cause this, and of course within a couple days the market began selling off...

HOWEVER, I think any further market sell off could present an attractive buying opportunity. So, with about 30% (about $34K) of my portfolio in cash, I am constantly refining and evaluating my watch list. Current stocks that I find interesting include BAX, APOL, CNX, GENZ, AHS as well as existing holdings SD, GMXR, and EXC.

As always I'll post about any transactions.

Transaction Alert: Exelon LEAPS Part 2

I just bought 10 contracts for EXC January 2012 $50 Calls at $2.00. I previously purchased 10 identical contracts earlier in the month, the only difference being that I paid $2.10. So, now I have a total of 20 contracts for EXC January 2012 $50 Calls.

Transaction Alert: FAF Call Options

On Friday I purchased 2 sets of call options in FAF for a combined outlay of about $2,000. The first was 10 contracts of FAF October 2010 $40 Calls at $1.10 and the second was 20 contracts of FAF June 2010 $37.50 Calls at $0.50. The price of FAF is currently around $35 a share, so both these call options are currently "out of the money."

This bet falls a little outside the realm of normal value investing. FAF is splitting into 2 companies on June 1st, one that focuses on title insurance and another that focuses on information services. My current thinking is that FAF has a fair value of about $50 a share, and my hope is the spinoff will act as a catalyst for FAF shares to appreciate.

The danger with this investment is that it's very short term - so if there's a broad market selloff these options could easily expire worthless. On the flip side, if the market rallies in the near term these options could be worth a lot of money.

In conclusion, this "investment" is 1/3 special situation, 1/3 value investing, and 1/3 luck - my guess is there's a 50% it'll make money and a 50% chance it won't. HOWEVER, if it does make money it'll be 3x to 4x my initial investment, which is why I felt comfortable making the bet in the first place.

Transaction Alert: Exelon LEAPS

I just purchased my first option - 10 contracts of "EXC January 2012 $50 Calls at $2.10." In other words, anytime between now and January 2012 I have the right to buy shares in Exelon for $50. Each contract includes 100 shares, and I bought 10 contracts, so my sunk cost in this investment was $2,100 (plus a small commission of ~$11).

Since the contract price was $2.10, I make a profit if the share price exceeds $52.10 (50+2.10). Due to the leveraged nature of LEAPS, for each incremental $1 above this price I make a $1,000 profit! My hope is the economy continues to rebound and both power prices and energy consumption rise along with it. If this happens my guess is EXC could be worth $60 to $80 a share, which would generate a profit of $7,900 to $27,900, respectively - not bad for a $2,100 investment.

On the other hand, there is a decent chance my investment thesis could be flat-out wrong. If this is the case and EXC never gets above the $52.10 threshold then I only stand to lose $2,100.

Time to lever up?

LEAPS, or Long-term Equity AnticiPation Securities, have recently grabbed my attention. LEAPS are simply a long-term call option, or in other words the right (but not obligation) to buy a stock at some point in the future at a predetermined price.

Here's an example: let's say stock XYZ is being investigated for some alleged wrongdoing. Currently the stock is trading at $100 a share, but it's worth $200 assuming they're innocent. However, if they're guilty the stock is probably only worth $50. If I were to purchase XYZ common stock, based on my current portfolio size, I'd probably buy $10,000 - and I'd either lose $5,000 or gain $10,000.

However, let's say I could buy XYZ LEAPS (expiring 1/2012) with the following terms: a strike price of $150 and a contract price of $5. In other words, for $5 I reserve the right to buy one share of XYZ for $150 anytime between now and 1/2012. If I were to invest $5,000 in XYZ LEAPS I could potentially lose it all if the stock never gets to $150 (which is the same amount I'd lose with the common stock).

But what happens if the stock goes to $200? Well, since I invested $5,000 I have the right to buy 1,000 shares at $150. Since I could immediately sell them for $200, I'd realize a $50,000 profit! So, with LEAPS I'd either lose $5,000 or gain $45,000 (50K profit less the initial investment of 5K).

Obviously this is a very simplistic example - the real world is much murkier. However, the economics of buying LEAPS can be extremely attractive, and in some cases it just makes more sense. I'm specifically looking at Jan. 2012 LEAPS for EXC and MON and as always I'll post about anything I decide to do.

Transaction Alert: Sold USG

Knowing when to sell is definitely more tricky than knowing when to buy, and selling can be especially difficult if the stock has been on a run. Nonetheless, today I sold my 800 shares of USG at $21.83 (I purchased the shares in March of 2009 at an average price of $4.91). This position resulted in a return of approximately 345% in just over 13 months.

Transaction Alert: Bought Sandridge (SD)

Today I purchased 1700 shares of SD at $7.06. I've previously discussed my interest in this stock on my blog and on Gurufocus at http://www.gurufocus.com/news.php?id=89642.

In conjunction with this trade I'll probably also sell GMXR. I will discuss my rationale as time permits...

Updated Returns

I last posted about my portfolio returns at the end of Q1, but due to the recent runup I thought I'd recalculate (see "My Returns So Far..." to the right). Over the past 4 years and 3+ months my annual rate of return is 21.4%. Over this same time period the "S&P parallel portfolio" would've returned 3.5%.

I realize that 4+ years is not long enough to know if my results are simply dumb luck, so I'm keeping my fingers crossed and hoping the streek continues!

Feeling Fearful

It's been quite a ride over the last year! I remember in March 2009 the fear in the market was almost palpable. Now, 13 months later, all the major indexes continue to soar, seemingly defying gravity. IMO the market, in aggregate, has turned greedy - so is it time for the individual investor to turn fearful? I think so...

These days I find myself asking, "Where is the opportunity, where is the value, and most importantly where is the risk?" I've been struggling to find individual stocks that offer an acceptable margin of safety and potential return. Additionally, several portfolio holdings of mine are approaching my guess of their intrinsic value. As a result, my portfolio's cash position has grown to about 30% and I'm very seriously considering selling several more holdings. Specifically, these are USG, WTM, and COV. However, this is only half the story. I have found a small handful of stocks that seem attractively priced. Among these are GENZ, EXC, SD, MON, ISCA, APOL, and FNF.

My sense of it is that a lot of investors spend a great deal of time picking stocks at the expense of portfolio management. David Swensen is the master of this - in his excellent book, "Unconventional Success," he lays out a fairly simple but powerful plan based primarily on portfolio management. Additionally, I'd argue that one of the main reasons the Magic Formula works so well is because there is a defined, rigorous plan around portfolio management (although everyone seems to focus on the stock picking aspect).

I have to admit, holding on to USG is tempting because it has the potential to be my first 10-bagger. And it was difficult for me to sell SHLD because I kept thinking it might be the next Berkshire. But the fact of the matter is "hope" isn't an investment strategy. SHLD hit my estimate of its intrinsic value and USG is quickly approaching it. IF I can find stocks that are priced at a greater discount to my estimate of their intrinsic value then, by definition, they have a better margin of safety and better potential return. Of course I could turn out to be wrong for any given stocks I buy/sell, but I think the process I've laid out is right.

As always I'll post about any stocks I buy or sell.

Opportunity in Natural Gas?

I wrote an article for the awesome website http://www.gurufocus.com/ called "EMT, 'Ick' Investing, and Natural Gas." Readers can access the article here: http://www.gurufocus.com/news.php?id=89642#89677

This article basically outlines my thoughts on efficient market theory, why I'd be considered a "contrarian" investor, and why I think there are currently opportunities in natural gas exploration and production companies.

I specifically discussed SandRidge, which is one of the top stocks on my watch list. Other stocks high on my watch list that weren't discussed are MIR and EXC, and obviously I already own GMXR. I'll keep you posted if I decide to make any purchases...

My Returns as of Q1 2010

At the end of every quarter I will write a quick post that details my returns. I started 2010 with $107,514 in my portfolio and finished the quarter with $114,624. I didn't make any deposits or withdrawls, so the increase in value is straight appreciation.

• On an absolute basis, my portfolio appreciated 6.6% during the quarter. Annualized, this rate of return is 29.7% (this is slightly better than the S&P).
• I've been tracking my returns for 4 years and 3 months, during which time my annual rate of return is 19.4%. Over the same period the S&P returned 2.3% annually.

Following are my portfolio details and a summary of transactions for the year:

• I started my blog in the beginning of March 2010. Between then and now I've sold my stakes in SHLD and MDZ.
• Prior to starting my blog but during fiscal 2010 I sold my stakes in PFE and WSC.
• The only new position I've initiated during 2010 is GMXR.
• Currently I only own 6 stocks and about 30% of my portfolio is in cash, as shown in the picture below (and on the "My Current Holdings" link to the right).

Transaction Alert: Sold MDS, Inc. (MDZ)

I'm getting very aggressive (and hopefully opportunistic) with my MDS, Inc. trades as I just sold my remaining 1100 shares for $8.23. Here's my rationale:

It was reported today that the old reactor is going to take longer to repair than originally anticipated (thus leaving MDS without their primary supply of isotopes). While this is a problem in and of itself, the real concern is that the Canadian government may abandon their nuclear program altogether. Afterall, they build a new reactor but can't get it to work and their old reactor is literally falling apart. If you go to my original post, http://mevsemt.blogspot.com/2010/03/special-situation-in-canada-hey_21.html, this is the first outcome I listed and would be a worst case scenario.

However, and here's where it gets interesting, MDS is only down 3% today because IMO the Reverse Dutch Auction has essentially created an artificial price floor. The auction ends Monday, March 29th (thus removing the price floor), and after the results are publicized I think there could be significant selling pressure. I discussed this selling pressure in my previous post, http://mevsemt.blogspot.com/2010/03/transaction-alert-trimming-mds-inc.html, but now I think it has an increased liklihood of happening and my guess is it will be greater in magnitude.

If the price falls enough I may reinitiate a position in MDS. If you go back to my first post I outlined 4 possible outcomes. Based on the news today outcome #2 became less likely and outcomes #1, #3, and #4 all became more likely, so this could still be a highly profitable investment. If I'm wrong and the selling pressure doesn't materialize, then at least I've locked in my gains and I'll sleep well at night.

Transaction Alert: Adding to GMXR

Today I bought an additional 400 shares of GMXR, bringing my total share count to 1400. This stock looked cheap when I originally bought it on 2/5/2010 for $9.94. Assuming I'm right, at $8.65 it's even more of a bargain!

Additionally, I wanted to bring the position back up to around 10% of my portfolio (10% is a pretty standard bogey for any one stock). Lastly, I have a very large cash stake (about 26K of my 117K portofio is cash after today's purchase), so I'm looking for attractive opportunities to deploy it.

Transaction Alert: Trimming MDS, Inc.

Today I sold 400 shares (leaving me with 1,100) of MDS, Inc. (MDZ) at a price of $8.50. I bought this stock on November 13th and December 24th for an average price of $7.65, so my IRR is pretty decent. My rationale for this transaction is discussed below.

MDS, Inc. has gone up over the last few days, probably as a result of arbitrageurs buying up the stock in hopes of a quick gain (an opportunity created by the mechanics of a Reverse Dutch Auction). As a result, this one position accounted for around 11% of my portfolio before today's sale.

As you can see from my previous post (here's the link: http://mevsemt.blogspot.com/2010/03/special-situation-in-canada-hey_21.html) there are a number of potential outcomes for MDS, not all of them good. I also emphasized MDS is one of my first special situation investments, so there's a chance my thesis could simply be wrong. Therefore, having such a large % of my portfolio allocated to this one position made me a little nervous, and my thought was it would be prudent to sell a portion of my shares.

On a side note, if the arbs currently buying up the shares are unable to tender them via the Reverse Dutch Auction, they will probably scramble to sell. This in turn could pull the stock down, creating a second buying opportunity. I have absolutely no idea whether this will happen or not, but it's something I'm going to watch for and if the stock falls far enough I may buy more.

Transaction Alert: Sold Sears (SHLD)

Today I sold all my shares of Sears Holdings (SHLD) for $106.73. I initially purchased SHLD in February 2008 and continued buying sporadically until February 2009. My average price per share was $61.36. Overall I'm quite happy with the way this investment turned out. I'll write another post in the next couple of days outlining my rationale behind this transaction.

A Special Situation in Canada, hey?

I’m writing to introduce MDS Inc., which is one of my portfolio holdings (ticker is MDZ). MDS is undergoing a significant transformation, and as a result I think there is a special-situation-type investment that could produce very good returns.

WARNING: This is one of my first “special situation” investments; my past performance has been driven by plain old value investing (see the “My Returns so Far…” link). So, please recognize there’s a chance my thesis could be flat-out wrong. Additionally, I’m a little nervous b/c there are no structural characteristics that would create a mispricing (i.e. spinoffs and companies coming out of bankruptcy may have forced/non-discriminating sellers, which can create an opportunity to buy the stock cheap). BTW if you haven’t read Joel Greenblatt’s excellent book, “You Can be a Stock Market Genius,” I highly recommend picking up a copy as it’s a great introduction to special situation investing.

Anyway, back to MDS. First go to http://www.mdsinc.com/ to learn the basics about the company’s operations and transformation. As you can see, it’s all about their Nordion division going forward. Nordion gets their isotopes (which are used for medical applications) from a very old nuclear reactor run by the Canadian government, and the reactor ain’t doing so hot (no pun intended). However, if the reactor has a good year Nordion can earn about 75 MM in EBITDA, but if the reactor has a bad year then there’s a supply disruption and results suffer. So let’s be conservative and say this business is worth 4x our assumed EBITDA, or 300 MM. Currently, MDS has a market cap of 1B, but due to a recent divestiture they’ve also got about 650 MM of net cash on their balance sheet.

So here’s where it gets interesting; 400 to 450 MM of that cash (let’s just say 425 MM) will be used to repurchase shares via a Reverse Dutch Auction. Based on the auction price range, 40% to 46% of all outstanding shares will be retired (let’s just say 43%).

After the auction, MDS will have 650 less 425, or 225 MM of cash on their balance sheet. They’ll also have a market cap of 570 MM (current market cap less 43%). This gives them an Enterprise Value of 345 MM. NOTE: This makes sense – remember we gave MDS an EV of 300 MM, so we’re in the same ballpark. Thus, the logical conclusion is the market is valuing MDS fairly and there’s no opportunity here.

But Wait! MDS is suing the Canadian government for 1.6 billion (yes, with a “b”)! It turns out MDS had invested 350 MM with the government to build a new reactor. However, after running into significant problems and budget overages, the government suspended construction. As a result, MDS is suing to get their initial investment back along with the foregone profits that surely would’ve ensued had the government actually built the plant.

So, here are the possible outcomes:

1) MDS loses the lawsuit and, because they can’t get the new reactor online, Canada discontinues their nuclear program. In this case MDS is really not worth much more than the cash on their balance sheet, Ouch!

2) MDS loses the lawsuit and continues getting isotopes from the problem riddled nuclear plant. MY guess is not much will happen to the stock price here, as it appears the market is already valuing the stock under this assumption.

3) MDS wins the lawsuit. With 225 MM in cash and a market cap of 570 MM, a settlement of 350 MM will basically bring MDS’s cash balance up to today’s market cap. In other words, you get the business for free!

4) The Canadian government says to heck with it and finishes building the new plant. With a predictable, steady stream of isotopes MDS could probably earn about 100 MM in EBITDA. Also, the market would probably pay a premium, maybe as high as 8 to 12x.

Some last items worth mentioning. It looks like MDS management as well as the largest shareholder will be holding on to their shares, which is definitely a good sign (see FAQ's on the MDS website). I have no insight into the timing of the lawsuit/settlement, but my guess is management wants to do the auction b/c it will be resolved sooner rather than later. Also, my guess is management would not change the operations and capital structure of MDS so radically if they did not have confidence in Nordion going forward, which makes me think outcome #3 or #4 is more likely than #1 or #2. Lastly, MDS is just over 10% of my portfolio as of today.

An Introduction

Welcome! As this is my first post, I’d like to take this space to introduce myself and introduce my blog. In general, this is a blog about VALUE INVESTING, but more specifically it will track my investment desicions and the results of my personal stock portfolio.

I started investing seriously in 2005, as I was a few years out of college and had built up some savings. I started out reading books on EMT, but eventually found myself drawn to value investing. Beginning in late 2005, I began actively picking stocks using this philosophy to guide my decisions.

On Jan 1, 2006 I started diligently tracking my investment returns and comparing them to what I would’ve earned had I invested in the S&P instead. My reasoning went something like this:

Even if value investing works, there’s a good chance I don’t have the temperament or intelligence to execute on it. After several years, if I’m not earning returns in excess of the S&P, I’ll just move everything to a Vanguard Retirement fund.

HOWEVER, this has not been the case! After four+ years of actively picking stocks I’ve managed to earn an annual return of 19.5%! My hypothetical S&P (w/ dividends reinvested) would have returned just 1.5% (returns are as of 3/5/2010, the detail can be seen on the “My Returns So Far…” page to the right).

So, going forward I will discuss all of my investment decisions on this blog, as well as my existing holdings and the stocks on my watch list. Generally speaking my portfolio has high concentration and low turnover (you can see my current portfolio by clicking on the “My Current Holdings” link to the right). Currently, I only own 8 stocks and have less than 10% of my portfolio in cash.

If this strategy appeals to you, I encourage you to follow my blog. If nothing else it might provide some interesting food for thought. Since I’m just starting out (and I have a very full work week with my job), my goal is to write about 1 post per week, Enjoy!