Today I dumped my position in gdc.to. I have a rule in my trading/investing bible that says when a major reason you bought a stock no longer exists you must sell the position. - no rationalizing, no excuses -sell. I bought gdc.to for 3 major reasons. 1) it was fundamentally cheap 2) it was showing a multi-month bottoming formation and 3) it had good potential to be a takeover target in the near future given that there was already a takeover attempt last year which fell through and that the company stated shortly afterwards it was putting itself up on the block for a merger/takeover. Today the company announced that it couldn't find any suitors willing to pay an adequate price and so it's giving up on shopping itself around. As a result, buying reason number 3 no longer exists. I thought it was pretty shitty that they announced this news in the middle of the trading day forcing me to make a quick decision but in the end I followed my rules and sold. I realize that only 1 of the 3 reasons I bought the stock are no longer there and the news doesn't change the undervalued fundamentals which I rank as most important so maybe I was too brash. But you know what? Why compromise? Why settle for anything less than what meets your expectations? I have other undervalued candidates with similar fundamental attractiveness that deserve my money more. Having a takeover/merger possibility with your stock improves the reward part of the risk/reward ratio and with gdc.to that reward potential is no longer there.
I still managed to exit the position with a marginal gain but if I had been in a position when I'd have to take a loss I still would have (unless there was a really steep, emotionally charged panic sell-off). When people see bad news that makes them want to sell they'll often say "I'll sell when the stock bounces back and I break even". That's not the way you play this game. The market doesn't give a rat's ass what you paid for the stock -it's gonna take the stock wherever it feels fits. You have to be willing to take a loss in this game. I know it can be especially hard to take a loss if you were up on a position for quite some time and then suddenly your gains are wiped out or turn to losses but you have to be willing to do that IF it's the right thing to do, meaning rational analysis suggests you do so. You can't get hung up on the past. Again, the market doesn't give a rat's ass about the past and how much you were up.
Here's the way I look at things when it comes to buying stocks. My capital is the equivalent to the most eligible bachelor in the world and the thousands of stocks that are out there are the equivalent to the thousands of eligible women who are throwing themselves at me. I can have any of these women at the snap of a finger much like how I can have any stock with a click of a mouse. So, if I select what I think is a perfect woman and then I realize she's not what I expected her to be, like for instance she starts giving me attitude all the time I'll kick her to the curb without any hesitation and look for someone else. How dare she give me attitude! She should be so grateful that I picked her over of the thousands of others who do would anything to have me! That's the way I look at the stocks I buy. This doesn't mean I'm completely intolerant of bad news. If for example I'm buying a company that I believe is near the trough of the cycle, I would expect the possibility of bumps in the road. But what I don't tolerate are the types of negative surprises that invalidate what I believed the risks and potential of the company were. I don't put up with that kind of shit.
It's amazing how people put up with abusive "stock relationships". When I was an adviser I can't tell you how many people I met who were still holding the bag on Nortel years after it peaked and crashed. I think 90% of the Canadian investing population was a Nortel bag holder. No matter how many times the company had promised things were going to improve and then failed to deliver, no matter how many times they had to restate prior earnings which were over inflated, you just couldn't convince most of these people to sell and move on. Instead they preferred to be abused over and over and over thinking idiotically "it's not a loss until I sell" or "it's too late to sell now". Most often it turns out that it's not too late to sell a loser like Nortel. Not only should you never be abused like most Nortel shareholders were, but if you're fully invested and you find another opportunity that has a better risk/reward setup then whatever positions you're in, you have to make the switch.
Wednesday, February 22, 2012
Sunday, February 19, 2012
Don't pass gas
Nat gas is by far the worst preforming major commodity since 2009. When it hit $2.30 about a month ago it was at its lowest point since 2002 and on an inflation adjusted basis, as low as it was in 1999. Anyone who tried to be a contrarian buying nat gas stocks and related ETFs has gotten their asses handed to them big time. But that was then, how about now? Could nat gas prices finally just about seen their worst? There's some good signs that it has.
I'm sure most of you probably know why nat gas is fundamentally appealing. One bbl (barrel) of oil has about 6 times the raw energy output of one mcf (1000 cubic feet) of gas which means the price of oil is theoretically fairly valued when it's 6 times that of gas. Now, I realize it's not that simple because these 2 energy sources are not interchangeable - we can't conveniently switch everything that runs on oil derived products to nat gas and vice versa, but when you consider that right now oil is 40 times more than the price of gas there's no question this ratio is out of whack. Either oil is overvalued, gas is undervalued or some combination of both. I'd say it's the last one with an emphasis of gas being undervalued. So, the potential is certainly there for the nat gas price to be a lot stronger in the years ahead.
We all know the culprit of weak nat gas prices - new advancements in drilling and fracing which allowed the ability to unlock gas trapped in shale wherby some massive discoveries of such have been made. The result has been a huge new supply in gas. In addition, natural gas liquids (NGL) which are often found in these new gas plays have significantly lowered the break even (b.e) prices of many of these shale plays which adds even more to supply pressures. When you combine this with a very warm winter you have the perfect storm for a collapse in price and that's what happened. But now the fundamentals are lining up in favor of higher prices.
From what I've read, the average break-even cost for nat gas producers is $5-7/mcf. Apparently, a big reason why gas production has been so high in the past few years despite prices trading below break-even is because producers were able to hedge future production at favorable prices but those attractive hedging opportunities are no longer available. That's a major positive. Just recently, thanks to the collapse in the price these past 2 months, big producers such as Devon, EOG, Encana and Chesapeake threw in the towel and announced significant cutbacks in production. Meanwhile, natural gas rigs in service in the US has been falling precipitously from a recent peak of 997 in 2010 to 777 (as of last month) and pretty much guaranteed to drop more after the cut back announcements by the majors. One article I read suggests that the market will be balanced when nat gas rigs in service are at 725 and that's quite likely going to happen very soon. So all in all, the supply glut is set to ease quite a bit in the coming months which should be supportive for higher prices.
On the demand side, we are starting to see a signficant shift by utlities from coal to nat gas but keep in mind not all utilities have the ability to make the switch. I'm not sure how much of an impact this switching will be....this is something I need to research more. If general economic activity continues to strengthen in the US, that too should add to demand pressures. The warm winter was definitely a hit towards demand but that impact has probably largely played out already. So, things should be looking incrementally better on the demand side too.
The supply and demand issues I discussed above are medium term in nature. When talking about the long run, things look really interesting for nat gas. As a result of the recent shale discoveries, some reports suggest the US has a massive supply of nat gas that can make them energy self-sufficient for 100 years. Even if this is exaggerated there's little argument that the US has landed a massive windfall with all this shale gas. The two major ways they can exploit this windfall is to 1) become substantially more energy self sufficient promoting nat gas powered vehicles and 2) wide scale exporting of nat gas to Europe and Asia where prices are north of $11/mcf. Whatever path is taken, demand pressures for gas will explode. However, it will require time and massive infrastructure investment before either option can be a reality and so in the meantime, it's best to focus on the medium term issues I discussed above.
From a sentiment and technical perspective there's some interesting things going on as well. The nat gas sector is clearly out of favor but despite this, I have seen countless failed attempts by retail traders in bottom picking UNG over the past few years. But I think we are finally at the point where even the most patient nat gas bulls and bottom pickers have given up. The capitulation by the majors to cut production also marks the kind of things you see near major bottoms. Here's what Cramer wrote about a month ago right smack dab at the most recent bottom.
What's happening with the natural gas sector right now reminds me a lot of what happened to gold in the late 90's. Before the bull market in gold began in 2001, it had been trading at or below the avg cost of production (estimated to be about $320-$350 at the time) for about 4 years, plagued by oversupply due to central bank selling. The selling was so pervasive that in September of 1999 "The Washington Agreement" was signed by major central banks to limit central bank selling which ended up marking the bottom of the gold bear market. This to me is similar to the recent announcement of major cut backs in nat gas production by the big boys. Getting back to gold... although the final bottom was made in 1999, it wasn't until 2001 when the bull market for gold began and by then all but the hard core gold bugs had given up on. There's no telling for sure when the final bottom will be made and just how that bottom will look like. It could be V shaped or gradual and drawn out like the bottom in gold was. If you compare nat gas to gold just prior to it's bull market, I'd say we're somewhere in 1999-2001 so I'd say it's time to get some exposure but only if you can be patient and a strong holder.
The best way to play the sector would be to focus on pure play stocks like ECA and CHK. I'd stay away from UNG or GAS.to because of the slippage due to contango in the futures. I have a position in High Arctic Energy Services (hwo.to) - a very undervalued small nat gas service company that operates in Alberta and Papua New Guinea. This company has gotten no respect whatsoever (probably because it's labeled as a nat gas stock) despite being very profitable. Their Canadian customers have focused on nat gas liquids plays which have been able to still thrive despite low nat prices (however at $2.50 that may not be the case anymore) and more importantly, 2/3 of their revenues come from a customer in Papua New Guinea (PNG) wherby they have LT contracts in place untill the end of next year and amgonst other things, is expected to have completed a LNG facility in 2 years to exports nat gas to Asia whereby prices have remained elevated and are well over $11/mcf. The company is making tons of cash relative to it's market cap, has a solid balance sheet, trades at tangible book value and has a p/e of 3! Even if there's a sharp decline in their Canadian operations due to the recent collapse in nat gas prices (which according to recent guidance doesn't appear to be forthcoming) the depressed stock price more than reflects this, plus they are still well positioned with their major customer in PNG which accounts for most of their earnings anyways.
I'm sure most of you probably know why nat gas is fundamentally appealing. One bbl (barrel) of oil has about 6 times the raw energy output of one mcf (1000 cubic feet) of gas which means the price of oil is theoretically fairly valued when it's 6 times that of gas. Now, I realize it's not that simple because these 2 energy sources are not interchangeable - we can't conveniently switch everything that runs on oil derived products to nat gas and vice versa, but when you consider that right now oil is 40 times more than the price of gas there's no question this ratio is out of whack. Either oil is overvalued, gas is undervalued or some combination of both. I'd say it's the last one with an emphasis of gas being undervalued. So, the potential is certainly there for the nat gas price to be a lot stronger in the years ahead.
We all know the culprit of weak nat gas prices - new advancements in drilling and fracing which allowed the ability to unlock gas trapped in shale wherby some massive discoveries of such have been made. The result has been a huge new supply in gas. In addition, natural gas liquids (NGL) which are often found in these new gas plays have significantly lowered the break even (b.e) prices of many of these shale plays which adds even more to supply pressures. When you combine this with a very warm winter you have the perfect storm for a collapse in price and that's what happened. But now the fundamentals are lining up in favor of higher prices.
From what I've read, the average break-even cost for nat gas producers is $5-7/mcf. Apparently, a big reason why gas production has been so high in the past few years despite prices trading below break-even is because producers were able to hedge future production at favorable prices but those attractive hedging opportunities are no longer available. That's a major positive. Just recently, thanks to the collapse in the price these past 2 months, big producers such as Devon, EOG, Encana and Chesapeake threw in the towel and announced significant cutbacks in production. Meanwhile, natural gas rigs in service in the US has been falling precipitously from a recent peak of 997 in 2010 to 777 (as of last month) and pretty much guaranteed to drop more after the cut back announcements by the majors. One article I read suggests that the market will be balanced when nat gas rigs in service are at 725 and that's quite likely going to happen very soon. So all in all, the supply glut is set to ease quite a bit in the coming months which should be supportive for higher prices.
On the demand side, we are starting to see a signficant shift by utlities from coal to nat gas but keep in mind not all utilities have the ability to make the switch. I'm not sure how much of an impact this switching will be....this is something I need to research more. If general economic activity continues to strengthen in the US, that too should add to demand pressures. The warm winter was definitely a hit towards demand but that impact has probably largely played out already. So, things should be looking incrementally better on the demand side too.
The supply and demand issues I discussed above are medium term in nature. When talking about the long run, things look really interesting for nat gas. As a result of the recent shale discoveries, some reports suggest the US has a massive supply of nat gas that can make them energy self-sufficient for 100 years. Even if this is exaggerated there's little argument that the US has landed a massive windfall with all this shale gas. The two major ways they can exploit this windfall is to 1) become substantially more energy self sufficient promoting nat gas powered vehicles and 2) wide scale exporting of nat gas to Europe and Asia where prices are north of $11/mcf. Whatever path is taken, demand pressures for gas will explode. However, it will require time and massive infrastructure investment before either option can be a reality and so in the meantime, it's best to focus on the medium term issues I discussed above.
From a sentiment and technical perspective there's some interesting things going on as well. The nat gas sector is clearly out of favor but despite this, I have seen countless failed attempts by retail traders in bottom picking UNG over the past few years. But I think we are finally at the point where even the most patient nat gas bulls and bottom pickers have given up. The capitulation by the majors to cut production also marks the kind of things you see near major bottoms. Here's what Cramer wrote about a month ago right smack dab at the most recent bottom.
"Only in this totally nuts country can the low price of natural gas not be a positive. We have so much of this stuff and we have so many ways to use it that aren't being used that it is disgraceful.
We are headed to $1 natural gas in this country. The rest of the world is headed to $18. The differential is amazing. The rest of the world is clamoring for our natural gas, but our administration hasn't been able to figure out a single way to make it work for us. There's no encouragement to get trucks to switch from dirty imported diesel, and no mandates like those we had for ethanol, even as ethanol jacks up the price of precious food and uses a humongous amount of water. Ethanol is a scourge to this nation and natural gas is a blessing, but it doesn't matter.
Here's the real crime. I was perfectly fine with the Keystone pipeline being blocked if we simultaneously said, "We don't need dirty Canadian crude to run our cars we can use our own natural gas until the cost of electric cars come down and utilities switch to natural gas from coal over the next few years when the coal plants' lives expire."
Nope. Nothing. We just said, "Canada, go send your oil to Asia, will you? We don't want it. We want to import oil from Venezuela and the Middle East."
And that is exactly what we are doing."
Here is another thing that makes me believe that nat gas is at or close to a major bottom. At the most recent low at about $2.30 nat gas was trading 40% below the 200 DMA. That's quite extreme. To put that into perspective, the SPX was trading 40% below the 200 DMA at the November 2008 lows when it hit 750 and at the bear market bottom in March 2009. So, folks it's quite clear to me that we are at at least due for a major snap back rally in nat gas and quite possibly have reached or close to reaching a final bear market bottom.
The best way to play the sector would be to focus on pure play stocks like ECA and CHK. I'd stay away from UNG or GAS.to because of the slippage due to contango in the futures. I have a position in High Arctic Energy Services (hwo.to) - a very undervalued small nat gas service company that operates in Alberta and Papua New Guinea. This company has gotten no respect whatsoever (probably because it's labeled as a nat gas stock) despite being very profitable. Their Canadian customers have focused on nat gas liquids plays which have been able to still thrive despite low nat prices (however at $2.50 that may not be the case anymore) and more importantly, 2/3 of their revenues come from a customer in Papua New Guinea (PNG) wherby they have LT contracts in place untill the end of next year and amgonst other things, is expected to have completed a LNG facility in 2 years to exports nat gas to Asia whereby prices have remained elevated and are well over $11/mcf. The company is making tons of cash relative to it's market cap, has a solid balance sheet, trades at tangible book value and has a p/e of 3! Even if there's a sharp decline in their Canadian operations due to the recent collapse in nat gas prices (which according to recent guidance doesn't appear to be forthcoming) the depressed stock price more than reflects this, plus they are still well positioned with their major customer in PNG which accounts for most of their earnings anyways.
Given my heavy weighting in Canadian small cap energy service stocks last year, I followed the news flow quite closely with the sector I can tell you without any doubt that pretty much EVERY company in the sector has focused their resources on servicing oil plays while shunning nat gas plays. This puts hwo.to in a potentially lucrative position long term. When nat gas becomes in favor again they will be one of the few companies readily available to meet the needs of the sector. In fact, the company has first call agreements with major customers. When the next boom in nat gas eventually takes hold, it will take a least a year before their competitors will be able or willing to shift back to nat gas service but by then the best opportunities will have been lost. Hwo.to will be in a similar situation like Forest Gump was when his boat was the only one to have survived the storm and he had all the shrimp to catch for himself! In addition to hwo.to I'm contemplating 2014 calls in ECA.to
Tuesday, February 7, 2012
How the dice rolls
Let me start off by saying that I'm part investor, part speculator with speculator being defined as one who trades based upon price action. I try taking the best of both worlds, however, I'm a investor first, speculator second. I invest using a value foundation because in the end the value approach wins the most. After all, a stock is simply an ownership claim to a business and if you buy that business cheap, or any other asset cheap for that matter, time is on your side and you'll come out a winner in the end whereas if you buy high to sell higher time is your enemy. This is why Buffett and Templeton are the legends that they are. They bought stocks that traded at a "bargain" to what they believed their true value was and held for years and sometimes decades. While, it's arguable as to what a company is truly worth, there are situations when little argument can made that a company is being valued a lot less than what it should be and those are the situations smart value investors look for. For instance who's hotter Jessica Alba or Scarlett Johansson? That's arguable, but there's clearly no argument that Jessica Alba is hotter than Rosie O'Donnell. So, a smart investor will look for those situations where the stock trades like Rosie O'Donnell but has Jessica Alba features.
It's important however to avoid value traps. That's a situation when you buy a stock of a struggling company which appears cheap on a book value basis. The trap is that the book value is an illusion because it will likely end up deteriorating a lot more in the months/years ahead if the company continues struggling racking up the losses and possibly writing down their inventories and LT assets. The best example of this was bank stocks in March 2008. Many "value investors" got crushed thinking they were getting good deals buying banks near book but those book values were tainted by toxic MBS and ended up getting substantially written down.
To be a successful value investor what you need to look for are "turn around" situations where a company may have been struggling for some time and thus trades at cheap valuations, but has recently (1 year or less) turned things around and are are making money again or have at least stabilized. I like to look for such opportunities in the small/micro cap space where analyst coverage is minimal. Mind you, there's a lot of junk in this space, but if you search hard enough and yes, get a little lucky, you can really score some massive gains. Small companies are often overlooked by analysts and big fund managers...until they start delivering solid results and then finally get the attention they deserve and when that happens look out above! You can get multi-baggers in rather short period of time and it's such a treat to see your stock "graduate" to the next level....but be careful not to fall in love with your stocks!
As I just mentioned above, I look for turnaround stocks....stocks that for whatever reason fell out of favor but are showing early signs of turning the corner or have turned the corner for some time but are not not getting the respect they deserve. Fundamentally speaking, I look for stocks trading at 1.5 times tangible bv or less, have low debt AND have just recently turned the corner in their business going from struggling i.e. a string of negative quarterly EPS to positive EPS or at least break even. It's important you see evidence of the turnaround otherwise you risk falling into a value trap.
Secondly, I want to see favorable price action. I want to either see a multi-month bottoming process or a new, non-parabolic uptrend. This would help to confirm that the turnaround in the company is indeed taking place and the market is just starting to realize it.
Third, I want the company to have 100 Million shares o/s or less. The less shares out there the quicker the stock can move higher. I'm flexible with this parameter though. I also don't want to see any insider selling. Insider buying and stock buybacks are a big plus but not a pre-requisite,
These types of turnaround plays I discussed above are what I call "sweet spot" opportunities. You're getting in early when both the fundamentals and technicals are in your favor...you're getting in when the stock is about to transition from a value stock to a growth stock and in such cases the returns are huge if you get it right.
Caveats to this strategy are as follows.
1. You need to use a buy and hold approach and be able to withstand a lot of noise volatility that is present in the small/micro cap space. Trading volumes tend to be quite thin when you are trying to buy early into a potential turn around situation and so you can see the stock drop 5-10% on just a few thousand shares. If you're one to use tight stops then you can't play these stocks.
2. When you are buying early, often times it will be as exciting as watching grass grow. You may have to wait several months to see any material results, but let me tell you, it's well worth the wait. When the move comes it tends to be out of nowhere and it's explosive. You have to fight the temptation to take profits too early. However, if you crave day to day action and feel pressured to beat the market day in day out (which I think is a bad way to play the game) this strategy is not for you.
3. You need favorable macro conditions i.e. bull market conditions for the sector of the stock and that in turn often means a bull market for equities in general. The mistake I see a lot of stock pickers make is that they think their stocks exist in a vacuum. They don't. Unless the company did something extremely positive like a drug company finding the cure for some disease, you need to have the macro winds at your back.
4. Speaking of drug companies, stay away from small cap pharma stocks. They are far too much like lottery tickets.
So, how do I find these turnaround plays? The main way I find them is to look at every chart of every stock that trades from $.50-$5 on the TSX and from $.30-$2 on the TSXV. I look for interesting price action (charts that fit the "favorable price action" criteria I outlined above). When I see a chart I like, I'll check out the fundies of the company to see if it meets my standards. If that checks out, I'll get familiar the company's "story" reading historical news releases and company presentations. If after all this I like what I see and I'm ready to buy, I'll start by committing 1/3-1/2 of my intended position. As per my rules, no more than 15% of my capital can be allocated to any one idea. This "starter" position will have no stops...the fact that I typically only commit part of my intended position is in effect like a stop. Once I'm in, I can only add more when the stock is behaving favorably and I'm showing a profit. No averaging down allowed. Of course there are exceptions but they should be just that.....exceptions and not the rule. By never averaging down only adding to winning positions it incorporates a method of discipline to counter act reckless conviction. If you want to make big money you gotta have balls but at the same time you can't be reckless and stubborn when you may be wrong otherwise you'll get wiped out. Discipline vs Conviction....it's a delicate balance but one that MUST be there.
Another exception I have is buying a stock that has all the investment criteria I want to see but is not yet showing favorable technical action (multi-month bottom or emerging uptrend). In such cases, there will be a high risk of a V shaped rebound and so waiting for things to settle down before buying could mean missing out on big gains. In that case, the risk/reward is worth "catching the falling knife" but again, I will only commit a portion of my intend position and will not add to it unless it shows a profit.
When I buy these small/micro cap stock I'm looking for at least a 100% gain within 2 years. So far my big winners have taken about 6 months to do so. As I said earlier, I don't use stops with my initial buys although I will sell for a loss if for whatever reason I no longer believe the company will preform as I expect it to. Once I'm fully committed in a position, which means I'm showing a profit, I'll take more protective action with my add-ons. I may designate a portion of a my position as "trading" while keeping the core in tact at all times.
Stocks that I recently purchased are gdc.to, isc.vn, hwo.to, fmc.to, prt.to. I've been quite busy reviewing a few more candidates and so on that note, I'm going to go dark for a while with the blog. Feel free to leave comments/question. Happy hunting!
It's important however to avoid value traps. That's a situation when you buy a stock of a struggling company which appears cheap on a book value basis. The trap is that the book value is an illusion because it will likely end up deteriorating a lot more in the months/years ahead if the company continues struggling racking up the losses and possibly writing down their inventories and LT assets. The best example of this was bank stocks in March 2008. Many "value investors" got crushed thinking they were getting good deals buying banks near book but those book values were tainted by toxic MBS and ended up getting substantially written down.
To be a successful value investor what you need to look for are "turn around" situations where a company may have been struggling for some time and thus trades at cheap valuations, but has recently (1 year or less) turned things around and are are making money again or have at least stabilized. I like to look for such opportunities in the small/micro cap space where analyst coverage is minimal. Mind you, there's a lot of junk in this space, but if you search hard enough and yes, get a little lucky, you can really score some massive gains. Small companies are often overlooked by analysts and big fund managers...until they start delivering solid results and then finally get the attention they deserve and when that happens look out above! You can get multi-baggers in rather short period of time and it's such a treat to see your stock "graduate" to the next level....but be careful not to fall in love with your stocks!
As I just mentioned above, I look for turnaround stocks....stocks that for whatever reason fell out of favor but are showing early signs of turning the corner or have turned the corner for some time but are not not getting the respect they deserve. Fundamentally speaking, I look for stocks trading at 1.5 times tangible bv or less, have low debt AND have just recently turned the corner in their business going from struggling i.e. a string of negative quarterly EPS to positive EPS or at least break even. It's important you see evidence of the turnaround otherwise you risk falling into a value trap.
Secondly, I want to see favorable price action. I want to either see a multi-month bottoming process or a new, non-parabolic uptrend. This would help to confirm that the turnaround in the company is indeed taking place and the market is just starting to realize it.
Third, I want the company to have 100 Million shares o/s or less. The less shares out there the quicker the stock can move higher. I'm flexible with this parameter though. I also don't want to see any insider selling. Insider buying and stock buybacks are a big plus but not a pre-requisite,
These types of turnaround plays I discussed above are what I call "sweet spot" opportunities. You're getting in early when both the fundamentals and technicals are in your favor...you're getting in when the stock is about to transition from a value stock to a growth stock and in such cases the returns are huge if you get it right.
Caveats to this strategy are as follows.
1. You need to use a buy and hold approach and be able to withstand a lot of noise volatility that is present in the small/micro cap space. Trading volumes tend to be quite thin when you are trying to buy early into a potential turn around situation and so you can see the stock drop 5-10% on just a few thousand shares. If you're one to use tight stops then you can't play these stocks.
2. When you are buying early, often times it will be as exciting as watching grass grow. You may have to wait several months to see any material results, but let me tell you, it's well worth the wait. When the move comes it tends to be out of nowhere and it's explosive. You have to fight the temptation to take profits too early. However, if you crave day to day action and feel pressured to beat the market day in day out (which I think is a bad way to play the game) this strategy is not for you.
3. You need favorable macro conditions i.e. bull market conditions for the sector of the stock and that in turn often means a bull market for equities in general. The mistake I see a lot of stock pickers make is that they think their stocks exist in a vacuum. They don't. Unless the company did something extremely positive like a drug company finding the cure for some disease, you need to have the macro winds at your back.
4. Speaking of drug companies, stay away from small cap pharma stocks. They are far too much like lottery tickets.
So, how do I find these turnaround plays? The main way I find them is to look at every chart of every stock that trades from $.50-$5 on the TSX and from $.30-$2 on the TSXV. I look for interesting price action (charts that fit the "favorable price action" criteria I outlined above). When I see a chart I like, I'll check out the fundies of the company to see if it meets my standards. If that checks out, I'll get familiar the company's "story" reading historical news releases and company presentations. If after all this I like what I see and I'm ready to buy, I'll start by committing 1/3-1/2 of my intended position. As per my rules, no more than 15% of my capital can be allocated to any one idea. This "starter" position will have no stops...the fact that I typically only commit part of my intended position is in effect like a stop. Once I'm in, I can only add more when the stock is behaving favorably and I'm showing a profit. No averaging down allowed. Of course there are exceptions but they should be just that.....exceptions and not the rule. By never averaging down only adding to winning positions it incorporates a method of discipline to counter act reckless conviction. If you want to make big money you gotta have balls but at the same time you can't be reckless and stubborn when you may be wrong otherwise you'll get wiped out. Discipline vs Conviction....it's a delicate balance but one that MUST be there.
Another exception I have is buying a stock that has all the investment criteria I want to see but is not yet showing favorable technical action (multi-month bottom or emerging uptrend). In such cases, there will be a high risk of a V shaped rebound and so waiting for things to settle down before buying could mean missing out on big gains. In that case, the risk/reward is worth "catching the falling knife" but again, I will only commit a portion of my intend position and will not add to it unless it shows a profit.
When I buy these small/micro cap stock I'm looking for at least a 100% gain within 2 years. So far my big winners have taken about 6 months to do so. As I said earlier, I don't use stops with my initial buys although I will sell for a loss if for whatever reason I no longer believe the company will preform as I expect it to. Once I'm fully committed in a position, which means I'm showing a profit, I'll take more protective action with my add-ons. I may designate a portion of a my position as "trading" while keeping the core in tact at all times.
Stocks that I recently purchased are gdc.to, isc.vn, hwo.to, fmc.to, prt.to. I've been quite busy reviewing a few more candidates and so on that note, I'm going to go dark for a while with the blog. Feel free to leave comments/question. Happy hunting!
Saturday, February 4, 2012
Weekend Ramblings
Ok, I know I said I wasn't gonna focus on the macro but given what's happened I'm going to talk about it in this post, get it off my chest and then that's gonna be it for a while regarding the macro. Given where I see the market headed, as I said last week, I think it's best I focus my attention on doing micro research going forward.
I look back at my posts in recent months and I recall how I was in "stock market purgatory". I respected both the bull and bear case equally. Although things looked pretty grim and I respected the "end game" scenario, I never fully embraced the bear case because of a few reasons. 1). Big bear markets of the past didn't begin with a crash unless it was the popping of a bubble and we did NOT have a bubble prior to the crash.....not even close with consumer sentiment still near historical lows, retail only moderately getting back in after massive outflows in the years prior and hearing commercials that say "in these challenging times" all of which suggests greed was absent 2) The doom and gloom in the summer was brick thick and main street dumb money - the best contrary indicator of them all, was flashing LT bullish signals. Remember when I made mention in the summer how Jay Leno and the other talk show hosts were making jokes about the economy and how a few of my friends on facebook said "here comes the recession". That told me not to fully embrace the bear case.....I respected it but I knew that if the bears would be right it would mean that dumbest of the dumb money as represented by Jay Leno and my friends would also be right and that indicated to me the door was left wide open for the bulls to somehow, someway still come out victorious. With the market now recovering just about all the losses from the summer (with the Nasdaq at new highs) and more importantly, doing so with bull market action, I'm in purgatory no longer. Bulls win bears lose. Case dismissed.
I ask myself should I have done better throughout all of this. I most certainly could have. Although I turned IT bearish in June and nicely sidestepped the mini-bear market I didn't do nearly as good a job getting back in. At the October lows I saw enough evidence of at least an IT rally and that warranted getting some exposure to the long side but I hesitated and failed to pull the trigger. I was overly cautious and too respectful of market action. I then started getting back in come December. There's a delicate balance you have to have in this game between discipline and conviction. Most people tend to have way too much of the latter and eventually go broke because of it. I tend to have too much of the former. I'm definitely working on correcting that.
Ok enough about past and the shouldofs, wouldofs couldofs. What about now? I see 2009 all over again. The trading community is fighting this rally tooth and nail and instead of capitulating they remain stubborn, angry and bitter than ever. Remember back in 2009 I coined the phrase "troika of death" which then was FAZ, SRS, and SKF? Well now we have a new troika of death TVIX, SPXU and TZA. I'm quite convinced that the average retail trader not only missed this rally but lost money during it using some combination this trokia of death. I can tell by looking at the messages on the SPY message board on yahoo finance. This behavior is LT bullish.
The US economy seems to be picking up steam and the evidence is clear that there will be no double dip. Jobs gains were strong this month and with the 4 week moving average of unemployment claims well under 400K hitting 3 year lows, we should see continued strong job creation. Last 2 month's figures were also revised higher and that's something you tend to see early in a recovery, not when you're gonna roll over into a recession but I'm sure the permabears are going to find something to criticize about this job report. You know what? I've had it with these permabears. Even when I've been bullish I've read the commentaries of noted bears like Maudlin and Hussman to give me a balanced perspective but I find they do more damage than good. At times they helped cause me to second myself just enough for me to miss an opportunity. And have you actually looked at the a LT performance numbers or track record of these guys? Not good...not good at all. So why the fuck should I allow these jokers to poison my mind? When I turned IT bearish in June it wasn't because of the permabears telling me it was because the market was telling me, just like when it was telling me to be bullish recently. From now on, I'm going only use "the force" and my indicators. If you find that reading my blog is causing you to second guess yourself then you should stop reading it...don't worry I'll take no offense!
Ok back to the market. Now look, I realize that the market already had a huge move and it can't go up at this pace forever otherwise were gonna have 60%+ gain on the year which obviously ain't gonna happen. But these big, relentless rallies are what you see early in new bull market advances - they don't give you a chance to get in and they surprise both bear and bulls alike with their strength and with all the top picking going on, I'm thinking pullbacks should still be shallow....eventually we'll get a bigger one and perhaps that happens very soon but that too should be relativity mild compared to the action in the summer. Whatever the case may be, I'm not going to fixate on this ST minutia. If I see a good long set up I'm gonna go for it but at this point I'm gonna be more selective. Chasing parabolic moves doesn't qualify as a good set up....I'm talking about stocks that are poised to play catch up on brink of breaking out from a consolidation. GDC.to is one stock I have which appears poised to do so.
At this point in time, I'm willing to commit 50% of my account to longs and keep in my mind, my longs are in the small/micro cap space which tends to have a lot of leverage. I will also be willing to put on a hedge if and when I see fit. When we do eventually get the correction, let's see how it plays out. If it's a true bull, we shouldn't see a big drop. Just how far can this market potentially go? A lot farther. There's still plenty of fuel in the tank. Last year the market made no progress despite reaching record earnings thus making it more attractively valued especially with how low bond yields still are. Retail has only been dribbling back in and there's a long way to go before they make up for all the outflows that have taken place over the past several months and years for that matter. Despite the big move in stocks, LT bond yields have remained near rock bottom levels. Any move out of bonds into stocks can drive them up and there's a lot of gas in that tank. If you look at what happened prior to any major declines in the market in recent years you will notice that bonds were selling off for months and were oversold. We are still at massive overbought levels in bonds which tells you not only is upside potential still large but also that downside should be limited at this point.
As per the request of someone on planbeconomics.com I'll go over my stock selection approach as well as discuss my system of money management in my next post.
I look back at my posts in recent months and I recall how I was in "stock market purgatory". I respected both the bull and bear case equally. Although things looked pretty grim and I respected the "end game" scenario, I never fully embraced the bear case because of a few reasons. 1). Big bear markets of the past didn't begin with a crash unless it was the popping of a bubble and we did NOT have a bubble prior to the crash.....not even close with consumer sentiment still near historical lows, retail only moderately getting back in after massive outflows in the years prior and hearing commercials that say "in these challenging times" all of which suggests greed was absent 2) The doom and gloom in the summer was brick thick and main street dumb money - the best contrary indicator of them all, was flashing LT bullish signals. Remember when I made mention in the summer how Jay Leno and the other talk show hosts were making jokes about the economy and how a few of my friends on facebook said "here comes the recession". That told me not to fully embrace the bear case.....I respected it but I knew that if the bears would be right it would mean that dumbest of the dumb money as represented by Jay Leno and my friends would also be right and that indicated to me the door was left wide open for the bulls to somehow, someway still come out victorious. With the market now recovering just about all the losses from the summer (with the Nasdaq at new highs) and more importantly, doing so with bull market action, I'm in purgatory no longer. Bulls win bears lose. Case dismissed.
I ask myself should I have done better throughout all of this. I most certainly could have. Although I turned IT bearish in June and nicely sidestepped the mini-bear market I didn't do nearly as good a job getting back in. At the October lows I saw enough evidence of at least an IT rally and that warranted getting some exposure to the long side but I hesitated and failed to pull the trigger. I was overly cautious and too respectful of market action. I then started getting back in come December. There's a delicate balance you have to have in this game between discipline and conviction. Most people tend to have way too much of the latter and eventually go broke because of it. I tend to have too much of the former. I'm definitely working on correcting that.
Ok enough about past and the shouldofs, wouldofs couldofs. What about now? I see 2009 all over again. The trading community is fighting this rally tooth and nail and instead of capitulating they remain stubborn, angry and bitter than ever. Remember back in 2009 I coined the phrase "troika of death" which then was FAZ, SRS, and SKF? Well now we have a new troika of death TVIX, SPXU and TZA. I'm quite convinced that the average retail trader not only missed this rally but lost money during it using some combination this trokia of death. I can tell by looking at the messages on the SPY message board on yahoo finance. This behavior is LT bullish.
The US economy seems to be picking up steam and the evidence is clear that there will be no double dip. Jobs gains were strong this month and with the 4 week moving average of unemployment claims well under 400K hitting 3 year lows, we should see continued strong job creation. Last 2 month's figures were also revised higher and that's something you tend to see early in a recovery, not when you're gonna roll over into a recession but I'm sure the permabears are going to find something to criticize about this job report. You know what? I've had it with these permabears. Even when I've been bullish I've read the commentaries of noted bears like Maudlin and Hussman to give me a balanced perspective but I find they do more damage than good. At times they helped cause me to second myself just enough for me to miss an opportunity. And have you actually looked at the a LT performance numbers or track record of these guys? Not good...not good at all. So why the fuck should I allow these jokers to poison my mind? When I turned IT bearish in June it wasn't because of the permabears telling me it was because the market was telling me, just like when it was telling me to be bullish recently. From now on, I'm going only use "the force" and my indicators. If you find that reading my blog is causing you to second guess yourself then you should stop reading it...don't worry I'll take no offense!
Ok back to the market. Now look, I realize that the market already had a huge move and it can't go up at this pace forever otherwise were gonna have 60%+ gain on the year which obviously ain't gonna happen. But these big, relentless rallies are what you see early in new bull market advances - they don't give you a chance to get in and they surprise both bear and bulls alike with their strength and with all the top picking going on, I'm thinking pullbacks should still be shallow....eventually we'll get a bigger one and perhaps that happens very soon but that too should be relativity mild compared to the action in the summer. Whatever the case may be, I'm not going to fixate on this ST minutia. If I see a good long set up I'm gonna go for it but at this point I'm gonna be more selective. Chasing parabolic moves doesn't qualify as a good set up....I'm talking about stocks that are poised to play catch up on brink of breaking out from a consolidation. GDC.to is one stock I have which appears poised to do so.
At this point in time, I'm willing to commit 50% of my account to longs and keep in my mind, my longs are in the small/micro cap space which tends to have a lot of leverage. I will also be willing to put on a hedge if and when I see fit. When we do eventually get the correction, let's see how it plays out. If it's a true bull, we shouldn't see a big drop. Just how far can this market potentially go? A lot farther. There's still plenty of fuel in the tank. Last year the market made no progress despite reaching record earnings thus making it more attractively valued especially with how low bond yields still are. Retail has only been dribbling back in and there's a long way to go before they make up for all the outflows that have taken place over the past several months and years for that matter. Despite the big move in stocks, LT bond yields have remained near rock bottom levels. Any move out of bonds into stocks can drive them up and there's a lot of gas in that tank. If you look at what happened prior to any major declines in the market in recent years you will notice that bonds were selling off for months and were oversold. We are still at massive overbought levels in bonds which tells you not only is upside potential still large but also that downside should be limited at this point.
As per the request of someone on planbeconomics.com I'll go over my stock selection approach as well as discuss my system of money management in my next post.
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