Author Archives: Scalper1

Spinoffs: Looking For Value

Investing in and around spinoffs has been an extremely lucrative endeavor over the past decade, according to the Nov. 30 issue of Value Investor Insight. Indeed, since the end of 2002, Bloomberg has maintained a U.S. Spin-Off Index, which tracks the share prices of newly spun-off companies with market capitalizations of more than $1 billion for three years after they begin trading. Over the near 13-year period tracked, Bloomberg’s U.S. Spin-Off Index has risen 557%, compared to a return of 137% for the S&P 500. Moreover, spinoff activity is close to an all-time high as companies, spurred on by activists, try to unlock value for shareholders by splitting up their businesses. This year’s total number of spinoffs is expected to be 49, the fourth-highest level on record. However, more often than not, due to a number of factors, spinoffs are mispriced by the market, which can lead to some very attractive opportunities for value investors. In this month’s issue of Value Investor Insight , four spinoff experts – Murray Stahl of Horizon Kinetics, Joe Cornell of Spin-Off Advisors, The London Company’s Jeff Markunas and Jim Roumell of Roumell Asset Management – discuss the key factors that lead to spinoff mispricing and where they’re looking for opportunity today. (click to enlarge) Spinoffs: Four key factors There are four key structural factors that can lead to spinoffs being mispriced : Limited information – The documentation filed with the SEC when companies split can be quite complex, and the pro-forma financials can be difficult to analyze. Moreover, analyst coverage tends to be limited, and investors, rather than do the legwork themselves, would rather look elsewhere. Forced selling – A spinoff may see a parent company force a SpinCo onto a shareholder that doesn’t want, or legally can’t hold the shares, which will lead to selling. An S&P 500 Index fund can’t own a spinoff company outside the index, for example. Sandbagging – SpinCo managements usually receive significant financial incentives to underperform and over-deliver. Top managers’ incentive stock plans are typically based on average share prices of the spinoff company for the first 20 or so days of trading after the spinoff, which can lead to sandbagging of the highest order before those prices are locked in. ” Capitalism works ” – According to Value Investors Insight , when a SpinCo leaves its parent, “pent-up entrepreneurial forces are unleashed” as “the combination of accountability, responsibility, and more direct incentives take their natural course.” In other words, without the parent, the newly independent company can take advantage of capitalist forces to improve performance. Spinoffs: Looking for value So what do the experts look for in a good spinoff? According to Murray Stahl of Horizon Kinetics, there are four key characteristics to look for when a company spins off an unwanted subsidiary or division. First, a higher-margin business is spinning off a lower-margin business. Second, CEO movements. If the CEO of the larger company decides the best place to be is with the spinoff it’s, “a message to heed.” There’s also the capital structure of the SpinCo to consider. Too much debt dumped on the SpinCo from the parent can be a burden that haunts the company and strangles growth. That said, if figures show that the debt can be paid down over time, this creates an opportunity, like a publicly-traded leveraged buyout, according to Murray Stahl. And the last spinoff situation that creates an opportunity for profit is the very small spinoff that those engaged in industrial-scale money management are unable or unwilling to own (market cap

Why Oil Is Crashing Again And How That Affects The Markets

The stock market fell yesterday as there are rumors that the Saudis will not cut production when they meet on Friday. As a result, this is what happened to oil yesterday. If that is not bad enough, then the statistics in this chart came out yesterday: For those holding anything to do with oil or oil production, it was a real wake-up call as the world now has +158 million barrels of oil in excess of the historical average going back to 1983. That’s right, +45.8% more oil in reserve than the historical average. Then this week the oil analysts got it wrong again as they expected crude supplies to drop by -800,000 barrels, but they actually went up by +1,177,000. Basically, we are running out of places to store the oil and that is an even bigger problem. As new oil gets produced, it immediately has to be sold on the open market right away at any price, as there is no place left to store it. When things get so bad that oil needs to be “sold at any price” , just to get rid of it, then you have serious problems. I have been warning about this for over a year now, but investors are still bullish about oil and say that we may have hit the bottom. Sorry folks; if the Saudis and OPEC do not cut production, then everything will start being sold on the open market and “$30 a barrel, here we come” or another 25% drop in oil from here. Now what does this have to do with our Apple (NASDAQ: AAPL ) or Gilead (NASDAQ: GILD ) stocks, and why did they go down? Well, since a majority of stocks are in ETFs and Indexes these days, any one sector’s collapse can bring everything else down with it, no matter how strong the companies are that you hold or how great each is doing on Main Street. It does not matter one bit how strong your holdings are as anyone with a computer and a brokerage account can sell at any second in panic, and then seeing this happen high frequency trading computers join in and then we go down. The way to combat this is to: 1) diversify heavily by never putting more than 2% in any one stock, 2) never buy or sell stock out of emotion without crunching the numbers (Friedrich), 3) only buy stocks with elite management and great Friedrich numbers, and 4) when such stocks are not selling at good prices => You Just Do Not Buy Them. Friedrich has only allowed my clients to go 23% to stocks as he just can’t find many things for us to buy. It is a mistake to be fully invested at all times “just to be invested” as it’s great to do so when the bulls are running, but as I have said it is a terrible strategy when the bears and not the bulls eventually control the show. Remember, going back 235 years we have averaged two bull markets and two bear markets every 15 years, so one has to invest with a 15-year time frame in mind. Here are the last 15 years as proof: (click to enlarge) When everyone else is greedy, you sit on the sidelines; and when everyone else starts to panic, you only then get greedy. That is not my saying but that of Warren Buffett (paraphrased). As you can see my job is far from easy these days, but I sleep well at night as I always operate with the knowledge that we will have two bull and two bear markets every 15 years; and thus, I am prepared ahead of time. Not having a bear market show up since 2009 tells us that we are historically due for one. To ignore this fact will open one up to huge potential losses, such as those experienced by oil investors in the last few years, as they did not operate off of facts but on what their gut is telling them. The Friedrich Investment System works off of the facts, off of history (by using ten years of data) and by getting the story right. As a result of this analysis, we are 23% invested and 77% in cash because there is a great deal of 1) uncertainty; 2) manipulation by the government, OPEC, corporations and traders; 3) 1 & 2 allows for high frequency computers to step along with hedge funds and just amplify everything to the n’th degree. So, as you can see, investing properly is a science, which only works best when zero emotion is present along with a tremendous amount of hard work and due diligence. But in the end, Warren Buffett has only two rules for successful investing: RULE #1 = Never Lose Money RULE #2 = Never Forget Rule #1

Stay Out Of The Junkyard: Low-Priced Stocks Are Hazardous To Your (Financial) Health

My last post generated a fair amount of negative feedback on my Yahoo Finance page and on Twitter . There’s nothing quite like waking up in the morning and being called an idiot (and worse) by all sorts of strangers on the internet. I understand that people have strong feelings about Fannie Mae and Freddie Mac, but I have to say, the vitriol of the comments took me by surprise. Setting aside whether it was fair (or legal) for the government to change the bailout terms for Fannie and Freddie, my main point in writing about the two giant GSEs seemed rather straightforward: the low-priced stocks and preferred shares of Fannie Mae and Freddie Mac are extremely risky investments. If Washington formally nationalizes these companies (or does so informally, as it seems to be doing right now), there is a good chance that their stocks will go to zero. Sure, the big hedge funds and their armadas of lawyers might prevail in court and win the return of the companies’ dividends to shareholders. But even if that happens, it will probably take years. As I wrote in the last line of the post, “There are easier ways to make money.” The broader lesson of the GSEs for both retail and professional investors can be stated in four words: What do I mean by junk stocks? There are all sorts of ways to answer that question. Usually, junk stocks are defined as companies with shrinking revenues, outsized debt loads and negative cash flows. But there’s an easy way to spot junk stocks without digging through financial disclosures: if a stock is below five bucks, it is more than likely a troubled mess not worth investing in. As I write in my book Dead Companies Walking , the vast majority of low-single digit stocks in the market are over – not under- priced. Almost all of them have been relegated to the stock market pick-n-pull for one (or more) of three reasons: a bad business, a bad management team, or a bad balance sheet. It’s not uncommon for companies with sub-$5 stock prices to suffer from all three of these maladies. Yet, many investors cannot resist the temptation to buy these jalopies, hoping for a turnaround that almost never happens. Like vintage cars, a small percentage of cast-off stocks do defy the (very long) odds and regain their former glory. But here’s the thing pick-n-pull investors fail to understand: those stocks are even better buys at $8 or $10 than they were at $2 or $4. Why? Because improving fundamentals have taken hold by then, and the wider market has taken notice. Good news spreads quickly, and healthy, wealthy, and popular companies tend to get healthier, wealthier, and more popular as cash flows fatten and more investors pile in. Consider how brutally top-heavy the markets have been this year. At the end of July, I (lightly) cautioned investors to be wary of the high-flying FANG quartet – Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google ( GOOG , GOOGL ) – saying that any correction in the tech sector could also drag these stocks down to earth again. So much for market forecasting. Shortly after I wrote that post, the market did go through a correction. The FANGs fell along with everyone else, but they’ve all charged to new highs since then. If you add the other two largest tech companies (Microsoft (NASDAQ: MSFT ) and Apple (NASDAQ: AAPL )) to the FANGs, these six behemoths now comprise 12 percent of the S&P 500’s $18.5 trillion total market capitalization, and have accounted for just about all of the index’s gains this year. If these half dozen names were flat, not up, the S&P would be down 1.5 percent year to date instead of up 1 percent. More importantly from an investment standpoint, the likelihood that any of them will go broke is exactly nil. They all have rapid revenue growth, strong balance sheets, capable Boards and highly educated employees. Those attributes are much harder to find at troubled companies with sub-$5 stock prices. The top-heaviness of the current market might be extreme, but it isn’t new. Historically, a minority of stocks have always outperformed the overall market over any lengthy time period. All the major indexes (minus the Dow) are market capitalization weighted. That means a few mega-cap winners, like Google or Amazon, can (and often do) offset the stock price declines at dozens, or even hundreds, of smaller companies. Though I usually don’t buy the stocks of large, widely analyzed businesses, my own returns as a fund manager bear this out. My best performance has occurred when most of my shorts are below $10 (and hopefully heading toward zero) and my longs are pricier. In years where junk outperforms value (like 2003 and 2009), I tend to underperform. A few years back, Blackstar Funds analyzed the returns of the Russell 3000 between 1983 and 2007. Even for a cynic like me, the bearish results were shocking. Of the 8000+ stocks that were either in the Russell 3000 originally or that entered it at some point during the study period (usually via an IPO), 39 percent produced a negative lifetime total return – with 19 percent losing over 75 percent. Only 1 in 5 stocks produced a 300 percent or greater return. And yet, over that same time period, the Russell 3000 gained over 1000 percent – all because a small handful of large winners crushed the median stock’s advance. In life and in the stock market, the rich tend to get richer. For everyone else, it’s a different story. Original Post