A new portfolio

I'm glad to announce that I'm starting a new portfolio. This will cover the 'special siutations' that I learned about in 'You Can Be A Stock Market Genius.' A few things fell into place to convince me that the time was right, and that it could be worthwhile. I discussed LPMA in my last post. Everything seems good (more checking to do, but so far...) so I bought today ahead of PAY (the acquirer) announcing earnings.

On top of that, there's the ACV spin-off that I still haven't completely figured out (I think that it will take their last SEC filing prior to the spin-off for that).

And today, senatornovus of the MFI group started a yahoo group dedicated to the special situations described by Greenblatt. I've already learned that Sara Lee will be spinning off Hanes (the underwear and apparel brand). This looks like a classic Greenblatt-style spin off, and may very well be a good value investment play. A post elsewhere (that I haven't yet confirmed the facts of) suggests that the officers of the new company will stand to benefit from share price being low initially. So they're making it unappealing to mutual funds and other large investors, which should trigger a massive sell-off in the first little while. This should depress the price unreasonably, and make Hanes a very attractive investment. We'll see.

In other news, I panicked a little and sold MEDX when it was announced that they might default on convertible notes. I think that it was a panic move because it looks as though they've got the cash on hand to cover the debt. But, I wanted to lock in my 12% gains. Medarex is a pretty reasonable long-term investment with several products in late-phase clinical trials and a strong pipeline. We'll just have to see tomorrow morning. I might change my mind about this move, and I might be kicking myself. As an aside, the low trading fees of MBTrading is the only thing that makes this possible; otherwise I definitely would have stuck it out.

LPMA

JG's writing taught me to look for special situations. Justadrone mentioned in his blog that LPMA is possibly being acquired. They've announced that there will be votes taken among shareholders mid-September. The risk/reward looks pretty interesting. I guess that this is essentially a situation called risk arbitrage, where the difference between the current price and that of the premium for the merger is the risk that people are willing to pay for. JG says that in most cases, it's pennies and not worth the risk. But in this case, LPMA is selling for $24, but the price if the deal goes through will be $29. That seems almost too good to be true. I've started looking through the latest SEC filing that I could find. As far as I could tell, there are two reasons that the deal might not go through 1) the shareholders will vote against it and 2) there will be some sort of antitrust situation and the acquisition will not be permitted to go through. I will still look into this further, but the premium is pretty large. It might just be worth it. We'll see.

Update

As the time for picking new stocks approaches, I thought it was time to update my picks to date.

I am very impressed with the MFI portfolio. VPHM announced phase Ib results yesterday that were positive, and the market put it up over a buck in after hours trading. For me what this really means is that the company knows that it needs products to take over from vancocin, and this means that they're on their way. A pipeline can't hurt, that's for sure. TRLG announced that they're opening stores in Palm Beach, I think NYC, and now Latin America. There are rumors that they're shopping themselves out to be bought out. It seems that this is common for MFI stocks: there've been a couple, and IVII (not IIVI from my HG portfolio) just announced that they were being bought out at a 30% premium yesterday. DECK announced great earnings, and that shot them upwards. It's not as clear what's going wrong with the two that are down.

My biotech portfolio has had some ups and downs. I'm looking forward to CBST turning profitable, possibly as soon as next quarter. MEDX is finally up, but it is basically on no news. Same for NOVC being down. I guess I suspected that NOVC was being driven by speculation and also by the institutional investors, which have now bought up 12.7% of the outstanding shares. I had thought that buying when I did was low enough, but maybe one or more mutual funds had to sell off as the price dropped. Who knows? I still think that the companies I have are great for long-term plays, but none are going to really quickly go up by some huge amount. I've invested more in this portfolio than I'd originally intended (a little too much enthusiasm, that I recognize as a beginner's mistake) so I may sell off some of this portfolio in an effort to balance the three portfolios.

My HG portfolio is doing well. Only about a month, and it's up almost 5%. I can't really explain any of this, though. Nothing seemed to have happened for SDA to have dropped, or for IIVI to have gone up (apparently I bought it at the bottom of an upward run). ALDN went up 8% around the end of the conflict in Lebannon (it's an Israeli company). CTRP went up, down and is now up again. Funny, I would have thought that it would have been the fastest riser, but of course this is way too short to say anything meaningful about that.

As I begin to look at MFI picks, I discovered something funny. As I've learned more about what to look for, I am finding fewer and fewer stocks immediately appealing. I'm not sure that I'm looking at exactly what is important, but I'm way too type-A to just pick randomly (like MFI says you're supposed to).

Was it a mistake?

As I mentioned, CBST was down dramatically (>15%) in the past couple of weeks. Should I have bought? I have some confidence in the company, it will turn profitable, and probably soon. But I didn't buy more of it while it was down. I have cash, but I had decided that I was as invested as I wanted to be in my One Up portfolio. In fact, I invested somewhat more than I had initially intended. The cash that I have is earmarked for my other two portfolios, which both have more regimented buying strategies. So was it a mistake not to buy into the downturn of CBST?

Similarly, NOVC has also plunged dramatically in the last few days, I'd guess around 40% or so. Today it gained back 12%. I have less confidence in NOVC than I do in CBST, but regardless, this looks like a bargain. Was this a one-day turnaround, or is it heading back upward? I have no confidence in timing the market, but Mr. Market just can't seem to make up his mind with these biotech stocks. What is the right move?

Exciting week

There's been a lot of excitement this week in my MFI and One Up portfolios.

Cubist's competitor Theravance (THRX) announced results of a clinical trial that were OK but still had some toxicity issues. CBST had dipped by about $4 over the last several weeks, and had been working its way back up. On these results, CBST jumped ~ $1.50 to about $24. Their antibiotic Cubicin is now predicted to be profitable for quite a while. Cubicin will be first-to-market, and is expected to pick up the market which can be anywhere from $200M to $2B or so. And this will only increase as the anti-infective vancomycin increases in failures when antibiotic resistance spreads, probably several years from now. Cubist is on its way to profitability. I expect (and analysts generally agree, from the couple of reports that I looked at) for CBST to achieve profitability as soon as next quarter, and to increase market share for a while to come.

Despite this good news for Cubicin, a product in competition, vancocin (the trade name of vancomycin) did not suffer. Yesterday, the stock price of VPHM was surprisingly unaffected by the good news for CBST, and now today Cowen upgraded VPHM, which sent that stock up as well. The prediction there is that a generic will take longer to hit the market than initially thought due to procedural changes at the FDA. Seems to me that this makes generics of vancocin a nonstarter: I would predict resistance to vancocin to be widespread within a few years, making it not worth the money to develop. But what it does make for is a good MFI stock, with a limited time to hold onto, and a (loose) timeframe for sale.

In the meantime. MEDX has been creeping upward over the last couple of weeks. After it's most recent low point, it is now up 13% (not all of that is gains for me, unfortunately), and has now topped $10. Nice! What I really like about MEDX - what sold me on the company - is their pipeline. Something like 30 monoclonal antibodies, several in phase II and III trials.

CBST, +7% (but still down a little)

VPHM, +8% (up 22% total!)

MEDX, +13% (up 6.9%)

Risk and leverage

What is the big benefit of investing in real estate? It's not the return on investment - it's usually around, what, like 5-10%, I think. (OK, the last couple of years were exceptional here in SD, but the market is tanking now.) The magic of real estate is the leverage. You make a big initial investment, make hefty mortgage payments, sure, but the return is on the total value of the home. That's the sweet part.

You get leverage on stocks by buying long-term options, LEAPs. Another lesson from Joel Greenblatt.

So how can I take advantage of this? I was thinking of buying LEAPs for some of my MFI picks. It's a really aggressive and risky strategy. Maybe more risky than I am prepared to accept. But the idea would be that one or two of every five stock picks from the MFI list would be a LEAP instead of the underlying stock. If the term of the LEAP is longer than the period that I plan to hold the stock, it would take the company tanking for the LEAP to lose all of its value. Especially since I have flexibility in sell date - MFI traditionally says to hold for about a year, and arrange selling to minimize tax effects; because this is a retirement account, that's not a concern. Instead, I can hold for about a year or as much as two years (Greenblatt says that two years should be about the same as holding for one, according to an interview mentioned in the discussion group). So is the riskier strategy worth the potentially higher rewards? I'll have to think about it. Maybe do some investigating into LEAPs of current MFI stocks, and follow their value over the next 6 months to a year. That might be a good test.

Alberto-Culver

In 'You Can be a Stock Market Genius,' Joel Greenblatt says that spin-offs are a special situation that can lead to extraordinary returns. So I've been trying to keep my eyes open. ACV has a well-publicized spin-off coming up, of their Sally Beauty section. It's currently trading at ~$48. At the spin-off, there will be a special dividend of $25. A private equity firm will acquire 47.5% of Sally Beauty for $575M, so they've valued the spin-off at $1.2B. With 92M shares, they are valuing Sally at $13.05 per share. So then Alberto should be valued at $10. How can I find out how this valuation compares to the actual value of the company? I have a suspicion that this undervalues the new companies, but I'm really not sure. The spin-off is expected to occur sometime in Q4. Not long before then, there will need to be at least one SEC filing that will give more details regarding the spin-off. I'll be sure to keep track.

And, to keep my eyes open for more spin-offs.

Scorecard

Here's how I'm doing so far. Don't read too much into this: My first purchases were made July 5, the latest were on July 28. So some of these results are from as little as one week worth of activity. In separate panels are my own biotech picks, my MFI picks and my Hidden Gems picks, and relevant indexes for comparison. What are the highlights? DECK has been nice to watch. They just announced earnings that were way ahead of guidance, but not that much improved relative to last year. Nevertheless, I guess the street liked what they heard. Everyone seems to be talking about Simple, UGG and the return of Teva sandles. Which is great for DECK.

The biotech portfolio is disappointing - the whole industry is down, and the stocks I've picked are especially volatile. But it's been way too short a period to say anything meaningful about these stocks. Let the companies have the chance to report on earnings for a few more quarters (CBST) or hopefully some other surprises (MEDX and maybe ALNY in particular). These picks are speculative, based on the probability of the technology paying off. And are definitely buy and hold plays. NBIX spectacularly showed how that could end up - on the downside. More in later posts.

Cubist

CBST is my biggest single investment. Partly, this was an exuberence purchase, and that is completely a mistake. However, I do think that it is on its way up. It's product, cubicin, was approved by the FDA for sale in the US. Q2 revenue increased $7M from last quarter, and 68% from Q2 last year as the company began to sell the product. Overall, they posted a Q2 net loss of $0.09 per share, when analysts were predicting -$0.05. The market reacted poorly. However, I don't understand the nature of this sell-off. 5 cents of this loss was due to stock compensation. My understanding is that this has to do with new laws regarding how companies account for stock and stock options granted employees. Discounting this loss, the income statement is slightly better than expected by analysts. Another 10 cents of this loss has to do with early debt repayment. While I would normally expect this to be good news for the street, in this case, I agree with notching it in the con column. CBST took on more debt, which was partly used to repay this old debt. So its a net even as far as total debt goes. The point is, though, that revenues are increasing by quarter and year-over-year. This is lesson number one of Investor's Business Daily - follow the earnings.

Reading List

I have read these:
Get a Financial Life - Beth Kobliner
9 Steps to Financial Freedom - Suze Orman
The Little Book That Beats the Market - Joel Greenblatt
You Can be a Stock Market Genius - Joel Greenblatt
One Up on Wall Street - Peter Lynch
Beating the Street - Peter Lynch

This is on my nightstand:
The Intelligent Investor - Benjamin Graham

I discommend these:
The entire 'Rich Dad, Poor Dad' series.

I read two books in the series, got really frustrated, found a critique and am happy to warn everyone away from Robert Kiyosaki's book series. Sadly popular.

Lesson #1

(Initially posted 06-14-06)

First lesson already. I was caught buying high.

Towards the end of last year, I bought into an emerging market fund. It rather quickly gained 50%. Excited, I made a substantially larger investment in the fund. That quickly rose 10%. And then May hit, and the markets tanked. I am now losing money on the investment.

Lesson #1: When I'm excited about my gains, it's time to sell.

Savings

(Initially posted 06-14-06)

Just to clarify about savings... I didn't mean that saving is a bad idea. The point is that I've pretty much got that part down. Given the salary I make, I think it's fair to say that I save a pretty good amount. So the question won't be about whether I save enough - it will be about whether the returns I get are sufficient to turn my savings into 'enough.'

The Starting Line and the Strategy

(Initially posted 06-06-06)

I've got three relevent savings accounts. One is just a regular savings account. Two are for retirement. One of those is a Roth IRA - save after-tax dollars, but no tax is paid on it ever again. The other is a 403(b) - like the more popular 401(k), but for people who work in an educational institution - money is saved tax-deferred. The three accounts are in the same ballpark in terms of dollar figures. This is my starting line.

I'm just getting started. How to go about it? Here's the plan: Use one of these accounts to invest in the stock market for now. This is something of a tester year. What am I comfortable with? How do I do? My regular savings account is possibly going to be needed in the next few years in the form of a down payment on a house/condo. My 403(b) can't be used for stocks - those are the (annoying) rules that the employer made. So, I'm going to use my Roth IRA for investing. I've found a deep-discount online broker - they charge only $0.01 per share ($1 minimum per trade). I'm going to form three portfolios in my Roth IRA, and compete three strategies against one another:

A. Use the MFI. The basic strategy of MFI is to rank all stocks in terms of earnings yield and, separately, return on invested capital. Combine the ranks (eg., if #1 on EY is also #153 on ROIC = combined rank is #154). Choose randomly from the top few percent of that list, such that 5-7 stocks are bought every few months until a portfolio of 20-30 stocks is built up. Hold each stock for a year, then sell and buy new stocks. (There are normally tax implications about exactly when to sell - a little less than a year for losers, a little more for winners - but I don't think that exactly applies in this case, since it's a Roth IRA.) I'm not going to choose 100% randomly - I'm going to also screen for companies in which insiders have recently bought shares. This has been shown to be effective (an online discussion group that I subscribe to posted a report with data on this, and there is an investment company dedicated to this strategy, as well). I'm learning what sorts of financials should be looked at, and starting to learn a little about analyzing companies as well, and these will inform which companies that I invest in.

B. The Motley Fool's Hidden Gem portfolio. Similar approach, but a less mechanical, more research-driven portfolio. Great returns over the last 4-odd years. After what I found about savings vs. returns, the cost for a years subscription seems much more worthwhile.

C. Something along the lines of the One Up on Wall Street approach. I haven't read the book yet, but I think I get the gist: my PhD should be good for something. Maybe it's good for having a superior understanding of the biotech market. For example: I am interested in ALNY. I recently read an analyst report that tried to rank ALNY by using the financials of companies that it called 'comparables.' One of those companies was DVSA. Yes, they are in the same general industry, but no, the business that they do is completely different. DVSA is an established, though still small, biotech company that focuses on producing industrial products using a well-founded technology. ALNY is aiming to produce therapeutics using a technology that is as yet unvalidated. If the technology works, ALNY will clean up, because they have cornered the market on all of the relevent IP. But to compare ALNY to DVSA is actually ridiculous. I'll definitely have more to say on ALNY in the near future.

In addition, I'm going to keep at least 10-15% in reserve, so that when markets tank (like they have in the last three weeks or so), I can buy into them and get great margins of safety.

Just waiting for my account to be funded... It could be up to 10 business days still! For the love--!!

Primer

(first posted 06-06-06)

I've lately become interested in investing in the stock market. I started several years ago investing in index funds. I wasn't interested at the time in getting exceptional returns - just getting returns and not having to think about it. Well, I put my money into an index fund at the top of the bubble, watched my index fund lose 1/3 of its value, and actually found a way to make this seem positive. (I was able to take advantage of dollar-cost averaging! What a coup!) Well, now I want to actually do something with my savings. So I've started to do a little reading.

My initial reading, years ago, was a book called Get a Financial Life. Next was Suze Orman's The Nine Steps to Financial Freedom, which was basically the same basic message as the first book. The investing that I had been doing was right in line with what was suggested by these books. I'm not sure what changed, exactly, but more recently, I became interested in reading about stock investing. I happened to hear about a book called The Little Book That Beats the Market. It came with a Magic Formula for ~30% returns (known as MFI, for Magic Formula Investing), and backtesting showed that the formula worked.

I read quite a while back about the magic of compounding. But yesteday and today, I played around with some numbers and was surprised to see how amazing it really can be. It seems pretty common to assume a $10K starting investment, so I've done that here. "Average returns" is the (more or less) 11% historical return of the market. "Modest savings" is $4K per year, the amount to max out a Roth IRA. The maximum investment in a Roth is bound to go up, but I left it at $4K for the entire time of the series. "Aggressive savings" assumes that the amount saved will go up every few years - to $6K in 3 years, to $8K in 6 years, and so on. "Amazing returns" is the 30% suggested by MFI.

For the first few years, saving helps a lot. But within ten years, MFI beats the more moderate returns. Here's a zoom on the first twelve years. (I added in a data set for amazing returns with moderate saving, because that is realistic - and in this case, average returns, even with aggressive savings, never wins.)

Another way to look at this is: how long until this hypothetical $10K has been turned into $1M? The difference in time scale is surprising. This was the data that made something very clear to me: The classic Suze Orman example of how to save an extra few bucks for retirement is to not drink coffee every day. That $4 at Starbucks really adds up! Well, I don't even drink coffee. As far as I'm concerned, I've saved a huge amount given that I've only ever been a graduate student and a post-doc. And if I listened to Suze, I'd never save enough to have even $1M at this rate - and my expenses are only going to rise.

There was a bit of a bait and switch there - when I complaind that my expenses will only rise. My salary will as well. But this small analysis tells me that the question is not how to save more - even a lot more, like after my salary makes a major jump when I get a real job. The question is how to get exceptional returns. That is what this blog will be about.