The Investing Ninja

Victor Neiderhoffer’s Education of a speculator:  

This book was written by one of George Soros’ former partners.  First of all, peppered throughout the book are various investment canards, that everyone mindlessly spouts, which he proceeds to defile using actual data and statistical computations.  The rest of book is part autobiography and part philosophy tome.  He relates things like sports, sex, music, horse racing and even natural phenomena to market movements.  

There’s a lot of strange things written about Niederhoffer and most of them are true. Yes, the only paper he reads is the National Enquirer.  Yes, he works barefoot.  Yes, he rarely reads any book that’s less than 100 years old.  Yes, he was the National Squash Champion for 10 years.  The eccentricities would make him a kook if he wasn’t so successful, but there is actually a method to his madness.  For instance, if he read what others (especially academics) were saying about the market or a particular stock, that might affect his judgment or make him second guess himself.  But by sticking to the National Enquirer, he avoids having to read that kind of stuff.  Think of it as “mental hygiene”.  

Since he is so methodical with testing and retesting his hypotheses, it makes you realize that you should be more rigorous in your analysis of your investments.  Even if you are making money, you should keep track of your trades to see which of your theories is panning out.  

Just like in his raquetball training, or horse betting, Niederhoffer is a big believer in consistency.  If you trade using different systems (value, speculative, growth) and invest using different sized trades and different strategies, then you can’t expect consistent results. Food for thought that is worth reading. 

I’m a big fan of Marty Whitman, which is why I really wanted to like this book. Marty’s investment results are great, no question about it, and his letters to shareholders are in plain English and very readable. He doesn’t have Warren Buffett’s folksy charm and pithy jokes, but there is a glaring lack of techno-babble and legal boilerplate in his letters. His book, however, is, well, turgid. He co-wrote it with an academic and the language shows. It is plodding, pedantic and has the affected writing style of an ivory tower academic who writes for people sitting in similarly situated ivory towers. It not’s really an academic tome, nor is it a book for the average investor. It ends up being one of those confusing “neither fish nor fowl” books. The best part of this book is the appendix, which features two case studies and goes through what Marty Whitman thinks are the important characteristics to look for in an investment. One of my favorite books is Joel Greenblatt’s book, because rather than just theory, he gives you actual examples and walks you through the thought process. Whitman’s thought process on investing involves a lot more sifting through accounting statements. Luckily, old Marty gives you a good education in reading financial statements before you get to the appendix, but reading 600+ pages before you get to the actual examples is a bit much. Like I said, I’ve read the annual reports from Marty Whitman’s Third Avenue Value Fund and I really learn a lot from them. Sadly, his teaming up with an academic has proved the old saw that too many cooks will ruin your dish. Anyway, I’m glad I read this because I did get useful information from it. I think as you read more and more on investing, you should add this to your queue, but for a novice investor, there are more readable books you can start out with.

The market is tanking today.  I’m down about $1,600 today in my ninja account (I don’t keep track of my IRA, ROTH IRA, 401(k), or my commodity accounts on a regular basis).  I have faith in all the stocks in my portfolio so I bought some more of Aetna (AET) with the money from the stock I sold in Tarragon (TARR).  PTEN is getting knocked down too and I was thinking of adding to my position, but my AET position is small and it’s currently trading below my entry point. (plus AET’s cash position is so strong that it’s hard for the stock to go lower).  Now I have about $7k in AET with today’s purchase.  In PTEN I have about $10k (including my Roth IRA) and a couple of January 09 LEAPS that are exercisable at $25. 

If you’re still a net buyer of stocks, then look at the market going down as a good thing.  You want your stocks to go up when you want to sell, not when you’re still buying. 

I saw this article recently on Long-Short Funds.  Long-Short funds are funds that, basically, take short positions in stocks, as well as long positions, in order to provide a decent return whether the market goes up or down–in theory.  It makes the case that investing in a long-short fund may be good for you because the fund might not make as much when the market goes up (because of the short positions), but you won’t lose as much when the market goes down (because of the long position). 

I disagree.  I NEVER short stocks.  The reason is simple.  When I invest in a company, I look at the possible upside versus the downside.  If you short a stock, you are betting that the price will go down. If you short a stock, the most you can make is determined by the difference between the stock price and zero.  But if the stock goes up, your losses are infinite.  So there is an unlimited loss, but a limited profit.  

Also: 

• the stock market has an upward bias of about 10.1% per year.  So you are going against the tide, and you will need to be really, really right to make up for that bias;
• the frictional costs are high.  you have to generally pay more than a nice chunk to borrow a stock to short, and you have to pay interest/dividends while you are shorting it;
• The Uptick Rule:  The SEC prohibits you shorting a stock unless the price moves up.  This prevents you from taking advantage of big market moves to the downside.  You have to wait till a lot of the price profitability has eroded and the stock bottoms out a little (like on a dead cat bounce) before you can make your move;
• short squeeze:  If the float is low, and there is a lot of short interest, market movers can keep the supply low in order to drive up the price and squeeze the shorts long enough to force them to cover at a loss;
• TIMING!  You may be right about how bad a company is, but shorting a stock requires a cash outlay in order to maintain or roll your position.  By the time you are proven right, you may be out of money. 

Now, that’s the problem with shorting in general, here’s why I additionally don’t like it in the mutual fund/hedge fund context.

The shorts, as a group, have a negative return of about 20% (which is understandable given the upward market bias and the transaction costs).  But the real number may be a loss of greater than 20%.  The -20% number doesn’t take into account "survivor bias".  That is, only the funds who survive will report their numbers.  The ones who implode don’t report.  If the odds are that much stacked against the shorts, then I don’t think it’s a good idea to invest in a fund where part of their strategy is shorting.  If they are average, they won’t do very well.  And I don’t want to think about how they’ll do if they are less than average. 

Was featured today in a Forbes article on the 20 most profitable corporations (along with some other notables like Berkshire Hathaway (Hi Warren Buffett), Citigroup, Microsoft, and Exxon).  I have about $10k of this in my regular account, about 75 warrants and another few thousand in my Roth IRA account.  Go, baby go! 

I think it’s a great company.  It’s probably still a buy at this price, but I think If I were to throw more money at it, I would buy the warrants (OCWAZ).  They are still trading at $5 a warrant, have an exercise price of $45 (stock is currently at $33) and they don’t expire till 2013.  No guarantee that it will hit $45 by then, but if it increases 10% per year (which is the historic AVERAGE return of the market) it will finish in the money.  If it outperforms the average stock over the next 6 years (which I believe it will) then it should be very profitable to own the warrants. 

I sold out of my position in Tarragon, a home builder, today.  The pain got to be too much.  Rot in Hell, Tarragon!!!  More to follow.

I own a little bit of this stock.  I bought it because I was able to get in at a price that is close to what Warren Buffet bought it at.  I got in at $47 and change (I think) and he got in about $46.  Strealing someone else’s good idea is never a bad idea. USG went as high as $56, but has recently dropped back down to $48.  I’m not in any position to buy more of anything, but if any of you haven’t bought, this may be a good time to get back in this one. 

 It dropped to $48 because USG did a new offerring of stock at the price to finance an acquisition that they just made.  USG is a good long term play for several reasons.

• Like Owens Corning (another of my holdings) it went through bankruptcy and shed it’s asbestos liability and is starting over with a cleaner balance sheet.
• Like Owens Corning it is the number one producer in it’s industry (the other two top Wallboard producers are Kock and National Gypsum, neither of which is publicly owned).
• Althought residential construction is taking a beating, commercial building, which also uses wallboard is strong.
• USG has few competitors and high barriers to entry.  It’s something that is heavy and inexpensive, so making it requires factories in all parts of the US, which limits non-local competition in each market (it costs too much to ship it in from far away, even if you get a cheaper price).
• It’s a simple product so there are unlikely to be surprises and the technology (wallboard) has been around a while and nothing has yet come along that is easier and cheaper to install. 

Therefore, there’s a lot of plusses here and you should put this one in your LONG TERM portfolio.  You probably won’t make a 1000% return like on a tech stock, but you’re unlikely to lose money and the long-term growth prospects now that they don’t have the asbestos liability hanging over them are pretty good.   

I sold out of my position in Hovnavian (HOV).   I made about 10% on it.  It was up about 20% at one point, but started back down, and I sold it because I thought there were better opportunities.  I bought it when the P/E ration looked decent (8?), but when the estimates for their future profits started coming down and the P/E was recalculated, it looked a little pricey for me. 

I Bought Some Aetna (AET) with the money from the stock I sold in HOV.  AET was trading about $46 when I bought it.  During the "correction" yesterday, it got down to $44.50.  If I had more money I would buy more.  Here are my thoughts on it:

• Warren Buffet bought into United Health Care (UNH) so the health insurance industry is not a bad one to be in;
• UNH has a forward P/E of about 15 and Aetna has a forward P/E of about 12, which is to be expected since it’s growing a lot less than UNH.
• BUT, AET has about $23 a share in CASH. 
• SO if you deduct the cash from the share price and THEN calculate the P/E, I get a P/E multiple of 6 or 7. REALLY CHEAP STOCK!!!
• Although UNH has a higher return on equity and return on assets, but if you think of the price paid for the stock vs EBIT, then AET wins by a mile on that metric. (I don’t like using EBITDA because you should deduct deprectiation and amortization to get a good picture of the amount of cash that the company can produce which doesn’t have to be plowed back into the business to maintain operations).   

Also, I think AET can do well since health insurance is a growing sector of our ecomony and AET has done okay at increasing its membership.

Also, they are doing okay at managing self-insurers (i.e. big companies that provide their own health insurance for their employees buy pay Aetna to manage it for them).  THis is a low margin business, but AET doesn’t have to set aside regulatory capital for these operations. 

WIth AET’s free cash they can do one of three things, which will be good for the stock:

1. Increase the dividend (or give a big one-time dividend);
2. buy some companies in related industries (which will increase their earnings and raise their share price if the P/E stays the same);
3. keep buying back stock which will increase the share price because if reduces the amount of shares and boosts the earnings per share.  

Owens Corning was up over 5% today.  I’m up about 18% from where I bought it in November.  I think it’s still got more upside.  If the housing industry picks up again, it could go through the roof.  Other positive things about OC:

• it instituted a $200 million stock buy back for up to 5% of the company’s stock (shows that management thinks it’s undervalued);
• Is coming out with new products like fiberglass heating ducts that are more energy efficient than metal duct;
• it’s stone veneer business is growing well and expanding (in europe too);
• they might get rid off certain other businesses that don’t fit well.