Stocks – Page 137 – The Aleph Blog

Fighting Illiquidity in my Nonsponsored ADRs

Posted on 14 November 2007 by David Merkel

I own three nonsponsored ADRs, and the liquidity of them is relatively poor: Royal Bank of Scotland [RBSPF], Dorel Industries, and Lafarge SA.? I have an opportunity now to improve the liquidity of Royal Bank of Scotland now.? They have recently created a sponsored ADR [ticker RBS].? I wrote Investor Relations at RBS to see if I could exchange my nonsponsored ADR shares for the new sponsored shares.? This is what they wrote back:

Dear Mr Merkel,

Thank you for your email regarding your RBS shareholding.

In order to convert your RBSPF ADRs your broker will need to contact our US depositary and paying agent, the Bank of New York who can transfer your shares to their CREST account and issue you with new ADRs. Contact details for the Bank of New York conversion desk are as follows:

Jaswinder Goraya or Rubely Marte – tel no 212 815 4502 / 2724

Your broker will also need to advise the Bank of New York’s Manchester office of the deposit into their CREST account.

Contact details:

Luke Owen or Mike Ashcroft – tel no. 0161 725 3433 / 3438

Please note that Stamp Duty Tax will need to be paid on each share as well as an ADR conversion fee. With the US share price currently at US$9.24 the conversion fee would be 4 cents per ADR (Please see attached Standard Fee schedule).

If you require further information please do not hesitate to contact me.

So, I contacted Fidelity, and we are doing this.? One down, two to go.? Perhaps my next move is to contact Dorel Industries and see if I can exchange my illiquid ADRs for shares that trade in Toronto.

Full disclosure: long RBSPF, DIIB, and LFRGY (pink sheets all)

Boing!

Posted on 14 November 2007 by David Merkel

Okay, so we got the bounce.? Or, at least the start of it; the market is not short-term oversold anymore.? The reasons behind the rally are a lot smaller than the run we had today; chalk it up to a previously oversold market.

So where do we go from here?? I’m not sure.? None of the long term problems that the market faces have changed, but neither has the relatively low yields of investment grade corporate debt.

One stock that lagged today was National Atlantic.? After the close they announced that they had appointed Bank of America to look into strategic options.? Not sure why they chose BofA; Citigroup brought them public, and kept coverage on them amid their stumbles, not like some.? National Atlantic should jump a little tomorrow.? (Boing!)? Personally, I view the odds of an outright buyout as low, but who can tell here?? The discount to book is significant, and I regard the DAC and tax assets as valuable; they should be included in tangible book.? At this point also, the reserves are clean; they’ve been scrubbed every which way, and should be regarded as sufficient.

National Atlantic is my largest position, and I expect to realize something over $10 before this is done.? Be aware that the stock is illiquid, and that operating results have been uneven over time, to put it mildly.

Full disclosure: long a very illiquid little stock, NAHC

Value Investing is Dull

Posted on 10 November 2007 by David Merkel

In The Art of War, Sun Tzu makes a great deal out of concealing one’s intentions, even to the point of making it look like you are dumb.? Value investing has elements of that, though we are not trying to deceive anyone.

Most investors fall for the idea that rapidly growing companies will produce greater returns.? Sadly, that’s not true most of the time, because investors usually overpay for growth.? That leaves investors like me puttering over companies that have grown slowly and have modest valuations.? They are in boring industries: cement, insurance, shoe retailing, etc.

This is a major reason that I like value investing.? It doesn’t appeal to most people.? Buying exciting companies with great stories is a lot more fun than buying slow-growing companies at modest multiples of earnings.? Sad, but the growth investor will earn less over the long haul.

My way of managing money will go out of favor someday.? That’s the nature of money management, though for the last seven years I have been immune to troubles.? I keep applying my strategy, because over the long run it will out perform indexes.? Courage is most needed, and least available, during the bear phase.

Gone for Two Days

Posted on 9 November 2007 by David Merkel

Sorry, but off on church business for two days.? As a parting shot, this is what I wrote on RealMoney yesterday:

		David Merkel
		What Do You Say When You Are Wrong?
		11/8/2007 5:34 PM EST

Well, I say I was wrong, then. Wrong about National Atlantic. Ordinarily, reserving at short-tail insurers is hard to mess up, because the claim cash flows quickly reveal mistakes. This is one of the exceptions to the rule.I hate losing money; the only thing I hate more is losing money for others. My sympathies to anyone who has lost along with me. I am still playing on this one, because the company is valued as if it will never make money again, and my opinion is that they will make money again, or, there might be M&A activity.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider National Atlantic to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Position: still long NAHC, longer even

		David Merkel
		How Do You Minimize The Costs Of Being Wrong?
		11/8/2007 6:40 PM EST

You diversify. Even with National Atlantic, my portfolio was even with the market today. Though it was my largest position, it was still only one of my positions, at less than 5% of the portfolio. Diversification is underrated, and we neglect it to our peril.Please note that due to factors including low market capitalization and/or insufficient public float, we consider National Atlantic to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Position: long NAHC

Holding My Nose, Still

Posted on 8 November 20078 November 2007 by David Merkel

Three companies of mine reported after the bell, Flagstone, Deerfield, and National Atlantic. I’ll take them in that order.

Flagstone beat handily, as I would have expected a property-centric reinsurer to do in this environment. Let’s see what optimism tomorrow brings. At 96-97% of book value, it seems cheap, but I can’t imagine property reinsurance rates will be that robust next year.

Deerfield is a little more tricky. They took a loss due to mark-to-market events in their portfolio. REIT taxable income is reasonable at 50 cents/share, and much of the writedown is a GAAP anomaly that shaves $1.20 off of the current book value. Economic book value is $11.84, which provides some support to the stock. The dividend of 42 cents is still intact. There is reasonable excess liquidity, even after the increase in repo margins during the third quarter. Let’s see what the market thinks.

Now for the problem child, National Atlantic, which takes an 83 cent loss. Here’s the main offending paragraph from the press release:

“For the three months and nine months ended September 30, 2007, reserves have increased by $17.6 million and $9.4 million, respectively, principally as a result of the strengthening of the reserves for bodily injury claims. During the third quarter it was determined that the Company’s policy related to claims handling procedures and reserving practices were not applied consistently, primarily within the bodily injury claims unit. As part of the resolution of this matter, the Company retained an independent claims consulting firm.”

For a company the size of National Atlantic, these are huge reserve changes, particularly for a short-tail line like auto. What I am about to write here is only a guess, but this likely was building up since sometime in 2006. One of the reasons I am willing to be a little more bullish on short-tail insurers is that it is a lot harder to get the reserve wrong. Looks like I am getting one of the rare events that teaches greater caution. (That said, my average cost is $8.85, so I’m not that badly hurt.) Given the large reserve change this period, ordinarily, the decks are cleared for future periods, but who can tell for sure? Also, this places the combined ratio since 2002 at 103.7%. It makes me think that the company will do well to eke out any underwriting profit.

I’ll be listening to the call tomorrow. What’s the endgame here? Given the marginal ability to earn underwriting profits, perhaps the company would best be reconciled by merging with another firm. That wasn’t my opinion over the past three years, but it is my opinion now. There are many firms that could have an interest at the right price, which probably approximates the book value of $13.28. That said, many of them may have kicked the tires already and passed, some probably thinking that a bid at book value would not be honored. All I can say is, give it a shot. Rumor is that Commerce wasn’t offering more than book, so if you want a greater presence in NJ personal lines, it may be available at a reasonable price.

Full disclosure: long FSR DFR NAHC

Circuit Breakers, but no Curbs

Posted on 8 November 2007 by David Merkel

Posted today at RealMoney:

		David Merkel
		Bye-bye to Trading Curbs
		11/7/2007 2:37 PM EST

When the NY Composite fell 2% today, no trading curbs kicked in. Program trading went on unfettered by a need for upticks. Around 1:20, when the curbs would have kicked in, the market fell a little, stabilized, and began to rally. So much for the curbs. Now all that remains are the circuit breakers, which kick in when the DJIA is down 10% and 20%. The circuit breakers only came into existence in 1987, and to the best of my knowledge, have never been triggered. (Anyone else know for sure? I don’t have intraday data.)

Using closing data since 1900 (again, I don’t have intraday), the circuit breakers would have been triggered 5 and 2 times each. That’s once every 21 and 54 years, respectively. To me, that’s not frequent enough to have a rule in place, even if intraday data would double the frequency.

Position: none

As it was, the market finished down nearly 3% today.? I suspect that curbs wouldn’t have helped much, but who can tell.? The market is a lot more game-friendly than it used to be; far fewer rules to observe (or flout).

On an unrelated note, here are my two REIT charts from yesterday, in thumbnail form, for those who had a hard time with them yesterday.

Mortgage REITs

Equity REITs

Buying Cheap and Holding My Nose

Posted on 7 November 20077 November 2007 by David Merkel

How comfortable would you be buying National Atlantic Holdings?

Or Deerfield Triarc?

Or YRC Worldwide?

I could go on, after all, recently I bought some Redwood Trust, and a number of smaller cap value names that don’t seem to be getting much respect right now. Value as a strategy is lagging now, and I am feeling that in my performance. Financials that deal with mortgages are out of favor also.
So why mortgage REITs now? Take a look at this chart of the 10-year Treasury yield less that on mortgage REITs:

Yields are pretty high relative to “safe” Treasuries, comparable with 1990 and mid-2002 spreads. Only the bad old days of 1974 surpass the yield spreads of this era by a significant amount. As I recall, REITs had a really bad name in the late 1970s after the mid-decade shellacking. I remember technical terms like “fraud,” but then, I was an impressionable teenager with an active imagination. 🙂

Now consider this chart of the 10-year Treasury yield less that on equity REITs:

The result is closer to fair value. I certainly would not call equity REITs as a group cheap; future returns rely on property price appreciation, which doesn’t seem likely to me at present.
Now, I’m not endorsing all mortgage REITs. Review funding structures and excess liquidity; you want excess cash flow and conservatism at this point. Heroics offer more downside than upside here.

As for YRC Worldwide, trucking is needed in our economy, and even with some slowdown, YRC should still make money, just not as much. On National Atlantic, I would only say that it seems that there is a forced seller in the name now, and when he is exhausted, the stock will lift. It is difficult to destroy a personal lines insurer with a conservative balance sheet. At 60% of a conservative book value, I can live with adverse outcomes.

Remember, do you own due diligence here. Just because it looks cheap does not mean it can’t get cheaper.

Full disclosure: long RWT NAHC DFR YRCW

The Problems of Ruin, Near-Ruin, and Decay

Posted on 1 November 2007 by David Merkel

Many investors, both institutional and individual, take too much risk. Taking too much risk can take a number of forms:

Buying companies with weak balance sheets.
Buying companies with high valuations.
Inadequate diversification, whether by number of companies, number of industries, or some risk factor like buying only high-yielding stocks.
And more…

There are three ways that problems can manifest themselves.? The first way is ruin.? An investor is so certain of himself that he uses a large amount of leverage to express his position.? When the bet goes wrong, he loses it all; he is ruined.? The second manifestation is near-ruin.? As ruin is threatening, the investor sells everything to preserve some of his assets, often near the local bottom for that set of assets.

The third manifestation is decay.? In this case the investor says, I will never take losses greater than x% of my position.? Nice intention, but it raises the spectre of the death by a thousand cuts.? Many assets fall before a significant rise; why get stopped out?? Instead, use falls in price to re-evaluate positions, and consider adding if the original thesis is still valid.

To be a little more controversial here, I don’t trust the bold claims of most technicians who place stops on their positions, and claim to have good performance.? Once one places stop orders, the probability rises for multiple small losses that exceed the few larger gains in the portfolio.? Call me a skeptic, but I would rather re-evaluate my positions than automatically sell, which seems to me to be a recipe for decay.

For My Canadian Readers

Posted on 30 October 2007 by David Merkel

If you are looking for more of me to read, pick up a copy of the November 2007 MoneySense magazine for my article “Nerve Medicine.”? It describes five points on risk control for individual investors.? Thanks to MoneySense for publishing my article.? The magazine costs only C$5.50 at the newsstand.? That’s about $6.00 US, right? 😉

As an aside, to editors of publications that peruse my blog, I am available for other writing assignments.? I enjoyed writing a longer article for a retail audience, and would accept the challenge again.? E-mail me if you have interest.

Second Video on the Federal Reserve

Posted on 29 October 2007 by David Merkel

Here’s my second video from TheStreet.com on the Federal Reserve.? This one is on where to invest from an equity standpoint.? There are two areas to look at.? Companies that benefit from:

Lower borrowing rates
Higher inflation

In the first category are healthy financials, and companies with the flexibility to borrow short-tern and buy back stock.? I highlighted insurance companies in my video, but this could apply to other financials and yield-sensitive companies, so long as they don’t face any significant fallout from housing and housing finance.

In the second category are companies that are exporters, and companies where the global prices of their products will rise in dollar terms, while their inputs stay relatively fixed.? This would include energy and most commodities.

Bonds were not a topic of discussion, but I still favor foreign, high quality and short-to-intermediate bonds for now.