From the 6/2 RealMoney Columnist Conversation:

		David Merkel
		Rebalancing Sales, and a Buy
		6/2/2008 4:08 PM EDT

Late last week, I had two rebalancing sells, Charlotte Russe and Smithfield. Today, two more, Honda Motor and Nam Tai Electronics. As the market has risen (or, some of my stocks at least), cash has been building up, and I have added some of my own free cash to the Broad Market portfolio. I’m at about 14% cash.

So, it’s time to buy something, though I am waiting on the market to show a little more weakness before I act. But, though dinner may wait, perhaps an appetizer is in order: today I added to my position in Reinsurance Group of America. MetLife finally decides to shed this noncore asset in a tax-free stock swap, allowing current MetLife shareholders to swap their MetLife shares for shares in RGA.

RGA should get a higher multiple as a “pure play” life reinsurer; that will come later. Today was the selling pressure in advance of the new supply. I like the management team at RGA, and think this will allow them the freedom to add value on their own. One other odd kicker… it might allow them to do more reinsurance business with MetLife, because they will be independent and thus truly be a third party.

Position: long CHIC SFD HMC NTE RGA

A few additional notes, for me long only means running with 0-20% cash. I don’t go above 20%; I don’t borrow. Under normal conditions, I like running around 5-7% cash. If the NAHC stake is counted in, (arbitrage gets a pseudo-cash return) then we are at that 20% upper limit.

That leads me to take a few actions — I have bumped up my central band for my holdings by 16%. Translated, the points at which I do buy and sell rebalancing trades has risen 16%, as has my normal position size. Looking back through the years, back to 1992 when I started value investing, my position sizes were 5% of what they are today, and back then I had 10 positions, not 35. There’s been growth.

My second action was a temporary purchase of some RGA. I doubled my position temporarily, because I think most analysts will smile on the deal, and RGA has always been a good buy at book value.

No telling whether buying at 1.0x book will continue to be a good idea in the future. RGA is a well-run company in an oligopolistic industry. The management is smart and conservative. They have international growth opportunities, and now, possible new business from MetLIfe. The moat is wide here. You can’t reverse engineer the #2 life reinsurer in the US and the World.

So, I’m happy with my position here. That said, I may trade away the speculative part of my holdings in the short run, and I may buy some MetLife as well. MetLife is cheap, though not as cheap as RGA, but I suspect when MetLife offers RGA shares in exchange for MetLife shares, they will have to make the tradeoff sweet in order to get some flexible institutional investors to do the swap. Why? MetLife is a large cap stock that is very diversified. RGA is a midcap that is not as diversified. MetLife is a well-respected brand name. RGA? Who?

Insurance is opaque; reinsurance is doubly so. There are no comparables for RGA. MetLife has Pru, Principal, Lincoln National, and a few more. So, I may speculate on MetLife in order to get some cheap RGA. Most likely, I’ll need to see the terms, but if RGA is up a lot tomorrow, and MetLife is not, I may just do the swap.

Note to my readers: one odd thing about my blog is that I write about a wide number of issues. I know I have been doing more on my stock investing lately, but that is partially due to the lack of news on the macro front. That’s the nature of what I do. I am an investor that pays attention to the global economy. I’m trying to make money off my insights, and not merely report on what is happening. I hope some of it rubs off on my readers also, and that you personally benefit from it. For those who find my blog to be a confusing melange — well, that’s who I am, a generalist whose interests are broad.

But, if you like the individual stock coverage, let me know. If you hate it, let me know also.

Full disclosure: long CHIC SFD HMC NTE RGA NAHC LNC

Of the 35 stocks in my portfolio, only 4 lost money for me in May: Magna International, Group 1 Automotive, Reinsurance Group of America, and Hartford Insurance.  My largest gainer, OfficeMax, paid for all of the losses and then some.

I am only market-weight in energy, so that was not what drove my month.  Almost everything worked in May: company selection, industry selection, etc.  My other big gainers were: Charlotte Russe, Helmerich & Payne, Japan Smaller Capitalization Fund, and Ensco International.  I have often said that I am a singles hitter in investing — this month is a perfect example of that.

Now, looking at the year to date, I am not in double digits yet, but I am getting close — I am only 3.6% below my peak unit value on 7/19/07.  My win/loss ratio is messier: 15 losses against 32 wins.  It takes the top 5 wins to wipe out all of the losses.  The top 5: National Atlantic, Cimarex, Helmerich & Payne, Arkansas Best, and Ensco International.  Energy, Trucking, and a lousy insurance company that undershot late in 2007.

The main losers: Deerfield Triarc (ouch), Valero, Royal Bank of Scotland, Avnet, and Deutsche Bank.

I much prefer talking about my portfolio than individual stock ideas, because I think people are easily misled if you offer a lot of single stock ideas.  I have usually refused to do that here; I am not in the business of touting stocks.  I do like my management methods, though, and I like writing about those ideas.  If I can make my readers to be erudite thinkers about investing; I have done my job.

So, with that, onto the rest of 2007.  I don’t believe in sitting on a lead — I am always trying to do better, so let’s see how I fail or succeed at that in the remainder of 2007.

PS — When I have audited figures, I will be more precise.  You can see my portfolio, for now, at Stockpickr.com.

Full disclosure: long VLO AVT NAHC XEC HP ESV MGA GPI RGA HIG OMX CHIC JOF

Time for another dose of my industry ranks.  Here’s the list, complete with the ideas that are most attractive for me to investigate:

Remember, this uses the Value Line Industries, and it can be used in Value mode (green industries), or Momo mode (Red industries)  I look to buy from the green list, but I have a tendency to let companies that I own that are on the red list hang around.  Momentum tends to persist in the short run, and I have usually trimmed exposure due to my rebalancing discipline.

My next reshaping is not until early July, but I expect that it will be a doozy, because I will redeploy proceeds from National Atlantic, as well as a new slug of cash that I have received.  I’m running at 12% cash now, but if you count in National Atlantic, it is more like 18%.  That has to come down, so in a month or so, I will have to deploy cash.  I’m looking for a downdraft to do it in, but those don’t always come on schedule.

Full disclosure: long NAHC

Part of being a good investor is recognizing when you have lost, so that you can cut your losses, or focus on what can win in the future. Today, I recognize my loss on National Atlantic. Why today? After talking with a friend who knows more than me about appraisal rights in this situation, in New Jersey, in cash deals there are no appraisal rights allowed, unless specifically granted in the corporate charter. Here is an example from a NJ bank deal.

Ugh. It shouldn’t be this way, but it is. Maybe someone with deep pockets could sue NAHC and its board and management, jointly and severally for fraud, but those pockets aren’t mine. So, I look forward to the merger vote. I will vote my 0.15% of the shares “against,” but I realize the NAHC management plus the arbs hold enough shares to win. Personally, I really dislike the disinformation that they have written in their definitive proxy regarding runoff; they paint a scenario that does not ring true with my knowledge of the insurance business.

$6.25/share — It could be worse, right? No, probably not.

Full disclosure: long NAHC

I’m a life actuary, not a pension actuary, so take my musings here as the rant of a relatively well-informed amateur.  I have reviewed the book Pension Dumping, and will review Roger Lowenstein’s book, While America Aged, in the near term.

First, a few personal remembrances.   I remember taking the old exam 7 for actuaries — yes, I’ve been in the profession that long, studying pension funding and laws to the degree that all actuaries had to at that time.  I marveled at the degree of flexibility that pension actuaries had in setting investment assumptions (and future earnings assumptions), and the degree to which funding was back-end loaded to many plan sponsors.   I felt that there was far less of a provision for adverse deviation in pensions than in life insurance reserving.

I have also met my share (a few, not many) of pension actuaries who seemed to feel their greatest obligation was to reduce the amount the plan sponsor paid each year.

I also remember being in the terminal funding business at AIG, when Congress made it almost impossible for plan sponsors to terminate a plan and take out the excess assets.  Though laudable for trying to protect overfunding, it told plan sponsors that pension plans are roach motels for corporate cash — money can go in, but it can’t come out, so minimize the amount you put in.

The IRS was no help here either, creating rules against companies that overfunded plans (by more than a low threshold), because too much income was getting sheltered from taxation.

Beyond that, I remember one firm I worked for that had a plan that was very overfunded, but that went away when they merged into another firm which was less well funded.

I also remember talking with actuaries working inside the Social Security system, and boy, were they pessimists — almost as bad as the actuaries from the PBGC.

But enough of my musings.  There was an article in the New York Times on the troubles faced by some pension actuaries who serve municipalities.  For some additional color, review my article on how well funded most state pension and retiree healthcare plans are.

Pretend that you are a financial planner for families.  You can make a certain number of people happy in the short run if you tell them they can earn a lot of money on their assets with safety — say, 10%/year on average.  Now within 5 years or so, promises like that will blow up your practice, unless you are in the midst of a bull market.

Now think about the poor pension actuary for a municipal plan.  Here are the givens:

• The municipality does not want to raise taxes.
• They do want to minimize current labor costs.
• They want happy workers once labor negotiations are complete.  Increasing pension promises little short term cash outflow, and can allow for a lower current wage increase.
• A significant number of people on the board overseeing municipal pensions really don’t get what is going on.  It is all a black box to them, and they don’t get what you do.
• You don’t get paid unless you deliver an opinion that current assets plus likely future funding is enough to fund future obligations.
• The benefit utilization, investment earnings, and liability discount rates can always be tweaked a little more to achieve costs within budget in the short run, at a cost of greater contributions in the long run, particularly if the markets are foul.
• There are some players connected to the pension funding process that will pressure you for a certain short-term result.

Even though I think pension plan funding methods for corporate plans are weak, at least they have ERISA for some protection.  With the municipal plans, that’s not there.  As such, more actuaries and firms are getting sued for aggressive assumptions, setting investment rates too high, and benefit utilization rates too low.

The article cites many examples — New Jersey stands out to me because of the pension bonds issued in 1997 to try to erase the deficit they had built up.  They took the money and invested it to try to earn more than the yield on the bonds — the excess earnings would bail out the underfunded plan.  Well, over the last eleven years, returns have been decidedly poor.  The pension bonds were a badly timed strategy at best.

Now, like auditors. who are paid by the companies that they audit, so it is for the pension actuaries — and there lies the conflict of interest.  One of my rules says that the party with the concentrated interest pays for third-party services, so it is no surprise that the plan sponsor pays the actuary.  I’m not sure it can be done any other way, unless the government sets up its own valuation bureau, and tells municipalities what they must pay.  (Now, who will remind them about Medicare? )

The suits against the pension actuaries and their firms could have the same effect as what happened to Arthur Andersen.  These are not thickly capitalized firms, and many could be put out of business easily.  For others, their liability coverage premiums will rise, perhaps making their services uneconomic.

Finally, the flat markets over the last ten years have exacerbated the problems.  Partially out of a mistaken belief that the equity premium is large (how much do stocks earn on average versus cash), actuaries set earnings rates too high.  The actuarial profession offers some guidance on what rate to set, but the reason they can’t be specific is that there is no good answer.  With all of the talk about the “lost decade,” well, we have had lost decades before, in the 30s and 70s.  Even if the statistics are correct for how big the equity premium is, equity performance comes in lumps, and in the 80s and 90s, when we should have taken the returns of the fat years and squirreled them away for the eventual “lost decade,” instead, politicians increased benefits as if there was no tomorrow.

The states and smaller government entities have dug a hole, and they will have to fill it somehow.  Lacking the ability to print money, they will raise taxes as they can, and borrow where they may.  We are seeing the first pains from this today, but the real crisis is 5-10 years out, as the Baby Boomers start to retire.  You ain’t seen nothin’ yet.

Recently I received an e-mail:

David,
Always enjoy your blog - very thought provoking, and I’ve learned a lot from reading you across a variety of topics. Assuming I haven’t missed this in an older post… one thing you mention as a key investment strategy is finding the right industry at the right time, and I’ve never seen a very good explanation of how one goes about that. In one of Jim Cramer’s recent books he offered a sort of stylized graph outlining a general playbook to that effect - I’ll send it to you if you’d like - but I’d like to get a primer on how you go about industry over/underweights.

Thanks and Best,
JC

It made me think that I should go through my basic principles of industry selection, and explain them.  JC mentions Cramer’s “playbook” — that’s the classical guide to what industries do best in an “ordinary” business cycle.  Personally, I think Cramer’s views on industry selection are more complex than that, largely for the reason that I don’t follow the “playbook” in any strict sense: global demand is more important than US demand alone for many industries.  The old playbook is no longer valid, until we get a totally integrated world economy.  (Side note: we will never get that — some war will upset the globalization — it is the nature of mankind.)

Anyway, I have four basic tenets when looking at industries:

• Buy strong companies in weak industries when the industry pricing outlook seems hopeless.
• Buy moderate to strong companies in strong industries where the earnings power and duration are underestimated.
• Underweight/Ignore/Short industries where pricing power is likely to be negative for several more years, and especially industries that are in terminal decline.
• Avoid fad industries.  There are P/E levels that no industry can grow into.

My best example of #1 is the P&C insurance industry in early 2000.  Total gloom.  I bought a lot of The St. Paul then.  Another example: Steel in 2001-2002.  I bought Nucor.

For #2, think of the energy industry — current stock prices embed oil prices far below current levels.  Or, think of the life insurance industry — low P/Es, but the demographic trends are in their favor.

On the third one, think of newspapers, whose richest revenue sources are getting eaten up by the internet.

For the last one, think of the internet/tech bubble 1998-2000.  Very few companies that were hot then are at higher prices now.

I share the results of my industry model once a quarter at minimum.  But I don’t use my model blindly.  For example, lending financials and housing have been cheap for some time, but I have avoided them.  They are cheap for a reason.

My main model uses the Value Line ranking system, and uses the nominal rank, and how it is different from the average historical rank.  It can be used in two ways: highly rated industries can be analyzed to see where the pricing power is not reflected in the stock prices yet.  Low rated industries should be analyzed for the possibility or reversal due to undeserved hopelessness.

But you can create your own model just from a series of index prices.  The idea is to look at industries that either have strong momentum that you think is deserved, or industries with weak momentum where things seem very bad but not terminal.  You can even modify it to look at industries that have bad performance over the past 3-5 years, but have rebounded over the past 6-12 months.

Behind all of that, remember my rule: sharp movements tend to mean-revert, slow, grinding, fitful movements tend to persist.  Things that are too certain tend to disappoint, while those things that are less certain tend to surprise.

One reason I have done well over the past 7+ years is that I have been willing to let my industry selection vary considerably from where the indexes have been.  If you think that you have insight into the longer-term earnings power of industries, then take your opportunity, and deviate from market weightings.

To start, let me gather together my conclusions from the prior articles, and add one more:

• Get the right industry.
• Get a bright management team.
• Don’t panic over small setbacks. Buy more.
• Rebalance your portfolio regularly to fixed weights.
• Dividends matter.
• Buy cheap.
• Trade away for better opportunities when you find them.
• Don’t play with companies that have moderate credit quality during times of economic stress.
• Measure credit quality not only by the balance sheet, but by the ability to generate free cash.
• Spend more time trying to see whether management teams are competent or not.
• Cut losses when your estimate of future profitability drops to levels that no longer justify holding the asset.
• Diversify, diversify, diversify!

Okay, take another look at the graph above, and see that my gains are bigger and more frequent then my losses. Nonetheless, I took some significant losses. How could I bear those losses? Diversification. No position has ever been more than 7% of my portfolio, and the normal position is 2.9% in my 35 stock portfolio. I can take some whacks on individual positions if my overall investing is working.

My key question in deciding whether to sell a stock is whether I think its future returns are likely to be less than alternative investments. That is the only good reason to sell a stock, but few investors follow that rule. I may get my estimates of future value wrong, but if I do it consistently, my results should be good.

You can review my eight rules here. From my prior articles, you can see how my rebalancing trades have added value overall, even though on my losing trades, they added to the losses. Value works, Momentum works, and industry rotation works if it is done right.

My focus on accounting integrity, similar to to the work done by Piotorski, helps value investing work by avoiding value traps. I don’t miss every trap, but if I miss enough of them, I end up doing well.

Finally, our minds are not geared to make decisions where the dimensions of the decision are large. My methods compress the dimensions of the decision, and turn the decision into a swap transaction, where you trade something worse for something better.

That’s what I do in investing, and perhaps in the near term, I will gain my first sizable external clients. In closing, here is a list of all of my trades over the past 7.7 years:

Full disclosure: long the portfolio listed at Stockpickr.com.

I’m going to go in reverse order here. These were my best investments in the Broad Market Portfolio over the past 7.7 years measured by total dollars gained. After this post, I should have one or two more to wrap up the series, to try to explain why I think my methods work, and flesh out the lessons that I have learned. I am a generalist, but if I have a core skill, I think it is being a portfolio manager, especially regarding risk control, though as I have admitted, I have had some real losers.

Drumroll, and here goes:

10) Anglo American plc

When I bought it originally, it was the cheapest of the diversified miners. I wanted some base metal mining exposure, because I felt it was an industry trend that was underdiscounted. The metal prices were ahead of the stock prices. (And, I wish I had never sold Cleveland Cliffs… then again, for many of the names on this post, I wish I had never sold a share, but discipline in risk taking gives you the confidence to take risks.)

The trading of this one was simple — one rebalancing buy in 2006 during a small metals panic, but aside from that, the thesis was perfect, and I kept selling as the price kept rising. As is common for me with big gainers in my taxable account, I gave away the last bit to charity. If you are charitable, giving away appreciated stock is a wonderful way to do it, and the Fidelity Charitable Gift Trust makes it sooooo easy.

9) Ameron International

You ever heard of Ameron International? I’m not sure to this day where I first heard of it. For much of the time that I owned it, it was one of the larger stocks with no analytical coverage. Ameron International is a multinational manufacturer of engineered products and materials for the chemical, industrial, energy, transportation and infrastructure markets.

Anyway, I bought some, and then Chris Edmonds, who at that time wrote for RealMoney, separately picked it for one of his Holiday Portfolios. I e-mailed my hearty assent.

Ameron didn’t do much for the first three years that I owned it, but I kept clipping the dividend, and doing rebalancing trades, while the internal value of the business grew. Finally, some institutional investor(s) realized what a gem this company is, and the price exploded. I gave the final slug to charity. Would that I had held on, but I have had other good stocks since then.

8 ) SPX Corp

SPX Corp is a diversified industrial corporation that fell on hard times. I looked at it as a turnaround, with global growth as a tailwind that would eventually drive the stock up. In the fall of 2004, I felt pretty dumb about my purchases, but I persevered, thinking that there was value to be unlocked through intelligent management.

Many companies that I own have significant declines for no good economic reason. SPX was one of them. It is difficult to tell apart those that will disappoint versus those that will persevere, but my experience is that more of mine persevere than fail.

Again, another company that in hindsight it would have been better not to sell, but it was outside my valuation boundaries, and as I would say along with Lord Rothschild, “I always sell too soon.”

7) Helmerich & Payne

I still own Helmerich & Payne, and have sold once more in May. As the oil price kept going higher, I looked for related entities that had not gone crazy and would benefit from the higher prices. HP was one of them. (And, as I wanted to say to my pal Cody Willard — “Hey, Cody, I own HP, but it’s the right HP.”)

Contract drilling is a great place to be, when oil prices are so high. During the rise in energy prices, I moved more of my exposure into services, because even if oil would not be found, still those that were aiding the attempt to find it would get paid.

6) Cemex SA

Cemex is the company that I have held the longest. I have long been a fan of the cement industry, because it is the cheap way to facilitate global growth, and catch up on delayed infrastructure investment in the US. My first article for RealMoney was on the cement industry, and I owned three companies in it at that time, a massive overweight that paid off.

It was not a popular idea to buy Cemex when I did. They had problems with derivatives and mis-hedging in recent memory, but the stock was cheap enough that I thought it was worth the risk. For the next year it got cheaper, and I bought more. Most investors would have assumed that they had gotten it wrong, and bailed out. That’s not my way.

As you can see, though the price of Cemex rose, it rose in a volatile way, and my rebalancing discipline captured a lot of extra value in the process. I still own Cemex, and still think that it is cheap, and that management is pretty bright. I’m getting close to another rebalancing sale. This is a gift that keeps on giving.

5) Valero Energy

I own Valero today, but I sold out of it in entirety in 2005. I also owned Premcor during the best part of the run, and through the acquisition by Valero. At the end, I sold some and gave the rest away. If I added Valero and Premcor together, they would be my #1 gainer.

When I bought Valero, I felt that refining was in short supply, and would get rewarded. I don’t expect to be right that fast, but it is gratifying when it happens.

Now, after Hurricane Katrina, I felt that the price rises were overdone for refining stocks, so I sold, and gave the rest away.

4) Lyondell Chemical

Lyondell was an idea that I grabbed from that grand old man, John Neff. He is a humble guy, so you won’t hear him tooting his horn. My idea was that they owned half of a refinery with Citgo, and the rest of their business I was getting for the price of the refinery.

As it was, Venezuela needed cash because of the self-aggrandizing goals of Chavez, and they sold their half of the refinery cheaply to Lyondell. There was some confusion in the process and the rating agencies had their doubts, but Lyondell managed it well, until selling out to Basell, a Russian company. I gave the remainder away to charity.

3) Conoco Phillips

I have owned Conoco for a long time. It is my second longest holding, and it has rewarded me well. It looked cheap when I bought it, and on an earnings basis, it doesn’t look much different now. I have had a few rebalancing buys, but on the whole, the mix of exploration and refining has done admirably.

2) Plum Creek Timber

There is a small complexity in this investment. When Plum Creek bought The Timber Company [TGP], I swapped my holdings of Plum Creek for the Timber Company. When the deal closed, I had more Plum Creek shares. Even after that, to mid-2002, I bought more Plum Creek, making it a triple-weight in my portfolio. I felt that timber assets were undervalued, and I was happy to clip dividends while the market caught up with me.

In late 2004, I began the process of scaling out of the position, moving from a triple weight to a double, single, and then zero weight. I like the management of Plum Creek, but there are price levels that I can’t pay, and I must sell.

1) Companhia de Saneamento Basico do Estado de Sao Paulo — SABESP

What a company; this was an idea from Cramer (yes). I have long believed the thesis that potable water is scarce, and that companies that facilitate fresh water will be rewarded. SABESP is one of the few companies that was cheap enough to buy in 2005, and remains so today. Demand for water remains high, particularly in Sao Paulo, Brazil. I have sold many times, but not bought because there haven’t been any pullbacks; what a happy problem to have.

So, there are my top ten. They are a mix of:

• Get the right industry.
• Get a bright management team.
• Don’t panic over small setbacks. Buy more.

It is worth noting that the top 11 companies that I have owned covered all of my losses. The gains have been bigger than my losses by a wide margin , and I have had three gains for every loss. In my next post or two, I will wrap up this series, and try to explain underlying ideas that helped me do so well.

Full disclosure: long SBS COP HP VLO CX

Finishing off the average 10, the slightly better 5…

Deltic Timber

Deltic Timber was an idea that I gleaned from Jim Grant.  They have a lot of timberland in the Southern US, a decent amount of which is next to Little Rock, Arkansas.  The land near Little Rock, once developed, could be quite valuable in a bull market for residential real estate.  I ended up selling because I lost confidence in the residential housing market.

Honda Motors

I still own Honda.  Does the world need cars?  Does the world need small cars?  Yes!  Is Honda cheaply valued?  Yes.  Can they beat the cost levels of Ford, GM, and Chrysler?  Yes.  I like Toyota as well, and have owned it in the past.  I have owned American auto part manufacturers, but never the automakers themselves; their credit quality is too low.

Mueller Industries

This is a case where I found a cheap industrial, bought it, and waited.  The price rose, and I concluded that I had cheaper opportunities, so I sold.  Also, their raw materials prices were going to rise…

American Power Conversion

American Power Conversion was a cheap tech stock with products that are difficult to obsolete.  Eventually I had cheaper investments to buy, and I sold.  This is another example of how the rebalancing discipline can turn a flat stock into extra profits.

Australia & New Zealand Banking

This seemed to be a cheap, well-run foreign bank so I bought some.  As with many of my average investments, I sold it to fund other more promising investments.

Summary of Part II

• Rebalance your portfolio regularly to fixed weights.
• Dividends matter.
• Buy cheap.
• Trade away for better opportunities when you find them.

It is important in investing to have something to compare investments against.  Make them compete against each other for your dollars, and be rigorous about it.  Don’t invest because “That sounds like a good idea,” rather, is it better than what you currently have?  Keep improving the quality of your portfolio, in terms of cheapness, quality, and future prospects.

Full disclosure: long HMC

Okay, same drill as my pieces for my worst losses, but this time I chose the ten most average investments of mine in terms of dollars earned. Remember, one of my key disciplines is rebalancing.

Honeywell

Honeywell was short and simple. I felt it was out of favor, and I bought some. Six months later, I had cheaper stocks to buy, so Honeywell was gone.

Stone Energy

Stone Energy was a weird one. As you will note, the initial purchase and final sale prices aren’t that much different. Interim trading made a difference to the total return.

The stock popped after hurricane Katrina, and sagged quickly thereafter on an audit of proven reserves that came up light. The rebalancing discipline was a big help here.

Dow Chemical

Dow Chemical has two stories. First, dividends are valuable. Second, rebalancing adds value. Dow was a cheap stock that did not get respect, but I still made decent money off of its gyrations, and dividends.

Universal American Financial Corporation

This one is too early to tell. I still own it. Sometimes investments make significant money out of the gate. That is not often, in my experience. This is a little individual and group healthcare company that has gotten smashed over the merger integration. That is a relatively stable business, but small healthcare players have been harmed in the past. Insider buying here is a plus.

Aspen Insurance Holdings

Aspen was a relatively cheap reinsurer. I bought some and sold a chunk into a runup, and sold the rest as I concluded that I had better places to put money.

Summary of Part I

• Rebalance your portfolio regularly to fixed weights.
• Dividends matter.
• Buy cheap.

If done consistently, these principles will raise your overall return, and reduce overall risk. Pretty good performance from a bunch of average stocks.

Full disclosure: long UAM