I am overweight financials, but I don’t own any banks, or entities where the primary business is credit risk.? I own a bunch of insurers, because they are cheap.? The first one to report came Monday after the close, Reinsurance Group of America.? They beat handily on both earnings and revenues.? They are the only pure play life reinsurer remaining.? Competition is reduced because Scottish Re is for all practical purposes dead.? They make their money primarily off of mortality, charging more to reinsure lives than they expect to pay in death claims.
This is a nice niche business, and a quality competitor in the space — well-respected by all.? And, you can buy it for less than book value.? Well, at least you could prior to the close on Monday.
Here are the financial stocks in my portfolio at present:
Safety Insurance? (Massachusetts personal lines)
Lincoln National (Life, Annuities, Investments)
Assurant (Niche lines — best run insurer in the US)
Hartford (Life, Annuities, Investments, Personal lines, Commercial Lines, Specialty Lines)
RGA (Life reinsurance)
Universal American Holdings (Senior Health Insurance — HMO, Medicare, etc.)
MetLife (Life, Annuities, Investments, Personal lines)
National Atlantic (waiting for the deal to close)
Now, I do have my worries here:
Even though asset portfolios are relatively high quality, they still take a decent amount of investment-grade credit risk, and even squeaky-clean portfolios like the one Safety has are exposed to Fannie and Freddie, unlikely as they are to default on senior obligations.
Those that are in the variable annuity and variable life businesses might have to take some writedowns if the market falls another 10% or so.? For those in investment businesses, fees from assets under management will decline.
Pricing is weak in most P&C lines.
Away from that, though, the companies are cheap, and I have a reasonable expectation of significant book value growth at all of them.? Also, a number of the names benefit from the drop in the dollar — Assurant, MetLife, Hartford, and RGA.
One final note before I close: diversification is important.? I have Charlotte Russe in the portfolio, and it got whacked 20%+ yesterday.? Yet, my portfolio was ahead of the S&P 500 in spite of it.? If Charlotte Russe falls another 5% or so, i will buy some more.? There is no debt, earnings are unlikely to drop much (young women will likely continue to buy trendy clothes), and there are significant assets here.? I don’t expect a quick snapback, but as with all of my assets, I expect to have something better 3 years from now, at least relative to the market.
Full disclosure: long SAFT LNC AIZ HIG RGA UAM MET NAHC CHIC
Selling 70% of my National Atlantic stake freed up cash, and I deployed half of that today in a variety of rebalancing trades.? Today I bought some Jones Apparel, Valero Energy, Hartford Financial Services, and OfficeMax.? I sold some RGA to buy some MetLife, in order to get cheaper RGA.
Today’s actions brought cash in the portfolio from 14% to 11%.? It’s a good time to be adding to positions in a modest way.? If the market declines further, I will continue to slowly reduce cash and add to positions.? One nice thing about the rebalancing discipline is that I don’t time the market, but it often seems like the rebalancing discipline forces buying low and selling high, in ways that most investors would not want to emulate, because I am constantly leaning against the wind.
Starting on Monday, I’m going to be on the road until July 8th.? My ability to blog and follow the markets will possibly be impaired, because I will be busy the first week with the annual meeting (Synod) of my denomination, and the next week, with my parents’ 50th wedding anniversary.? I will be in rural Western Pennsylvania and Northern Wisconsin, respectively.? The first is a lot of work; the second, a lot of fun.? In both cases, Internet access may be spotty.
I’ll leave a few standing orders out to take advantage of further declines in the market, especially if the NAHC deal fails on Monday.? Beyond that, I will start in on the next portfolio reshaping when I return.? For those that want an early preview, here are my current industry ranks.? It’s been a good year so far, but who can tell, the market can spin on a dime, and once again find a new way to make fools out of us all.
Full disclosure: long NAHC JNY VLO HIG OMX MET RGA
To whom it may concern: please send your agent soliciting my proxy to charm school. I don’t like being pushed to give my vote over the phone. I don’t regard it as secure as the internet or paper balloting.
Yesterday was a funny day, I received three communications (in this order) on National Atlantic.
An e-mail from some dear friends pointing out our former employer’s SC 13D/A, declaring their opposition to the deal.
The call from the proxy solicitor.
As I said to my friends: “I suspect that by this time, Gorman [the CEO] plus the arbs hold more than 50% of the shares. I will be voting my 0.15% against the deal, for what good that will do.
There are no appraisal rights, and I think the only possible remedy would be lawsuit alleging fraud, with a temporary restraining order on the deal. I don’t think that a lawsuit would succeed, but the laws of NJ, and the regulators are management-friendly.”
I have already admitted defeat on this one. Should the merger vote fail, I would expect the stock to drop considerably, because without replacing the current management team, there are no good options.
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.
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. 🙁
In some ways, this one was pure slop on my part.? In September 2005, I thought the setback in Dana’s auto parts business was temporary, and bought a little more.? After the second dose of bad news, I looked at the statements afresh and kicked myself.? How could I have missed the growing negative divergence between earnings and cash flow?? I waited a few days for a rally, and sold.? As it was, Dana filed for Chapter 11 in March 2006.? This could have been a lot worse for me.
How much can you lose on a $7 stock? Seven dollars. Dana (DCN:NYSE) just filed for bankruptcy, and trading is temporarily suspended. I think the common will get wiped out, so any long trades here are purely speculative. Unsecured debt is trading in the high $60s, so they look like they are the new owners of the company (but that’s just a guess).
Don’t be afraid to take losses, if you know the situation is worse than the current price would indicate.
The common was wiped out when Dana recently emerged from bankruptcy in February of this year.? PXRE made out better, merging with Argonaut.
National Atlantic Holdings
I’ve written more than my share on NAHC, and for the good of my readers, probably too much.? Perhaps this one might be a good example of taking time to accumulate a position.? My average cost is $6.67, which means that if the deal goes through at $6.25, this isn’t one of my ten largest losses.? Tentatively, though, I plan on filing for appraisal rights if the deal goes through.
Consider the 1Q08 earnings conference call on Monday:
Operator:
And we have a follow up from David Merkel with Finacorp Securities.
<Q – David Merkel>: Hi.? Sorry to trouble you, one follow up. It’s basically the questions I asked on the last call.? Your loss reserves, there’s nothing there in terms of future development that should have been reflected in the first quarter that isn’t there in the statements, and your bonds are stated at their fair market value to the best of your knowledge.? You’ve got a high-quality portfolio there.
<A – Frank Prudente>: Yes we do, David.? This is Frank Prudente. I’ll take the second part of your question first if you don’t mind.? Our portfolio remains to be very conservative and very high quality.? With the implementation of the new accounting standard we’re at Level 2 two for all of our available for sale securities.? So we continue to feel very comfortable about our investment portfolio.? And as Bruce alluded to earlier, we do a comprehensive actuarial analysis every quarter which is further validated by the review performed by our external auditors each and every quarter.? And what I can tell you is we base our estimates of loss and loss adjustment expense reserves based on all of the most relevant data we have available to us for each and every financial statement close process.
<Q – David Merkel>: Thanks, Frank. I appreciate that. Take care.
What that may mean to the court is that twice after the announcement of the merger, they publicly stated that their most variable assets and liabilities were correctly and conservatively stated on their balance sheet.? That means anyone receiving much less than book is not getting fair compensation.? This one is not over yet; I may get out of this one with a gain.? :(? (Dreamer…)
My failure here was not carefully evaluating the management team, and rely on my usual benchmark that a short-tail P&C company earning money, and trading below book is a good deal.
Vishay Intertechnology
I am still invested in Vishay.? It earns money, generates free cash flow, debt is being reduced, and the balance sheet looks decent.? The sorts of electronic components that they make will be difficult to make obsolete.? I still like the name; I don’t think this one will be a loss for me in the end.
Tellabs
Tellabs looked cheap and got cheaper.? Almost every small tech company was getting thrown out; valuations reached record low levels by the end of third quarter 2002.? Tellabs had disappointment after disappointment, and I concluded that if it couldn’t earn money, the book value was overstated.? I sold, and bought stocks that I thought have more promise.
That said, my rebalancing discipline allowed me to reduce the overall losses from this volatile stock.? I didn’t lose nearly as much as a buy-and-hold investor would have.
Deutsche Bank
This was a failure to integrate my overall markets view, and allowing short-term valuation issues to dominate my decision.? I thought the investment banks wouldn’t do well, but I thought Deutsche Bank might escape the troubles.? Well, I was wrong.? European institutions mimicked Wall Street to a higher degree than most would have expected.
My last buy was a rebalancing buy, but as results came in from other European banks, I ended up selling Deutsche Bank, and RBS as well.? Time will tell how smart that was… the investment banks of our world are tied together through counterparty exposure — to a degree, they succeed and fail as a group… that’s why the Fed bailed out Bear Stearns.
Summary of Part II
I’ll repeat what I said in part one, and add a little.
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.
The next two articles in this series will be about investments that went right.? They should come soon.
Just a quick note on how my equity investing is doing — in April I was slightly ahead of the S&P 500, and year-to-date, things are quite good. This is not to say that I haven’t had my share of failures… Deerfield Capital, YRC Worldwide, Jones Apparel, National Atlantic, and Vishay Intertechnology have hurt. But in a portfolio of 35 stocks, even large percentage whacks get evened out if the stock picking on the remainder has been good enough. And, for me it has, though the successes are not as notable as the failures.
As an investor, I am a singles hitter, but my average is high, and strikeouts low. I have my failures, but the eight rules, which are my risk controllers and return generators, protect me. At least it seems that way for the last 7.7 years, but I know enough that even if the principles are right, they are no guarantee for the next day, year, or decade. “The markets always find a new way to make a fool out of you,” and so I encourage caution in investing. Risk control wins the game in the long run, not bold moves.
So, I keep plugging on, adapting to what I think the market will reward in the future, and ignoring the past for the most part.
I will have a fuller post after I talk with Jim Gorman, CEO of National Atlantic.? If he thinks his company, which he owns around 13% of is only worth $6.25/share, that is a real surprise to me, and inconsistent with all of the other discussions that I have had with him over the last four years.? A few of you have asked me about appraisal rights.? Really, we should talk about this later if the deal gets approved; it’s too early to speculate there.? For those that remember my early posts at RealMoney on the Mony Group acquisition, remember that book value is sometimes illusory.? I don’t think that is the case here, but let me talk with Jim Gorman, and listen to the earnings call on Monday.? If they deliver another bomb, like last quarter, maybe $6.25 is generous.
Disclaimer: David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent “due diligence” on any idea that he talks about, because he could be wrong. Nothing written here, or in my writings at RealMoney is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, “The markets always find a new way to make a fool out of you,” and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves.
Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here or on RealMoney is meant to be formal “advice” in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.
My disclaimer dates back five years.? It’s at the bottom of my blog, and is there for a reason: I get things wrong.? Now, I like to think that I get things right more often, but let’s just look at the gritty downside for a moment.? I wrote a series of articles at RealMoney on using investment advice.
I wrote these with Jim Cramer in mind.? Now, I like Jim Cramer; he says a lot of bright things.? But when you talk about so many things, and put out so much content, particularly on TV, you have to be careful.
I don’t have 0.1% of the exposure that Mr. Cramer has, but I care what happens to my readers.? (I think Jim does too, but the shell has to get hard when one is that exposed, or, you’ll give up speaking and writing.)? So, when I make notable errors, it hurts me double.? I usually have my cash on the line when I write, or at least, my reputation, which is more valuable (you only get one of those).
Today was my worst relative performance day in a long time.? Deerfield Capital, National Atlantic, and Gehl, all did badly.? I bought more Deerfield today, and I’ll put out a post on my thoughts soon.? That said, March is off to a bad start with me, after a tremendous first two months of the year.
So, I am eating my crow, lightly seasoned, and with humility.?? Always do your own due diligence when you read me, because I get it wrong now and then, at least in the short run.
