Positions Revisited

I want to revisit some of my stock decisions and see what was the outcome and analyze if there is anything I should have done better. I will try to be intellectually honest with my assessments and recognize my errors. Also i want to look back and see if there are any mental traps that affected my decisions and recognize when i fall for these psychological biases.

Below is all the positions that I have talked about on this blog for over a year or so. All are businesses that I looked to own but did not or I bought and sold.

General Growth (GGPWQ): I have dismissed the value in this name when it was trading at $.35. now the stock is over $4.5 an impressive 600%+ return. Was I wrong? Off course I was. Would I do the same decision again? Probably yes. There is nothing inherently wrong in how I analysed the situation. I came to the conclusion that there is a probability of permanent loss of capital; this probability excluded the equity of GGP right away.

I honestly can live with the consequences of such decisions. I prefer to err on the side of preserving capital than take a speculative position like General Growth.

Coach (COH): I liked the business and its management but I decided I will only buy at $18 or below to give me enough margin of safety. Coach is trading at $33; some 80% return if I have gone ahead and bough at my buy decision.

My inaction cost me here. This one hurts more than General Growth because there was no reason not to buy. I scummed to the fear and paralysis during the market tumble earlier this year. My bias for the status-quo and regret avoidance have cost me.

Hawk Drilling (HAWK): I did not like this spin-off for various reasons. However, the stock has gone from $22 to $35 in the span of several weeks. The business has a lot of ugly factors in it, which is what you want to buy in a spin-off. But again this one I can live with. The price has gone up not to the specifics of the company but because of movement in natural gas as evident of a similar move by its competitor Hero Drilling as seen in the chart; Natural Gas has also moved from $2.7 mcf to $3.7 during the same period. I concluded that this was a leveraged play on Natural Gas and I did not want to call its direction.

Switch of Bank of America to American Express: After BofA bought Merill Lynch I decided to get out and switch to AMEX. My analysis were right that BofA would have tough time with Merill and I am better with a company that have a great brand name and much more easily understood and analysed than a bank. AMEX return 65% from the switch to BofA -14%.

In this instance I did not have any status-quo bias I acted and I did not have a loss aversion bias. I hope I can have the same capacity to perform the same decision in similar situations.

Preferreds (Brookfield and Bombardier) and Senior Loans Positions: I have bought several positions with the credit theme to be a better proposition than equity. All worked very well with most of them 70% gains plus their yield.

However, equity performed very well since its March lows. All my buying from late 2008 to early 2009 has been tilted toward credit instruments rather than equities. There were several companies that I liked that could have provided me with handsome returns over the last six months. Again, some paralysis on my part to pull the trigger on stocks with attractive prices, similar to Coach above.

Teck Resources (TCK): This position has worked as I expected. The assets were too valuable. When it was trading at $4, I did not think there was any chance of loss of capital. Now that the stock is trading at $30 it still has some room to high 30s.

However I made a silly mental error. I sold too early and left a lot of profit on the table by halving my position. The business did not hit my value estimate and I reacted to the price run and I fell to regret avoidance mode. I should have asked what is the value?

FirstService (FSV): I sold at 8% loss when I realized I made several errors in valuation and business model assessment. My mistake here is that those assessment should have been made before hand not afterwards. I rushed to take advantage of price decline before the opportunity escapes me. Little I know the price declined further. Here it was a process violation; the position should have never been established and because of the error I am 8% poorer.

NorthStar Realty (NRF): I am down some 50% on this one. I can be wrong on this one but I followed my process and my thesis still good. I am willing to hang onto it until I see another opportunity with better return profile.

Sears Holding (SHLD): I am down 30% on this position. Again so far I am wrong and the intrinsic value has declined with the name as its real estate assets have went down in value. Moreover, I realize now that valuation discount alone is not enough it has to be coupled with good business model and economics.

Cardinal Health, Peyto Energy, and Burlington Northern: All of these positions are recent and any analysis is not worth its trouble.

I just wonder how this post would have been different if the market have not rallied. I come to remember the quote " rising tide lifts all boats". So I am thankful that I did well but I always think that there is an element of luck in my decisions.

Value idea: Peyto Energy Trust

Natural gas is at extreme lows as it should; there is tremendous supply in the system. Storage is almost full. There will be no where to put extra production. The reason is the vast discoveries of shale gas. North America is abundant with natural gas contrary to what was believed of North America peak gas. Even with a harsh winter I do not think the supply picture will improve.

However I believe that goods or assets can't sustain prices below its average production cost over the long term. Sure there will be some divergence in some periods but it should return to equilibrium eventually. The question is when. I am not going to speculate on that as it is going to be a crap chute at best.

However a good position if I can find a way to participate in the price recovery of natural gas, while I get some downside protection and a margin of safety. I think Peyto Energy Trust (Pey.un) gives me this proposition. Peyto is :

Canada-based energy trust. The Trust’s principal business activity is the exploration for, development and production of petroleum and natural gas in Western Canada. As of December 31, 2008, the total proved plus probable reserves were 998.3 billion cubic feet equivalent (166.4 million barrels of oil equivalent) with a reserve life of 23 years. Production is weighted approximately 85% natural gas and 15% natural gas liquids and oil.

I like Peyto for the following:

• hedge book for half of their production of the next 12 months at an average price of $7.5 per mcf
• low debt to capitalization and good coverage of debt service and dividends
• low cost producer of natural gas. currently their operating costs per BOE is $2.56 as of their latest quarter
• long life reserves
• the cost structure for the most part is variable and gets reduced with lower revenues.
• cheap valuation where its Entp. Value to NPV is .57, a measure to value the company to its discounted cash flow from reserves in the ground.
• The current dividend yield is Distribution is 15.5%. The coverage of the distribution is good but if gas prices continue its decline it will be halved.
• I get good odds betting on natural gas plays. The upside is potentially large while the downside is limited. We are already at a decade low of natural gas price. Most Natural gas producer did not participate fully in the recent rally and lag the indices by a wide margin.
• And a very good management, extremely good management.
• My catalyst will be the revision to mean in natural gas prices as most likely it can't keep going down. We are in a period of supply and demand imbalance and there should be an equilibrium found in the next 12 months.

What can go wrong:

• Payout ratio is trending higher, which is understandable given the weak revenue figure. Peyto has already cut its distribution and it could a further cut is probable.
• Natural gas is the "widow maker" and can be very volatile. There is no reason it can't go to low $2s per mcf.
• Their operating lines can be shut or reduced if credit environment deteriorates further. Producers rely on operating lines to fund operations and exploration.
• Royalties are influx in the government of Alberta and can be very fickle to factor in analysing operations. Couple years ago royalties has been hiked on gas producers but once the bust has set in it was reconsidered.
• The conversion to corporate entity issue. Trusts will be subject to regular corporate taxes in 2011 so this is issue is hanging on Peyto and all trusts alike.

A note: This is a Canadian trust equivalent to master limited partnership in the US so it will have personal tax consequences that will have to be taken into consideration when purchasing

Changes to portfolio

Reducing EEM stake by more than half. I have been holder of Emerging Market index for a while in an effort to diversify internationally. The call was to hold the index for the long term but as my style of investing changes, more focus on event driven investing, I find my emotions rule how I view this position. I get swayed by economic analysis from various sources. I do not have any insight or edge.

Also, I have bought in the EEM when all were selling in Sep of last year. Valuation then made sense. Now emerging market funds are loaded with capital as money flow into them like crazy. Valuation has increased from 10 x earning to 20 time earnings now. People have high expectation of emerging market due to growth potential. I think it is a likely scenario that economic dominance will shift to some emerging economies like China and India but the odds that the market gives me for returns are not favorable. So I am taking my profits here and I will set tight.

I am also selling out of FirstService(FSV). I am existing this position with a small loss of 7%. I have made this call based on valuation alone. the value of the sum of the parts were higher than the market cap of the company. However as I started to look at the business details, a step I should have done before buying, I started to change my mind and cheap valuation does not cut it alone. I sold because:

• high compensation to CEO and management compared to peers and level of earnings growth.
• rollup strategy that is empirically destroys value
• ROIC is on par with the cost of capital
• bulk of the growth is attributed to acquisitions. what will happen if they can't acquire anymore?

Another sell decision TSX index: too much concentration in Natural resources and financials. Actually between the two sectors it makes up to 75% of the index. And those two areas where I do not have a lot of insight. Another small loss of 4%.