Friday, December 31, 2010

Top Investments for 2011

I recently ranked my top invesment choices for 2011, as I will be putting at least some money to work come the new year.  I have my own quantitative ranking system that I use to rank investment ideas, but ultimately my choices aren't always the ones the promise the best gains but those that offer the best gains at the lowest risk. 

I will add the my quantitative system looks at what the specific company can earn in profits under normal economic times, and are not some pie in the sky estimates.  Many of the companies listed have significant earnings potential but the current recession has given them some problems to work through before the normal times return. 

The top idea I recieved from another investor, the rest are my own. 

So the best ideas for 2011, drum roll please....

Citizen's Republic Bankcorp - (NASDAQ - CRBC)

Citizens is really cheap on on any valuation measure.  However it faces significant pressures because they mainly operate in Michigan and that state has one of the highest unemployment rates in the US.  The current price is around 0.63/share and I would put fair value at around $2.90/share implying a discount of 78%.  The company has currently loan loss reserves for just under 5% of the loans.  That is nearly twice the rate of other banks.  Obviously the biggest question is can the economy turn around before this company's losses drive it over the edge.  Many investors have gotten out of the way, and most funds wouldn't even look at it because of the price per share and also because of it's low market cap. 

The non performing loans have been falling for a number of quarters and is almost equal to the total loan loss reserves which means the company is nearly out of the woods.  The most interesting this that catches my eye on this company is the insider buying.  The new CEO has made some significant insider buys this past year.  Without this insider buying I wouldn't even consider investing in the stock.

While this stock is selling very cheap there is some significant risks and I haven't done nearly enough homework to justify an investment.  This is something that definitely looks interesting but you must recognize the risks.  As Warren Buffett would say, he prefer's 1 ft bars to jump over than 6 ft bars... degree of difficultly doesn't matter in investing.

Bank of America (NYSE - BAC)

I have written about Bank of America in the past it it still ranks very high very high in my ranking methodology.   BAC sells for slightly more than tangible book value and at $13.27 and I would put fair value at $28/share, implying a discount of 62%.  The most recent quarterly number look bad on the surface because of the goodwill impairment due to the card fee regulations but BAC like other banks will be able to earn those fees back in other areas.  Banks consistently find a way to keep their hand in your pocket. 

The company has done some dumb moves in the past few years, like buying Merrill Lynch with significantly undervalued stock.  Then again Merrill Lynch was cheap too.  I know many would add Countrywide Financial to that list, but the company did write down a large portion of that loan book when they purchasing them.  Countrywide will be a decent asset, but they have to deal with all the loans (mainly HELOCs) that they gave to people who can not and will not be able to pay it back. 

Regardless, credit quality is improving and so is the economy.  It will take the better part next year to really show better earnings, but the true earnings power of this financial giant will return.  It can earn decent returns on equity and will likely earn $1.50 next year as loan losses slide to $20 billion from $30 billion in 2010 (and down from $48.6 billion in 2009).  The BAC 10K and 10Q's are not for the faint of heart.  Their latest 10Q is sitting beside me and is 216 pages long. 

As I have mentioned before an interesting way to play BAC is by the warrants they issued to the government that were recently sold to the public.  I have written about them in past articles (to read Click Here).

Hardwoods Inc (TSE - HWD.un)

I have previously written about HWD.un on my blog (to read Click Here).  Hardwoods is a wholesale lumber and sheet goods company that has been around for decades.  It recently went public as an income trust as the company spews free cash and the previous owners wanted to cash out (Sauder family).  Due to the recession, the company has run into problems especially in the US where the housing market is depressed.  Once the company can get it's bad debts undercontrol it will start to earn very good profits again.  No company can do well by giving away product for free. 

Hardwoods shares currently sell for $2.27/share and fair value is roughly $4.50/share, implying a discount of 50%.  If you apply the lowest net profit margin (since the company has been public) to the current sales levels, the company can earn $0.44/share.  That means the normalized P/E ratio is 5.2 or an earnings yield of 20%.  I will add that the company has been profitable during the entire recession, and losses were mainly the writedown of goodwill.  Company sells for 75% of book value.  I would love to own the entire company. 

This investment is ideally suited for individual investors as the volume is quite thin and company isn't really covered by anyone.  Recently there has been some better volume.  Simply put in your bid, be patient, and tuck these shares away and you will do fine in the long term. 

Morgan Stanley/Goldman Sachs (NYSE - MS/GS)

I lump these two together as they are both investment banks.  While I have read more on Goldman Sachs than Morgan Stanley, I do recommend them both.  Morgan Stanley is selling cheaper than Goldman on most metrics, and I estimate both companies are selling at a 45% discount to fair value. 

I do like Goldman Sachs better as they are the premier investment bank on wall street.  I do find it interesting that many people, including bloggers, who hate Goldman Sachs.  Just because they were on the correct side of the trade on the housing market doesn't mean they caused it.  I find the hatred of Goldman very interesting and believe the firm needs to do more to salvage it's reputation in the coming years.  I prefer to invest in what everyone else hates. 

The main reason that Goldman Sach is selling so cheap is because it's trading revenue is way down.  It's FICC (Fixed Income, Currencies, & Commodities) division has been hurt by reduced trading over the past year.  This slowdown has become even more pronounced this past summer and fall.  The trading will pick up again, once the market reaches new highs... it always bring new fools to the game of "trade your way to riches".   Investment banking will also pickup as the economy inproves going forward.  Needless to say, I will likely be adding some GS in the new year. 

Fairfax Financial (TSE - FFH)

Now this is perhaps the biggest no brainer on my list for 2011.  A lot could be said about this company, but let's begin with it's CEO, Prem Watsa.  Prem is considered the Canadian Warren Buffett and for good reason.  He has handly beaten the Oracle of Omaha's invesment record over the past couple decades and he uses the same vehicle, insurance companies, to get the job done.  Under his leadership, Fairfax has grow book value at an amazing 26% annualized rate for the past 24 years.  While that is good, what is interesting is that the company sells for book value? 

I find it amazing how many investors don't understand Fairfax and once they see the $400+ dollar price per share they instantly write it off.  Secondly, they also don't understand the insurance and how investment returns can be huge if the float is handled by a value investor like Prem Watsa.  I will break it down. 

At the end of 2009, Fairfax had $1064/share of investment working for each shareholder.  The breakdown is $370/share of common equity, $115/share of debt, and $579/share of investment float.  If the total portfolio goes up just 6% net of expenses, the book value will increase by 17.3%.  Now the company, debt, and the float all have a cost, but then again the investment returns have also been quite a bit higher at Fairfax.  Hamblim Watsa Investment Counsel manages the investments of the company, and over the past 15 years they have averaged 18.3% on their common stock portfolio and 10.6% on their bond portfolio, handily beading the S&P 500 which return 8.0% during that time period and Bank of America Merrill Lynch Bond index which returned 6.8%. 

How undervalued is Fairfax?  We'll I will leave that up to the reader as it will depend on your assumptions going forward.  I like to bet on proven performers, and as I have been reflecting on this stock... I wondered why I am even attempting to manage my own money.  Individual investors will be hardpressed to beat Mr. Watsa and his team. 

The biggest reason I like Fairfax is the risk adverse nature of Prem Watsa.  He is the chief risk officer, and he shows up everyday on the lookout for new risks.  In conclusion, if I were to go away and put all my money into one stock it would be Fairfax Financial. 

Other Options

Too keep this short, here are some other options.  I also believe Wells Fargo is still selling at a 40% discount to intrinsic value, despite it's recent increase of approx 15%.  Bank of New York Mellon is selling at a 20% discount and so is Manulife Financial.  Lastly, General Electric is selling at just under a 20% discount to intrinsic value.

Some of the regional banks look cheap.   PNC Financial Services is another that looks like a decent bargain, but I need to do some work.  There are also some thrifts that are very cheap , if you are into those types of plays. 

In conclusion, I believe most of the above names are very good long term investments.  If you are looking for a quick buck you may or may not get lucky.  The biggest risk I see this year is that the market as a whole is fairly valued.  That means it may go up or it may go down.  If it goes down, likely the broader market will drag all of these companies down.  However, in the long run (4-5 years) you will do fine.  With that said, a very prudent strategy would be to accumulate cash and wait.  Doing nothing can be very intelligent.   

I will likely be adding Fairfax Financial and Goldman Sachs to my investment porfolio in the new year. 

Best Regards,
Kevin Graham

Disclosure - Long BAC.wt.a, WFC, GE, MFC, HWD.un, FFH

Thursday, December 30, 2010

Happy Holidays - Back Tomorrow

Hope everyone has enjoyed their holidays. 

I have taken a break from blogging for the holidays and will be back tomorrow with top picks and I will be doing a review of some of the stocks mentioned this past year.  Many are up 10-20% in the past few weeks removing any margin of safety.  The economic data is slowly improving. 

I have been working on a few different deals the past couple weeks and investigating a distressed debt situation.  I read three books over the past few weeks and may mention some details in the coming weeks. 

I'm off to meet up with an old high school friend who is now an analyst with USB.

Until tomorrow. 

Best Regards,

Thursday, December 16, 2010

Recent Economic Data - Definitely Looking Up!

Recent economic data seems to be painting a solid recovery coming in the next few years if one looks at the raw economic data.  The media tends to spin whatever information is released to make news.  For the past while the media has been making their money selling negative news.  They love to highlight the recent recession, housing foreclosures, and even talk of a double dip recession.  Those advocating a double dip definitely didn’t get any support this week if we examine the economic data released this past week. 

To read the rest of this post click here:

Monday, December 13, 2010

Finding Value in Financial Stocks - Bank of New York Mellon, Goldman Sachs, & Morgan Stanley

Well bargains are getting really slim at the present, but I recent identified three companies that present some potential and warrant further research.  For those not interested in financial companies you might as well stop here.  I personally don't care where the bargains are and financials are one of those remaining areas.   

As a disclaimer, all banks are inherently risky.  They typically use substantial leverage and a small miscalculation in risk can erase a large portion of the equity in any financial company.  This was definitely the fear during the panic and what ultimately caused the failure of Lehman Brothers and Bear Stearns.  If confidence is lost in any financial institution it is basically game over.  With that out of the way let's dive in. 

To read the rest of this article click here:

Monday, December 6, 2010

Margin of Safety - Downside Risk

“The research task does not end with the discovery of an apparent bargain. It is incumbent on investors to try to find out why the bargain has become available. If in 1990 you were looking for an ordinary, four-bedroom colonial home on a quarter acre in the Boston suburbs, you should have been prepared to pay at least $300,000. If you learned of one available for $150,000, your first reaction would not have been, "What a great bargain!" but, "What's wrong with it?"

The same healthy skepticism applies to the stock market. A bargain should be inspected and reinspected for possible flaws.  Irrational or indifferent selling alone may have made it cheap, but there may be more fundamental reasons for the depressed price. Perhaps there are contingent liabilities or pending litigation that you are unaware of. Maybe a competitor is preparing to introduce a superior product.”

Margin of Safety - Seth Klarman– Page 153-154

I have been thoroughly enjoying reading Seth Klarman’s book, Margin of Safety, the past little while.  When I read this passage my mind instantly went to ATPG, and all the comments on my article.  Almost all comments and articles highlight the huge value in ATPG while completely ignoring any potential issues. 

To read the rest of this article click here:

Friday, December 3, 2010

Weekly Roundup - COS.un, PEY.un, FFH

I have been corresponding with a number of individuals regarding investments after starting this blog.  Some have offered to pay for investment analysis and others are just deep value investors looking to share ideas.  I must say that I appreciate those who have contacted me and am always looking for others to discuss investment ideas (Especially here in Canada). 

Energy Trusts - COS.un & PEY.un

We'll one of those individuals sent me a note today regarding Canadian Oilsands Trust (TSX - Cos.un), and their big drop after the corporate conversion announcement.  For those who are not familiar with income trusts, many are converting back to corporations at the end of this year because the Canadian Government is ending their special tax treatment.  My friend was wondering if I was worried that Peyto (TSX – PEY.un), one of my core holding, will suffer a large market drop like COS.un did today (down 12%). 

I told him that Peyto had made that announcement a couple months back on Sept 28th.  They cut their dividend by 50% from $0.12/mo to $0.06/mo.  The reason for the cut was partially because of taxation, but they went deeper than that to retain capital to increase capex.  Peyto closed at $14.35 that day and immediately jumped and is up 21% since the announcement.  Their horizontal drilling is really a game changer, and the announcement discusses corporate plans.  I highly recommend everyone read it:

What I just love about Peyto is that they understand investment returns on every dollar the company spends.  If you have some spare time it would be well worth listening to Darren Gee, CEO of Peyto, speaking at the First Energy Conference in Montreal this past week.  You can access here:

If you don't have the time at least listen to what Darren says at the 24:20 - 25:20 mark.  To paraphrase somewhat he says, "Every company stands up here and say they can drill wells with 50, 60, 100% rates of return.  To investors that is meaningless.  What we want to see return on capital coming out the back end of the organization.  Who cares what the well economics are if they are eaten up by G&A, taxes, stock options, bonuses, etc." 

Now I couldn't agree more and most investors don't understand how real returns are generated. 

To get back to COS.un, it doesn't really make sense why the market tanked on COS.un as the conversion process has been known for several years now.  Secondly, COS.un differs from Peyto because they likely don't have any tax pools generated to offset taxes.  I would guess COS.un is partially or fully taxable.  Peyto should be able to shelter for around 3 years with existing tax pools and if they can spend enough capex they should be able to shelter for at least another 2-3 years after that.  Those tax pools at Peyto are a significant unrealized value.

COS must have some other issues and rising costs may be one of them.  I guess their cut wasn't expected to be that deep by most of the shareholders.  It also doesn't hurt that a handful of analysts have cut the stock. 

While I am not really interested in own COS.un, I wouldn't mind it at the right price.  I will have to do some reading this weekend and attempt to put a value on COS (if I have time).  A good place to look is what others have paid/sold their share in the Syncrude project.  If you have a reasonable analysis I would be interesting reading it.  And not some pie in the sky estimate.

Fairfax Financial - Prem Watsa 

Moving away from energy, I noticed some interesting comments from Prem Watsa, CEO of Fairfax Financial (TSX – FFH), this week.  He believes there may be a bubble brewing in commodities and agriculture.  Now Prem Watsa isn't afraid of going against the crowd and standing along (and appearing to be wrong) for long periods of time. 

He has for many years warned of the problems coming in the US and was hedged against them for several years.  He lost on those hedges for many years until the harvest finally came in during the financial crisis and he made billions on credit default swaps and equity hedges. 

I would take it he is referring to Gold/Silver/Copper as well as agriculture.  I personally agree and don't care to invest in whatever is popular.  There are always opportunities elsewhere. 

Now I personally don't own Fairfax (but do for some family accounts), but it it's getting temping.  FFH currently sells for book value, and their goal is to grow their book value at 15% per year.  During the past 24 years they have compounded book value at 26%.  If they can compound at 15% for the next 24 years their shareholders will be rewarded appropriately. 

Best Regards,
Kevin Graham

Disclosure: Long PEY.un, FFH

Possible Sale Going on at COS.un

Just a quick alert.  Saw that COS.un was down about 12% on news of a dividend cut as they are converting back to a corporation. 

Any news that drop the bottom out of any stock always get my attention.  I will be doing some investigating this weekend. 


Saturday, November 27, 2010

Moose Hunting - Down Markets

We'll we made it back and were successful in harvesting a young bull moose.  Missed another.  Saw several other moose, so overall it was a very successful hunt.  Some other hunters shot a bull moose 250 yards from our cabin the day before we got there.  We definitely hunt in a fantastic area. 

I though it was going to be cold up there as temperatures were around -25°C (-13°F) overnight, and only reached about -18°C (0°F) during the day.  I was worried we were going to freeze to death but marching through 2-3 ft deep snow definitely keeps your heart rate up. 

Tuesday I got on a fresh set of tracks and walked for 2 miles with only a fleece coat over a long sleeve t-shirt.  Stayed plenty warm, even sweating.  Even at night, it's amazing how warm you can stay in a really good sleeping bag. 

Well, it looks like I didn't miss much on the markets during the past week.  Hopefully investors get even more scared about the European debt issues with Spain and Portugal.  I know most investors don't like falling markets but you really shouldn't care what your portfolio does in the short term.  I am very patient when I purchase anything and stocks are no different.  I love a good deal and when I see one I whip out my cheque book.  Parting with cash is difficult for this investor unless I feel I am getting a really good deal.  What I paid for our acreage would be a great example, and I nearly walked away from the deal.  Regardless, it's now worth 4 times what I paid for it. 

Bring on lower prices.  Perhaps it will be a Merry Christmas on the markets this year!

Best Regards and Go Riders,


Saturday, November 20, 2010

Moose Hunting - Value Investing

Just as an update, there will be no posts for the next week or so as I will be gone hunting. 

We are all packed up for another adventure into the northern forest to hunt down big bull moose.  We may also take down a whitetail deer if the opportunity presents itself. 

No running water, no toilets, no showers... just snowmobiles, a wood stove, and high powered rifles. 

Hunting and value investing do share a number of common characteristics.  You have to be very patient, survey your surroundings carefully, you have to watch for signs, and often sit inactive for long periods of time.  Often you have to pass over several animals before finding the right target.  Sometimes you have to be quick to the draw or you'll miss a great opportunity. 

Quite often patience is rewarded and you can land a trophy.

In the meantime, if you are looking for an outstanding business selling for a reasonable price I would really suggest reading up on Wells Fargo.  Between Warren Buffet and myself we collectively own 17% of the company.  When Buffett first made his initial purchase of Wells Fargo back in 1990, it was for at or around book value.  Today it sells for a slight multiple to book value.  Compared to other banks it is in a league of it's own.  Net interest margin is the highest amoung large banks and historic ROE is between 18-20%.

Best Regards,
Kevin Graham

PS. I also think there is a good possiblity that Wells Fargo will increase it's dividend in early 2011.  They have dramatically inceases their capital ratios over the past year because of the lower dividend rate. 

Disclosure: I own shares in Wells Fargo.

Wednesday, November 17, 2010

Bill Miller Q3 Letter - Listen to Buffett

I recently read Bill Miller's Q3 Commentary.  I know most everyone has written Bill off as a decent investor becuase of his bad bets prior to the financial meltdown.  Here are what I consider the highlights of his Q3 letter to investors. 

The economy is expanding, liquidity is ample, inflation is under control, profits are growing rapidly and are set to pass their all time high, nominal GDP is at its all time high and real GDP will have fully recovered to its all time high within a quarter - two at the most, profit margins are at record levels, and  orporate balance sheets are the best they’ve ever been, yet stocks languish below where they were in late August 2008, and that was hardly a bull market.

One of the most remarkable things about the investing world is how (correctly) venerated Warren Buffett is and how completely people ignore his investing advice. Since Mr. Buffett has made more money than anyone in the history of the planet solely through investing, one would think that when he says quite clearly what to invest in, people would pay attention. I guess they do pay attention, they just do the opposite. In 1974, near the bottom of the market, he said stocks were so cheap he felt like an over-sexed guy in a harem. In 1999, near the top, he opined that stocks would see returns way below those experienced in the bull market up to that time. From the time of his comments in November 1999 to the end of October 2008, stocks fell over 2% per year. In October 2008, again near the bottom, Buffett published an op-ed in the New York Times entitled, “Buy American. I Am.” telling people to buy American stocks. They promptly accelerated their selling. On October 5

What will bring the public back to stocks? The same thing that always does: higher prices.

The reason for this is that investors practice what I call rear view mirror investing.  Look at the recent history and invest in what has done well the past few years.  The truth is investors would be better served to look at poorest performing sectors of the past ten years and invest there.

Large cap stocks have returned zero for the past ten years and investors shun them for that reason.  To see exactly what I am talking about take a look the valueline investment survey for the Dow 30 (Valueline offers free analysis for the Dow 30, click here).  Take a look at Walmart, Cisco, HP, Microsoft or Johnson & Johnson.  Their balance sheets are rock solid and most are sitting on billions in cash.  These are solid companies that earn very high return on equity, and pay large dividends.  Tell someone that Walmart has more than doubled sales in the past ten years and they look at you funny, and say "really".  Combine the sales growth with the share buyback and improved margins and it adds up to earnings growth of 13% at Walmart for the past ten years.  Incredible. 

If you want a cheap way to and less risky way to bet on the oil markets, Chevron and Exxonmobil sell for single digit P/E's and both have negligible debt (net of cash).  Both companies aren't nearly sexy enough (or risky) for most investors.  Exxon is extremely well run, and have returned significant amounts of cash back to shareholders in the form of dividends and share buybacks.  Both have earned very good returns on captial over the long haul.  Just remember the price of oil is the major driver of these companies. 

Lastly, it is important to act like a business owner when investing in any company.  If you pay in excess of book value you better make sure you understand the value of the intangible assets you are paying for.  If not, you may record a "goodwill" writedown of your investment in the future.

So the choice is yours.  You can either live in fear or seize the opportunity to buy high quality large cap stocks trading at reasonable levels today. 

Best Regards,

Disclosure:  None positions, except JNJ in an account I manage for a family member. 

You can read the rest of Bill Miller's Q3 Commentary:

Sunday, November 14, 2010

Wells Fargo - Profits, Do They Matter?

Just a quick follow up from my previous post regarding profits. I was told that I didn't understand profits. In response I offered a simple formula to person who made the comment. It was,

Revenue - Costs = Profit.

Now some companies understand that formula and some don't. Some companies can control the revenues, while others cannot.  I believe all companies can control the cost part of the equation.

The best management of any business strive to minimize costs and maximize profits.

If I could quote from the 2008 Wells Fargo annual report to shareholders.

Our revenue grew 6 percent, and our expenses declined one percent — the best such revenue/expense ratio among our large peers, and the one we consider the best long-term
measure of a company’s efficiency.

• Our return on equity (after-tax profit for every shareholder dollar) was 4.79 cents for every dollar of our shareholders’ equity, best among our large peers.

Now those are wonderful words to read from any CEO in which you own shares.  Maximizing revenue while lowering costs, it all adds to higher real returns for the shareholder.

Don't let anyone tell you investing is difficult, like some who have commented here make it out to be. They liken investing to panning for gold, or a search for buried treasure. It has far more with understanding your assumptions, focusing on real returns, and a consistent operating history. I'm not saying there isn't value in the panning for gold technique but you have to understand your assumptions, accounting, and risks involved.

Futhermore, degree of difficulty doesn't matter in investing. Temperment does. Investing within your circle of competence does. I find it amazing that many value investors don't understand what Buffett means by the circle of competence comment. Personally, I take it to mean more than avoiding technology stocks, but understanding and minimizing your variable/assumptions.

Finally I leave you with a quote from Wells Fargo's 2009 annual report. I highly recommend reading the letter to shareholdes for the last few years if you haven't read them already.

Where does the bank stop and the community begin?

How have we been able to grow earnings and capital internally, and become even stronger, even while building a storehouse for credit losses of almost $25 billion? It’s because our business model doesn’t run on just a few sources of revenue or even 20 or 30 sources of revenue, but on more than 80 different businesses across financial services. It’s because our loan portfolio is diversified across many different industries. It’s because we’re not geographically concentrated in one region, but serve
70 million customers across North America. It’s because of our time-tested credit discipline. It’s because we have the deepest, most talented, most experienced and people-focused team of senior leaders in the industry. It’s because we believe our longterm success depends on our ability to help our customers and communities succeed financially.

And often overlooked, it’s because all banks are not created alike. We’re not a hedge fund disguised as a bank. We’re not a proprietary trader (which produces no customer benefit) disguised as a bank. Nor are we simply a mortgage company or an investment broker or an insurance broker or a credit card company. What we are at our heart is community-based, and relationship-oriented. We serve our customers online, on the phone or at our ATMs, and we welcome them into our 10,000 stores. We greet them on neighborhood sidewalks. We have breakfast with them at the neighborhood diner. We serve alongside them on local chambers, Rotary, nonprofit boards, at community events. We worship with them in churches, synagogues, mosques and temples. Many of our customers know our tellers by their first names, and we know them by theirs. We want our banking stores to be more than just storefronts, but like community centers where neighbors meet.  Call this old-fashioned if you like, but our customers can’t get enough of it. They wouldn’t trade it for all the hedge funds in the world. I could tell you a thousand real-life stories to prove this point. You can read about just a few beginning on page 24 of this Report and in our new Social Responsibility Report.

Management who understand and focus on customer service are the ones who will reap the largest returns.  Meet the needs of your customer in any business and your reputation & profits will follow.

Well if you can't already tell, I absolutely love Wells Fargo.  I plan on owning my shares for several decades.  The recent credit crisis has afforded an opportunity to purchase shares of Wells Fargo at very reasonable levels to book value.  The company can and will earn large profits, around 18% on equity, long, long after ATPG goes broke trying. 

Best Regards,

Disclosure:  I own shares in WFC

ATPG - Final Comments

First off, I have made some changes to my Blog. Anonymous comments will not be allowed. If you want to comment you will need an ID. If you don't want your name attached to your comments you won't be able to leave them here.

Comments on Profit

Now, I seemed to have struck a nerve with my comments on profits (or lack thereof). One example is,

You suggested that OracleofMumbia "start your own company and learn the importance of profits." I pretty sure that he does, but he also understands how the industry and profits within it works. This is a skill that you seem to be lacking. Please reread his last post and try and learn something for a change!

Your right I don't understand profits.

Let's keep it simple.

Revenue - Costs = Profit

If revenue and costs are the equal you have not earned a profit. Do you make believe that profits exist in companies you own? Some people think investing is hard or complicated but it isn't. You want to own companies that earn large returns on capital and equity.

There is no such thing as a free lunch. All losses have to be paid for, either out of equity or increasing debt. You cannot defy economic gravity.

The OracleofMumbia said,

That said, your comments about "profits" are a bit strange. Most plays I invest in don't have them - or so low as to be virtually meaningless. The name of the game for early stage plays (juniors) is to reinvest cash flow back into operations and grow production - then comes profits, although they typically like to sell out at that point and repeat the cycle. The TSX Venture is full of guys making millions doing the same thing over and over.

Listen, I understand early startups do not earn a profit as overheads can be large, but you have to overcome that eventually (sooner than later to stay solvent). ATPG has been around for a while now, overpromising and underdelivering. Perhaps management will deliver this time and perhaps they won't. All I raised were red flags that investors can and should understand if investing in ATPG. The longs didn't even take the time to value the assets before making their purchases, they call it value investing.

Attention - Millions to be had over at the TSX-V

According to the OracleofMumbia everyone is making millions on the TSX-V. Whenever you hear comments like that run, don't walk, for the exit. It's almost as bad as the commercials on Sirius/XM 129 (CNBC). Those who listen know exactly what I am talking about.

The only ones making millions on the TSX venture are the promoters and financial engineers who know how to exploit the individual investor.

I really wonder what the Oracle of Omaha would think of your comments?

Asset Valuation

Now you can also own assets that don't generate profits, gold is an example. I know a lot of people who own shares in a non producing diamond mining company based in Saskatchewan (Shore Gold - SGF). I was asked by several people what I thought of it, and my initial reaction was I have any idea what the assets were worth. I have subsequently reviewed their NI 43-101, and the project is marginally economic with an IRR of 12.2%. Using a discount rate of 10% the NAV is $1.15/share. The project is borderline economic. Many people lost a great deal of capital on this investment.

As Buffett says, "the market like the Lord helps those who help themselves, but the market unlike the Lord does not forgive those who know not what they do."

Now here is the funny part. When I shared my findings with a fellow engineer from Edmonton he told me I was missing a whole bunch of their assets. Now doesn't that sound familiar...

Final ATPG Comments

Lastly, I made a mistake (not the first). I said in a comment last night that interest expense was $80 million per day for ATPG. It actually comes out to be $600k per day. Regardless, interest expense was 68% of revenue in the third quarter. Incredible!

I was also forced to amend my article on ATPG as it was disputed by one of the fanatics over there. I had only read the 10-k and the financial covanents had been removed. However many over there were stating that all covanents had been removed, this is simply false. The amendment can be read below.

Best Regards & Go Riders,

Kevin Graham

All information in the article was taken from the latest 10-K filing for ATPG. On April 20th, 2010 the BP Deepwater Horizon oil rig exploded. Then on April 23rd, 2010 the company refinanced its outstanding debt. Subsequent filings have shown that the financial covenants listed in the article (and the 2009 10-K) have been removed. However, the additional covenants were added and are discussed below. This information is from the latest 10-Q filed November 9, 2010.

The Notes and New Credit Facility contain certain negative covenants, which place limits on the Company’s ability to, among other things:

•incur additional indebtedness;
•pay dividends on the Company’s capital stock or purchase, repurchase, redeem, defease or retire the Company’s capital stock or subordinated indebtedness;
•make investments outside of our normal course of business;
•incur liens;
•create any consensual restriction on the ability of the Company’s restricted subsidiaries to pay dividends, make loans or transfer property to the Company;
•engage in transactions with affiliates;
•sell assets; and
•consolidate, merge or transfer assets.

As of September 30, total long-term debt totaled $1.8 billion compared to $1.2 billion and the end of 2009. The effective annual interest rate on the long-term debt was 12.3% at September 30, 2010. The notes and credit facility also contain some steep provisions for ATPG to repay the notes. The company states the cost of repurchasing up to 35% of the notes on or before May 1, 2013 at 111.9% of face plus accrued interest, if any. The loan shark obviously wants to ensure he gets paid well regardless of whether ATPG pays the debt back early or not.

Saturday, November 13, 2010

Cisco Systems - Big Drop

Wednesday after the closing bell, Cisco Systems announced their results for 2011 Q1. Revenue and earnings were in line with expectations, but projected revenue was down. The result? The stock got nailed with a 16% decline when it open on Thursday and is now down closer to 20%.

Personally, when I hear of a drop like that it gets my attention (similar to Manulife's (MFC) big drop after Q2 that also got my attention). I took a look at Cisco's past ten years and while the drop was large, it wasn't large enough to warrant action. Cisco has averaged 18% ROE over the past 10 years which is decent but the current price is 2.6 estimated year end book value.

I am a book value investor. As Walter Schloss stated, always use book value as the starting point when valuing assets. I don't mind paying a multiple to book value if the company has a consistent operating history. But in the case of Cisco I don't have that faith.

Warren Buffet doesn't invest in technology is because of the constant change that takes place. Change is the enemy of the investor. You cannot make any predictions about the future without some degree or assurance of stability. It is easy to look back over the past few decades and seek the constant change. Cloud computing is the latest paradigm shift and companies are constantly changing areas of focus. Oracle has now shifted into hardware.

Buffett understand how change in the industry makes the investment process very difficult. It adds to the assumptions you have to make. The only way you can pay a huge premium to book is by finding a company with an outstanding competitive advantage and generates high return on equity. This is what Buffett considers paying a reasonable price for an outstanding business with outstanding economics.

Manulife, as compared to Cisco, sells for book value and normally earns 13-14% on equity. Less than a couple weeks ago it was selling for tangible book value. It has a strong franchise in Canada and owns John Hancock in the USA. Their asian insurance business has been growing very fast. They have had some issues with reserving on some variable annuities but the company will get through the problems. I listened to one their Q2 conference call and I wouldn't consider management to be a huge strength, but not terrible either.

Now the insurance industry is a lot more predictable, but does carry some risks. With that said, Manulife appears to be a decent value at current prices and it will again someday sell for two times book value. Or to put it another way it's like buying Manulife for 6 times normalized earnings.

Have a Great Weekend,

Kevin Graham

Disclosure: No position in any stock mentioned.

Wednesday, November 10, 2010

ATPG - Caught the longs with their pants down?

We'll I just received an interesting link to a board over at the motley fool website. (If you posted the link at my blog please send me a quick email, I would like to talk to you.)

To begin I would like to address a few of the statements in ValuePEG's initial post.

ValuePEG states, "In Kevin's opening paragraph he states "I have never read any analyst reports nor have I read any comments by CanadianValue (a blogger was mentioned in the comment by Jason)". This was a bold face lie as he posted the following on his blog on Oct 23rd"

Please read the comment in context. I have never read any analyst's reports on ATPG and I have never read any of CanadianValue's comments on ATPG.


1) ATPG hasn't earned a dime in profits as a corporation.

Bold face lie, not only has ATPG earned a profit based on GAAP rules in the past, more importantly they have been cashflow positive the last 9 months on a operating basis, as most investors look for in stocks in the E&P business

Dear ValuePEG, please learn how to read a balance sheet. As of the end of 2009 they had negative cumulative earnings. I'm sure if I looked at the latest quarterly it would be even worse. Secondly, No matter angle you look at the income statement a profit is a profit and a loss is a loss. Go ahead a use Cash Flow if you like but that is what they did with internet stocks back in 1999. Lastly, speak for yourself, but please don't speak on behalf of other investors.

And finally, "To toot my own horn the writer has 22 followers as of this writing here at SA, while I have 31 at MF CAPS"

Congratulations you are my hero, do you pat your own back regularly?

Then we have another commenter named Justmee1 ask Swizzled (Devin Shire aka CanadianValue) the following question.


And Morgus will move additional P UD reserves to developed reserves, raising asset values again 1H 2011? How exactly is the asset value calculated? (I presume that developed reserves are higher value, but how much higher?)"

And then we catch Devin with his pants down.

"I don't know enough about the calculation to offer an opinion."

Well finally some honesty out of Devin Shire (CanadianValue). He knows nothing about reserves, how they are valued and walks around telling everyone he's an expert in oil and gas.

And then we catch ValuePEG with his pants down.

"As far as how exactly it is calculated i couldn't state but it is obvious that PDP counts at a much higher rate then P.D.P." (I believe he meant PUD's)

Thanks for attempts to lecture me on ATPG. I am embarrassed I wasted my time discussing the stock with these guys. You both call yourselves value investors, yet you haven't determined what assets the company owns and tried to value them. It appears that these guys are attemping to determine how to calculate a net asset value over at the motley fool boards.

You can follow their ongoing discussion here:

Have a great Remembrance/Veterans Day Holiday!

Best Regards,

Peyto Energy Q3 Conf. Call Notes

I took the time to listen to the Peyto Conference Call that was today. As a long time shareholder, it was the same old news… working hard to generate maximum returns on every dollar spent.

I took three notes away from this call. The third is another competitive advantage that they focus on.

1) Taxes and converting back to a corporation. Peyto is converting back to a corporation at the end of the year. They have approximately $850mm in tax pools that will shelter income for three years. Obviously they will be spending more capex during that time and they estimate that will further push the tax problem out another 2-3 years.

2) I quote Darren Gee, “when I meet with investors I tell them we don’t want gas prices to go up.” Now that is incredibility ironic. You will never hear another O&G CEO make that statement. Obviously Darren wouldn’t mind the additional cashflow from the higher prices, but it will increase competition. Essentially, the low gas prices have created a monopoly for Peyto. They don’t have to worry about service cost inflation and they are earning very good returns at current prices.

3) Peyto not only wants to earn high return on capital, but they want to turn the capital expenditures around as fast as possible. Now a lot of energy investors could learn something here. Spending huge amount of money on land doesn’t generate any return till the first well starts producing. The strategy of buy up the hottest play (at huge prices), screw around for a few years doesn’t work and is a huge cost. If you can have the shortest turn around from capex to cash generation you minimize the period where capital is not earning but costing you.

Anyway, Peyto should be a case study for Harvard MBA’s. Their clear focus on maximizing returns while continually minimizing costs. What more can you ask from your management team?

As Warren Buffett has said the best management teams don’t show up for work one day and decide to cut costs. It should come naturally to them, just like breathing. At Peyto, they continually strive to cut costs in order to maximize returns.

They also just announced they are also raising $125 million in equity to accelerate their drilling opportunities. While I am not a huge fan of any company I own raising equity (unless grossly overvalued), I have full faith in Darren Gee (CEO) and Don Gray (Chairman & Founder) in managing the business.

Best Regards,

Disclosure: Long Pey.un

Sunday, November 7, 2010

Why I'd avoid ATP Oil and Gas

I was asked by a comment on my blog by someone named Jason to comment on what I think of ATP Oil and Gas (ATPG - Nasdaq). I honestly don't know anything about the company other than one of my holdings, General Electric (GE), has had some dealings with them. I have never read any analyst reports nor have I read any comments by CanadianValue (a blogger was mentioned in the comment by Jason). I have read some of Canadianvalue articles but they contain little substance regarding returns on capital.

I took some time reading ATPG's 10-K and here is my quick and dirty.

1) ATPG hasn't earned a dime in profits as a corporation.
2) Their business model is feeding off the leftovers of the majors.
3) They have ran into some major financial difficulty (and the BP issues hurt them big time in GOM hasn't helped).
4) They are hugely leveraged as debt to equity is something like 5:1.
5) They borrow money at 12.75%. If that is what the bankers demand the company is basically up against the wall with a gun to their head.
6) If oil prices fall this company is toast.
7) It doesn't take long to see why short interest in the stock tops 50%.

I personally hate losing money more than I like making it. Now that makes me ultra conservative so I wouldn't touch ATPG with a ten foot pole. If oil prices fall you will lose your entire investment (even if they are hedged). I would never take such a risk.

To be fair I asked an opinion of a fellow blogger who is long and this is what he wrote me in an email.

I'll just bullet a quick rundown of all the positives and negatives for ATP now:


- Very high long-term debt with a high interest rate that gives them high fixed costs, and an even higher rate of future borrowing.
- Management is continually over promising and under delivering. The good news is they have become aware of this finally, and have begun to withold projections. If you say a well will be 7-10K barrels and it's 6.5K the market gets mad. If you say 5-7, that is a surprise; I believe the light bulb went on based on recent conference calls.
- At the mercy of Washington and future regulations. (Their drilling rig the Titan is state of the art, their management spent most of the summer in Washington teaching the politicians things about safety, and new regulations have been based on the Titans structure).
- If one of their wells turns out to be less than desired stock will sell off really quickly (98% success rate in developing their wells).


-Daily production started the year at 13.5K barrels per day and it's currently around 30K (will find out more at tmw's conference call at 11 AM).
- A couple smaller wells are expected to be brought on prior to year end.
- When they receive permits to drill their next two Telemark wells that will be a catalyst, and there will be some short covering.
- Have hedged 1/3 of next year's oil production in the low 80s. I expect/hope that they have hedged a lot more since oil has entered the mid 80s.
- They have about a 65-35 mix of oil to natural gas in their wells; natural gas prices are finally rebounding.
- Entrada: They bought this for about 200K which judging by the excitement in management's voice should be a location for future production growth sometime around 2012/2013.
- Their Octabuoy right is already monetized which will give them new production in the North Sea in 2012.
- No financial covenants on their most recent debt.
- Capital expenditures are fully funded for 2011 based on the Titan Monetization: They do not sound as if they will need to take each of the last $50 million draws, but the money is there if they are short on cash.
- I have them cash flow positive with 32K barrles/ day at $80 oil and $4 natural gas; I feel like they are there, and have the production growth to stay there and in 2012 start to pay down that debt.

The only point of Kyle's that I wouldn't agree with is the point on the finacial convenants on the debt. They actually have a number if you read the 10-K. I quote from page 48 of the 10-K.

Covenant Requirement during the
Amendment Period (4)

1. Minimum Current Ratio (1)(5) Greater than 0.8 to 1.0
2. Ratio of Net Debt to EBITDAX (2)(5) Less than 4.0 to 1.0
3. Ratio of EBITDAX to Interest Expense (5) Greater than 2.0 to 1.0
4. Ratio of PV-10 of Total Proved Developed Producing Reserves based
on future prices to Net Debt (3) Greater than 0.5 to 1.0
5. Ratio of PV-10 of Total Proved Reserves plus 50% of Pre-tax Probable
Reserves based on future prices to Net Debt Greater than 2.5 to 1.0

If you read the 10-K it also explains how they are just barely keeping these amended convenants. Secondly, guys like CanadianValue might believe the total proved reserves don't matter but they definitely do to the bankers. To be a successful investor you must think like a banker.

My Summary

Now, I don't understand why so called "value investors" continually go for high risk investments like this. This one has red flags all over it. I have an investment checklist that I use and let me highlight a few on ATPG for the readers.

1) Is the business simple and understandable?

Definitely not. Now it would take significant time to breakdown what ATPG actually owns. They have sold off royalty stakes in all different areas of their business. It is definitely one big mess.

2) Does the business have a consistent operating history? NO

3) Does the business have favorable long term prospects? Not Easily Determined.

4) How much income tax was paid last year?

Now this one is interesting because oil and gas companies can shelter taxable income with drilling tax pools. If you do own an oil and gas company and they have never paid any income tax that is an immediate red flag they aren't earning any returns on capital. Now small startups can shelter income tax if capex continually creates tax pools, but you much be able to read the financial reports accordingly.

As for ATPG, I already mentioned they haven't earned a dime in profits over it's history. Enough said.

5) What is the EBIT/Enterprise value? Zero.

6) How much leverage does the company employ? Way, way too much. Personally I hate debt, both personally and in businesses I own.

Now I could go on but I don't feel it's necessary. Why do investors feel like they have to jump through so many hoops in order to justify an investment? As Warren Buffett has said, "degree of difficultly doesn't matter in investing." If you followed Buffett's policy of 20 spot punchcard for your allowable investments in your lifetime would you waste a punch on ATPG?

This investment can't be explained on the back of a napkin, doesn't earn outstanding return on capital, doesn't have any competitive advantage, and it has a terrible operating history.

I'm sorry I have to stick to my guns and toss this one to the too hard pile (and I would add not worth my time anyway). This is where I scratch my head and ask where are the true value investors?

I previously have posted nine stocks on my blog that should return 10-15% per year for the next 5 years quite easily regardless of factors like where oil price will trade in the next few years. I will add that some have moved up substantially this past week so use your own judgement.

If you feel you are a value investor and take Buffett's investment strategy seriously please comment as I am deperately interested in meeting some fellow value investor over the internet. Comment Below or send me an email.

Best Regards,

To read Kyle's Blog Click Here

Friday, November 5, 2010

BAC Warrants - (Huge) Opportunity?

Does anyone else out there believe that the Bank of America (BACP Class A warrants represent a huge opportunity?

Here is the quick and dirty.

The Class A warrants have a strike price of $13.30/share. The warrant expires January 16, 2019, very long dated. These warrants closed today at a price of $7.05/warrant. Each warrant is good for one common share. The strike price is adjusted downward for any dividends above $0.01/share on the BAC common.

Now if I do the math, in order to make a positive return the stock price of Bank of America needs to be above $20.35/share in January 2019 to breakeven. Given that book value is approximately $21.70/share for BAC, this is basically a bet that BAC will trade for the current book value in 2019. Additionally the warrant strike price will be adjusted for dividends above $0.01 between now and then.

Now that is a bet I am more than willing to make.

Today, nobody is willing to purchase BAC, or many other US bank. We could discuss all of the problems with mortgages, loss of revenue due to recent service charge changes, etc. Obviously the problems with mortgages will haunt them for the next couple years, but after that they will do fine. They are a large, profitable bank that is capable of generating a decent ROE, but by purchasing for half of book value you are giving yourself plenty of room for error. Uncle Sam is pumping the liquidity into the system right now, and banks have rallied this past week.

Hats off to Francis Chou for this idea from his semi annual report (link below). He purchased 1,200,000 BAC Class A warrants for $8.54/warrant. Like I mentioned they closed today for $7.05/warrant. I was lucky enough to buy some for much less over the past couple weeks.

Any thoughts?

Best Regards,

Disclosure - I own a boat load of these BAC Class A Warrants.

Original Investment Idea - Peyto Energy (Part 1/Part 2)

In order to make money in any commodity type business there is only one competitive advantage a company can have, and I believe Peyto (TSE – PEY.un) has got it by a mile.

What is that competitive advantage?

To read the rest of the article Click Here for Part 1

To read the second part of this article Click Here for Part 2

Friday, October 29, 2010

Current Investment Ideas

I was recently asked by a family member for some investments to diversify into.  Here is a list of some of the opportunities I offered, which I believe represent decent value at this time. 

In Canada:

Fairfax Financial (TSE - FFH)
Manulife Financial (TSE/NYSE-MFC)
Peyto Energy Trust (TSE - PEY.un)
Hardwoods Inc. (TSE - HWD.un)


Wells Fargo - (NYSE - WFC)
Bank of America (NYSE - BAC)
General Electic (NYSE - GE)
Johnson & Johnson (NYSE - JNJ)
Kraft Foods (NYSE - KFT)

Many will be familiar with these names, except possibly the Canadian companies.  I have a few others that are under investigation, but more reading and study is required.  They are generally smaller and carry greater risks.  I also see some value in select large cap companies.  This is mainly because they many of them have had severe P/E multiple contraction over the past 10 years.  Walmart is one example whose share price has been flat while it's P/E has gone from 39 to 12.5 over that period.  Investors are growing impatient and the don't care that the underlying earnings of Walmart continue to grow. 

All of these companies listed above have outstanding long term economics, strong ROE's & returns on total capital, and many have unique competitive advantages.  I believe that all of these companies are trading at reasonable prices and some at outstanding prices.  It's definitely a head scratcher that a company such as Fairfax trades just above book value per share.  They have compounded book value at 26% for 25 years now.  Their handling of the credit crisis is nothing short of remarkable, and I would have no problem entrusting my capital to Prem Watsa.  Prem Watsa understands value investing and is slowly building a fortress in Fairfax Financial. 

I would recommend these all as long term investments, but you will have to be patient.  Buy them and forget about them for at least several years.  Check your yearly statements and watch them grow.  As Warren Buffett has said, "I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years."

Accumulating cash at this time wouldn't be a bad option either. 

I have already posted on Hardwoods.  Click Here.  It is really only an opportunity for individual investors because it's thinly traded.  Volume has slowed, but to a patient investor you can pick some up here and there.  Couple of weeks ago the volume was very good (and so were the prices). 

Have a great weekend. 


Disclosure:  I own positions PEY.un, HWD.un, WFC, & GE.  I also own BAC warrants.

Always consult unbiased help to assist when selecting stocks to purchase.  As Warren Buffett once said, "The market like the Lord helps those who help themselves, the market unlike the Lord does not forgive those who know not what they do."

Why the Peak in Peak Oil is a Myth

Many of those who have energy investments will no doubt have an opinion on peak oil. For those not familiar with the theory, here is a brief outline of the premises that the peak oil crowd put forward. First, the world has a finite amount of oil and we have consumed approximately 2/5ths of that know resource. Further to this they believe peak oil can be represented as a bell cure, of which once we have reached the maximum petroleum extraction rate we will enter an era of sharp production decline. They also believe that we are getting close to this peak in worldwide production and that even with flat demand the price for crude oil will continue to rise.

Since I typically question conventional wisdom, I often asked myself the following questions? Who says peak oil is a bell curve, and how do we know that we have used 2/5ths of a known resource? These things are spoken as if they are matter of fact. Are we close to the maximum possible production rate? Perhaps I could offer some competing ideas that will rock the boat.

To read the rest of the post, click here:

Monday, October 25, 2010

The Absolute last post on Petrobank

This is my absolute last post regarding Petrobank to Devin on 

The second half of the post is about value investing for those who don't care for the details on Petrobank.

I quote again:

1) Mr. Graham missed two thirds of their Bakken assets. The 2P number which is all Mr. Graham used in his valuation work is derived only on wells drilled to date. Petrobakken has 1,050 drilling locations in the Bakken. The 2P number that you used is based on 348 wells drilled. That is 33% of their Bakken assets. The Bakken of course is a well known play, and these drilling locations are in the known to be in productive Bakken acreage. These are ultra low risk drilling locations. By ignoring them Mr. Graham is ignoring 67% of the value of Petrobakken’s Bakken properties.

I am going to explain this as clearly as I know possible. I will break it down.

The 2P number which is all Mr. Graham used in his valuation work is derived only on wells drilled to date.


The 2P number that you used is based on 348 wells drilled.

The 2P number I quoted includes all 384 wells you said have been drilled (I will take your word for this). Beyond, that they have booked 297 PUDs. These wells have not been drilled. This will be drilled in 2010, 2011 and 2012. Beyond that they have booked 180 probable wells. These wells have not been drilled. This will be drilled in 2010, 2011, and 2012, but more likely in the later timeframe.


348 wells already drilled + 297 PUDs (not drilled)+ 180 probables (not drilled) = 825 wells.

Please read the report and confirm this for yourself. Don't take my word for it.

I appreciate your new tone and I will try to be more civil as well. Next statement (from your last comment).

I think your valuation of this company is way off and I think that is fairly obvious to most readers. Stop trying to focus on whether the reserve report says 477 wells or 384 wells and apply common sense.

You thought my valuation was incorrect because you weren't aware that 477 undrilled wells have already been booked. Secondly, why should I stop using reason and apply common sense. I am trying to breakdown what the value is and isn't. Since the 2P reserves does include 477 undrilled wells then my analysis is the best we both have to go on. Can't you see that. You seem to imply that common sense is some sort of sixth sense where we percieve the value. Economics are economics.

I can tell that the prices I'm paying for PMG and PBN are at the worst fair and very likely a nice discounts.

Thanks for the admission of fair value. I will also go on the record and state that I believe the company is fairly valued. That said, they are trading at fairly significant premiums to the 2P reserve value so the wells they are currently drilling must perform better than what they forecasted.

You also state the Petrominerales has made a significant discover, which is why they are trading where they are. I will take your word on it, I will ready what the reserve report says next year to confirm it as so. So at best PBN & PBG are trading at fair value but are at a 50% premium to reserves value so they better deliver the goods. I just don't have that much faith in the company.

As for the heavy oil and THAI, you need to be very careful with the contingent resources. THAI is unproven and the heavy oil business is tough and in many cases borderline economic. It is very capital intensive compared to conventional wells.

With all that said, this is not a value investment by no means. A lot of expectations are already built into the prices so I don't see the value.

Back in 2001 you could buy oil and gas company's by the handful for 2P reserve value. Some could be had for just proven producing value (just the wells on production). Companies that operated in less politically unstable regions traded at steep discounts because of the additional risk. Someday they will trade at those levels again. Resources and gold have been the hot stocks lately.

Markets overshoot and then undershoot. Everyday the Market votes on the value of these companies but in the long term the Market will weigh the real value in these companies by the cash they produce. They better deliver.

The biggest reason it is hard to value the company is because PBG cannot control oil prices. Nobody knows where oil will be 3 years from now. Now for Walmart, I can reasonable guess what their earnings will be 3-4 years from now because they are very predictable. Degree of difficulty doesn't pay in investing, pick something simple and easier to value. This is what Buffett calls jumping a 1 ft bar, and recognizing what you know vs what you don't know (circle of competence).

As you know, I have already offered one original value idea on my blog. It's trading at 4x normalized earnings, and bleeds free cashflow. Hardwoods is a very simple company that has been selling wood for 70 years. I will bet on a company like that any day of the week than one that is so difficult to predict. Feel free to pick it apart. I would like to know if I am missing something.

I am moving on because I have to read the Kraft annual report. Been meaning to read it for a while.

Good luck with PBG!


Petrobank - This guy won't stop

Devin won't give up over on 

He said the following:

"1) Because you looked only at one number (PV10) you gave roughly 2/3rds of Petrobakken's land base exactly zero value. 2P reserves are booked on 348 out of 1,050 drilling locations. See page 11 in the link below:"

This is not true.  Here is my latest response.

You just won’t quit will you?

Now your comments further expose your ignorance. Did you or did you not read the reserve report before you wrote your masterpiece on PBG?

Now, let’s go back to the reserve report again. PBN has book ~300 PUDs in the Bakken/Mississippian formations. Those are proven undeveloped wells that have not been drilled as of the report. As for probable reserves they have booked another 180 wells in the Bakken/Mississippian formations (135 Bakken, 45 other Mississippian).

Let me quote the reserves report again for you so you can read it.

“The Sproule Report has assigned proved undeveloped reserves to 207 net light oil well locations in the Bakken properties in southeast Saskatchewan. In addition, the Sproule Report has assigned proved undeveloped reserves to 90 net light oil locations in the Conventional properties located in southeast Saskatchewan and Manitoba”

“The Sproule Report has assigned probable undeveloped reserves to 135 net locations in the Bakken properties in southeast Saskatchewan. In addition, the Sproule Report has assigned probable undeveloped reserves to 45 net light oil locations in the Conventional properties located in southeast Saskatchewan and Manitoba.”
Now, I will do the math since you seem to be fairly poor at reading. The total is 477 wells already booked that will take them out to the end of 2012. The probable locations are step out and carry greater uncertainty. Again, all of this is all in the reserve report. I shouldn’t have to explain this to you. You seem to think the Bakken is something else based on what you heard in the news. Why do you continue to think that they haven’t booked any of their 1000+ wells?

Now you can continue to think that I am some sort of amateur, go ahead. You can believe that along with your $80 price target on PBG. Arguing from ignorance is a sure fire way to lose any debate.



Sunday, October 24, 2010

Response To The Critique of My Petrobank Analysis

This is my response to the recent article by Devin Shire in response to my article on Petrobank. 

You be the judge. 

The entire article can be found here:

A nice gentleman named Mr. Graham that I don’t know was kind enough to write a very critical article of my analysis of Petrobank.

No where was I “very critical” of your analysis. All I said was that you presented an interesting, “heads I win huge, tails I win big.” That is a huge statement and better have substance behind it.

Since Mr. Graham can’t be bothered to look at these “other assets” of Petrobakken let me save him some time. Because unlike Mr. Graham I actually do bother to research companies before I write articles. Here is what was missed.

1) Mr. Graham missed two thirds of their Bakken assets. The 2P number which is all Mr. Graham used in his valuation work is derived only on wells drilled to date. Petrobakken has 1,050 drilling locations in the Bakken. The 2P number that you used is based on 348 wells drilled. That is 33% of their Bakken assets. The Bakken of course is a well known play, and these drilling locations are in the known to be in productive Bakken acreage. These are ultra low risk drilling locations. By ignoring them Mr. Graham is ignoring 67% of the value of Petrobakken’s Bakken properties.

This is not true. The 2P number does include drilling locations to be drilled over the next few years. In fact, the 1P number may also contain Proved Undeveloped reserves or PUDs. These are generally wells that are going to be drilled over the next 12 months located next to proven producing wells. I am not missing 2/3rd of their Bakken assets. Please read the reserve report before you demonstrate your ignorance.

Let me again quote from the reserve report that Mr. Shire has now demonstrated for us has not read.

"The Sproule Report has assigned proved undeveloped reserves to 207 net light oil well locations in the Bakken properties in southeast Saskatchewan. In addition, the Sproule Report has assigned proved undeveloped reserves to 90 net light oil locations in the Conventional properties located in southeast Saskatchewan and Manitoba."

Now that is approximately 300 wells that will be drilled to the end of 2012 that are already booked as reserves.

Oops… Now is Mr. Shire telling the truth or is he just using deception to promote his book?

Let me get Mr. Graham up to speed. Petrobakken this year aggressively acquired land in the middle of what is turning into a highly productive Alberta Cardium play (listen to the recent PWE investor day) In fact Petrobakken is now the 3rd largest holder of Cardium acreage. In total they have 120,000 net acres and over 500 drilling locations. Petrobakken has zero dollars of reserves booked on these properties (because they are just starting drilling) so Mr. Graham has not given Petrobakken a dime of credit for these properties in his analysis.

Wow, Mr Shire seems to know the value of these wells before they are even drilled. Just because you have land doesn’t prove it is going to be productive, let alone be even close to the most productive area of the formation. This is pure fantasy until the wells are drilled and economics proven.

At this point I’m tempted to stop. Mr. Graham has missed the majority of Petrobakken’s asset value in his brief analysis. His analysis does not appear to have been performed by someone familiar with this industries and certainly no familiarity with companies such as Petrobakken or other Bakken holders like Crescent Point.

No please don’t stop, I haven’t missed the majority of the value in my analysis. I am far more familiar with this industry than you would like.

Mr. Graham, those “other assets” that you can’t be bothered to analyze is where us value investors (and honestly anyone who follows the industry or reads the newspapers in Saskatchewan) knows hundreds of millions of dollars of asset lie.

You be the judge. Who has read the engineering report and who’s been reading newspapers? Mr. Shire doesn't seem to understand which wells are and aren't on the books.

That is it. 690 million barrels of oil (and that is at May River alone and excludes Kerrobert and . Mr. Graham figures the value is $367 million. Petrobank provides a PV10 estimate of these assets in their presentation of about $3.3 billion.

Now this shows a significant problem with how Mr. Shire determines the value of, well, anything. Just go look in the companies overhyped investor presentation and repeat it’s contents.

First, I don’t figure that the value is $367 million. That is the value the engineering report gave to the probable reserves. Call Sproule and discuss your issues with them.

Secondly, this creates another problem with inexperienced investors. Let me explain with an example. Connacher (TSE-CLL) is another oil & gas company that was touting the exact same thing a few years ago. They had this huge value of oil sand assets. The ignorant investors simple took the total value of from the investor presentation and divided the shares outstanding and came up huge value per share. The only problem was coming up with the billion plus dollars to get the project on production. Obviously it was going to take a huge amount of debt or equity to get the project off the ground. Obviously the faithful didn’t want to hear what I had to say, apparently Mr. Shire doesn’t either.

Some many investors fail to realize that heavy oil and oil sands are very capital intensive and return generally haven’t been that good. The only exception was back when oil was $130.

Beyond this Mr. Shire states that I am missing a bunch of speculative assets, such as land and “highly prospective” properties. Ok, maybe I am. As I said before if Mr. Shire wants to call this value investing, go ahead, perhaps he needs a new definition.

I am really over having to explain myself Mr. Shire. I have written enough here to prove who knows what they are talking about and who don’t have a clue. If I ever write a book it will be called “defying economic gravity.” Everyone tries to do it but eventually they come crashing back to reality.


Saturday, October 23, 2010

Removed from Devin Shire's Blog

This was my comment on Devin Shires Blog

It has since been removed. 

Come on Devin you can't be serious?

I know you will probably remove this response so I will be sure to post it on my blog anyway. 

First there is so much bunk in this article the readers can try to determine truth from fantasy.  You seem to know a lot about me and how I analyzed this company.  Again more speculation. 

Let me respond to your summary of points I am missing in my valuation. 

1) Ignoring undeveloped acreage.  Please inform me of the value, or should I say please speculate on the value. 

2) Petrominerales’ portfolio of highly prospective properties.  Again please inform me of the value, or as you said "prospective" properties. 

3) Heavy oil assets yet to be booked as reserves.  Again, please inform me of the (specutive) value...

4) Shell and Baytex.  Here you are half correct, they are partners but PBG owns the THAI technology.  That is not what I said.  I said Shell and Baytex knows how well the joint wells are performing and decided to sell.  Why did they sell, I offered my opinion lets have yours. 

As a value investor, you seem to be doing a fair bit of speculating on 1, 2, & 3 above.  If you want to call that value investing go ahead, but you need a new definition. 


Please note: I did not attack your analysis in my post but simply presented the facts.  Stop the childish attacks of my character and stick to the facts.

Petrobank Energy (PBEGF) – A Terrible Risk/Reward Scenario

I just submitted this article on gurufocus.  After reading some over-hyped analysis by a guy named Devin Shire, I decided to dig in and do some analysis myself.  The stock option pricing were quite a revelation, and it seems to be shaking things up over there.  You can check it out here:

Wednesday, October 20, 2010

Blog Introduction

I just want to welcome all value investors to this blog.  I hope you find it a valueable source of fresh, and refreshing content.  I don't intend to rehash the investment days news, because frankly I don't care if the markets went up or down. 

My plan is to publish one original investment idea on this blog per month, with other value investing insights inbetween.  If I cannot find a value investment idea I will let you know. 

I should add this caution.  If the market continues to rise it will become very difficult.  Currently I only see some value in large cap US stocks and some select small to mid Canadian companies.  Of the large cap US stocks it wouldn't bother me either way if I purchased or not.  They are not stand out values but many are companies with strong franchises.  They would be companies to own for the rest of your life. 

I will also update periodically on how the investment ideas that I post perform.  A full lookback will be performed and posted annually.  Anything shorter is a waste of time. 

I do work full time (Professional Engineer), have a family, and have some other responsibilities but I will strive to keep the content here top notch.  Investing is a deep passion of mine, I would love to manage investments for a living.  I do keep my living expense at a minimal, and I am likely one of the few people out there who don't have cable TV.  I prefer having more time to read (about investing, 10-K's, and 10-Q's).  If I can, I will make the switch as soon as I have passive income that will cover expenses.  Like Buffett has said, not doing what you love is like saving up sex for old age. 

That said I do have fairly decent investment funds for my age and I do find it fun working with the funds I do have.  I also advise some family members as well. 

If you have a similar value blog/website feel free to drop me a line. 

Kevin Graham

Tuesday, October 19, 2010

Buffett on Gold

This is taken from the following article:

My first question, as I sit there on the couch in his office, is: "What about gold? Is this a classic bubble or what?"

"Look," he says, with his usual confident laugh. "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"

Okay, so gold is not a screaming buy to Buffett. What should a typical upper-middle-class person in the U.S. buy to prepare for retirement?

"Equities," Buffett answers without a moment's hesitation.

It is remarkable how Buffett has a simple way of putting things.  I have recently been recommending anyone who owns gold to sell.

I know some value investors have have large gold holdings, but my question is how do you know if gold is over or undervalued?  Demand is high because of the poor state of the economy, but that can change quickly. 

If I were to take a guess, I think gold may have some more room to run.  My theory is that demand will grow because everywhere I turn I hear about gold.  It's on TV, radio, papers, home parties, and recently booths in the mall buying gold jewelry.

Gold is becoming a little too speculative for this value investor.  If I can't value it, it gets tossed.

Saturday, October 16, 2010

Investment Philosophy of Walter J Schloss

I came across this a few years ago.  It is the investment philosophy of Walter J Schloss, a contemporary of Buffett and worked with him at Ben Graham’s investment firm.  I will comment on his points in a future post.  Please note there are some spelling mistakes and they are not errors from being transcribed. 


Walter and Edwin Schloss Associates L.P

Factors needed to make money in the stock market

  1. Price is the most important factor to use in relation to value.
  2. Try to establish the value of the company.  Remember that a share of stock represents a part of a business and is not just a piece of paper. 
  3. Use book value as a starting point to try and establish the value of the enterprise.  Be sure that debt does not equal 100% of the equity.  (Capital and surplus for the common stock)
  4. Have patience.  Stocks don’t go up immediately.
  5. Don’t buy on tips or for a quick move.  Let the professionals do that, if they can.  Don’t sell on bad news.
  6. Don’t be afraid to be a loner but be sure that you are correct in your judgment.  You can’t be 100% certain but try to look for weaknesses in your thinking.  Buy on a scale and sell on a scale up. 
  7. Have the courage of your convictions once you have made a decision.
  8. Have a philosophy of investment and try to follow it.  The above is a way that I’ve found successful.
  9. Don’t be in too much of a hurry to sell.  If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit.  Before selling try to reevaluate the company again and see where the stock sells in relation to it’s book value.  Be aware of the level of the stock market.  Are yields low and P-E ratios high.  If the stock market historically high.  Are people very optimistic etc?
  10. When buying a stock, I find it helpful to buy near the low of the past few years.  A stock may go as high as 125 and then decline to 60 and you think it is attractive.  3 years before the stock sold at 20 which shows that there is some vulnerability in it.
  11. Try to buy assets at a discount than to buy earnings.  Earnings can change dramatically in a short time.  Usually assets change slowly.  One has to know much more about a company if one buys earnings. 
  12. Listen to suggestions from people you respect.  This doesn’t mean you have to accept them.  Remember it’s your money and generally it is harder to keep money than make it.  Once you lose a lot of money it is hard to make it back.
  13. Try not to let your emotions affect your judgment.  Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks. 
  14. Remember the work compounding.  For example, if you can make 12% a year and reinvest the moneyback, you will double your money in 6 yrs, taxes excluded.  Remember the rule of 72.  Your rate of return into 72 will tell you the number of years to double your money.
  15. Prefer stocks over bonds.  Bonds will limit your gains and inflation will reduce your purchasing power.
  16. Be careful of leverage.  It can go against your.