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.