Monday, October 11, 2010

11 October 2010 Risk Not Gain Not


11 October 2010 Risk Not Gain Not

Did you notice that today was first time in 11 sessions that the 10 Year Treasury Yield did not go down? That is because the bond market was closed today for Columbus Day. I’ll bet those people in the bond market are glad we created a Holiday for Chris before we all figured Leif Ericson had found North America 500 years before Columbus and 70 years after the Chinese. Heck, a day off is a day off.

Before I get to answering some of the questions I owe you, it seemed relevant to share a little article in the Journal (When I capitalize the word Journal, I am of course referring to The Wall Street Journal and not my private journal that I occasionally keep up to date with daily notes of life and other obscure concepts.) The article by Chuck Jaffe was about risk tolerance and investor psyche. He cites several studies, which conclude that investors buy high and sell low. If you follow the market, that is not news. People avoid the market when it is low. After the bad economic times of 08-09 and the May Flash Crash, retail investors are keeping cash in mayonnaise jars versus investing. (Not really, although I do know at least two readers who keep cash at home. By mayonnaise jars Jaffe is talking about low yielding cash accounts or bonds.) Bad move as inflation, even as low as it is, is eating away at that cash. He also discusses interest rate risks as people who have bonds maturing in this environment and might lock into low long term yields. Then he talks about shortfall risks and this applies to those people who calculated their retirement investments based upon the good old days of 2007 and before. Many are expecting 6-9% returns and will end up short and have to eat into their principals because they are being too conservative now when the market is volatile. Then there are the timing risks which basically compares what returns might be over the next 5-20 years versus the next 18 months.

Anyway I recommend the brief article to those who are waiting by the side lines for when the market hits 12,000 and everybody is feeling happy and then they get in just in time for inflation to hit and corporate earnings begin to soften and their portfolios begin to flatten.

To bring home the point, let me give a very good example of how to play the risk game. I had someone ask me about LMT Lockheed Martin Corporation engages in the research, design, development, manufacture, integration, operation, and sustainment of advanced technology systems and products in the United States and internationally. The company also provides management, engineering, technical, scientific, logistic, and information services. It operates in four segments: Aeronautics, Electronic Systems, Information Systems & Global Services (IS&GS), and Space Systems. The Aeronautics segment provides military aircraft, including combat and air mobility aircraft, unmanned air vehicles, and related technologies. Its products and programs include the F-35 Lightning II Joint Strike Fighter-multi-role coalition fighter, the F-22 Raptor-air dominance attack and multi-mission stealth fighter, the F-16 Fighting Falcon-multi-role fighter, the C-130J Super Hercules tactical transport aircraft, and the C-5M Super Galaxy strategic airlift aircraft. This segment also supports P-3 Orion maritime patrol aircraft and U-2 Dragon Lady high-altitude reconnaissance aircraft. The Electronic Systems segment offers air and missile defense; tactical missiles; weapon fire control systems; surface ship and submarine combat systems; anti-submarine and undersea warfare systems; land, sea-based, and airborne radars; surveillance and reconnaissance systems; simulation and training systems; and integrated logistics and sustainment services. The IS&GS segment provides federal services; information technology solutions; software and systems engineering support services; logistics, mission operations support, peacekeeping, and nation-building services for the various U.S. defense and civil government agencies. The Space Systems segment produces government and commercial satellites; strategic and defensive missile systems, including missile defense technologies and systems, and fleet ballistic missiles; and space transportation systems. Lockheed Martin Corporation was founded in 1909 and is based in Bethesda, Maryland.

At face value, despite some really sexy fundamentals, I am concerned because the US government as well as our brothers in arms (cute pun, could not resist) are cutting back federal spending and LMT will feel the pain. However, this is a good value stock and if you consider the words of Benjamin Graham in the Intelligent Investor when he addresses the margin of safety (the inverse of the margin of risk). He simply states a stock has a high margin of safety at one price, a limited margin of safety at another price, and no margin of safety at yet another price.

LMT is currently priced at 70 a share. It has a forward looking P/E of 9.35. If you just a little homework (Not enough to buy, but enough to see my point) you could quickly see that the analysts who get paid big bucks to qualify this company have a value of 83-86 a share. If you apply the current P/E for the S & P 500 to future earnings you are looking at a 106 dollar stock. This all sets up a decent margin of safety. Even if the S & P is over valued by 20% the stock is an 83 dollar stock. If the company only makes 6.50 a share rather than the expected 7.50 a share in 2011, it is 91 dollar stock. You get the point. It has a good margin of safety and you get a 4% yield on the dividend. Don’t get me wrong, I am doing more homework and there is an article in the Journal about defense contracting protocols that may have an impact of the likes of LMT in future contract bidding, but that ruling will apply to all the boats in that harbor. (GD, BA, NOC, HON etc.)

In a nutshell, if you wait long enough for the market to make you fell better the worse you going to feel at the end of the game.

How Much Fun Is Too Much Fun

One of the questions I got was how many stocks do I have and how many stocks should a normal person have?

Here is the answer. Too many and none.

I have too many stocks. There are 38 stocks or ETFs Options in our primary account. There are 4 bonds that require a basic understanding of the underlying equity and we have 7 portfolios that we are managing for trusts or with other people. There are at least another 12 equities in those portfolios eliminating all redundancies. (Hey even I was surprised buy the number.)

It would be a lie if I said I did all the proper homework on all 60 stocks. We (and I will say we as I do solicit input from my wife who constantly amazes me with her market astuteness.) probably do more diligence of the accounts that we co-manage or hold in trust than we do on our own, but we have a higher risk tolerance than most. I would rather loose my money than someone else’s. Of those 60 and using Pareto mentality, I do know my top 8 holdings intimately. KO, GLD, CVX, AAPL, IBM, BA, and INTC are some of the stocks that I have alerts set for so I see every piece of news (I was out of BP and RIG within hours of the spill.). I check the sec filings every quarter at earnings release. I listen to the conference calls at least once a year and usually more. I check the Ned Davis, Argus reports once a week and check the stocks of which gives me all the press releases for that company. With all of that I still miss important news that has “temporary” effects on the stocks. We are not a normal people.

How many stocks should a normal person have? None. Quite honestly unless a person has the time to determine their margin of safety, they become one of those people described in the Jaffe article where they get in the market when the headlines are good and a little piece of information about a company is promising so you pile on. That is the time you start taking profit and determine your exit plan. Unless if your margin of safety is still in place. AAPL is a great example. No debt, great profit, future earnings look good. Their forward looking P/E is getting above the S & P 500 number of 14, but it should be. The analysts target prices are in the 330-360 range and the stock is at 295. If the analysts are off 10% we are OK. If they are off 20% we are at that value. AAPL is getting very close to a margin of safety I am not comfortable with, but I will be watching AAPL close for an exit plan because my margin of safety is narrowing. Hope you get all of that because it will really help. We also have a 24% gain on AAPL so that helps too. It is actually higher because of the maneuvering we had to do around the May 6 Flash Crash.

In the Salve Lucrum Portfolio

Not much going on. We are betting on the GWW Grainger earnings report this week by picking up some January 2011 calls. We paid 3.19 for the calls and that means we would be in the money at 133.19 a share. It is currently trading at 123. We are thinking a great earnings report and a nice move toward the 130 mark at which point we would take the money and run. BTW this option play does not have a good margin of safety. A lot can go wrong. This is a very speculative trade.

We also added to our position on PNG on the stinky nat gas numbers. Of course I meant the numbers were stinky not the nat gas. But nat gas is kinda stinky so. . . But I digress.

From The War Room in the White House

President Lyndon Johnson getting his butt kicked again in a serious game of Chutes and Ladders
Salve Lucrum


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