August 2007 Archives (John Czerw)

August 2007 Archives

The Fundamentals

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What attracts me to a stock is a company's business fundamentals. Is there demand for the company's product? Can it meet that demand? Is there a substantial profit margin in the product? Is there growth within the company's market, or can the company expand within a mature market? Can the company grow cost efficiently? Can management contain overhead costs to maximize margins?

To further explore these issues I'd like to review the stocks in my portfolio

ACAS (American Capital Strategies) finances and invests in medium sized non-public companies. They are a business development company -- NOT a venture capital fund, so they do not invest in start ups. Their deal flow is strong (strong demand for their product) and they cherry pick their deals. Their revenue is growing at a 40% rate and their profit margin is 21%. As a business development company, they distribute 90% of their profits in dividends. Their current dividend rate is 8.8%. The diversity of their investments and the quality of their underwriting are strong. PE of 6.5 makes this stock look cheap to me. Finally, ACAS was recently added to the S&P 500 which should increase the market for this stock.

FDS (FactSet Research Systems) provides financial, economic and analytical information to financial institutions worldwide. Their profit margin is 22% and their growth rate is also 22%. With a PE of 32, FDS is more costly than ACAS, but the company's prospects appear strong. Jim Cramer recently opined that FDS could be a takeover target, but it was not that issue that attracted me to the company.

GIL (Gildan Activewear) If you own a ball cap or a tee shirt with a corporate logo on it, Gildan probably made the cap or shirt. This is an apparel company whose business is largely driven by corporate spending. (an interesting niche in which they are the leader). Their profit margin is 10% and their growth rate is 26%. Their trailing PE is 41, but their forward PE is only 18. Restructuring costs designed to reduce production costs (they moved some plants offshore) have negatively impacted their earnings recently.

LTFD (Littlefield Corporation) This company operates in the arcane world of charitable bingo. They are actually a lessor of space to charities that conduct bingo games. This is a highly regulated niche business that a lot of folks balk at, but the margins on the bingo halls are over 40%, and LTFD has 30 bingo halls with plans to go to 150. The company had a troubled past that current CEO Jeff Minch has all but put to rest, since he took control of the company by buying 35% of the company in the open market and becoming CEO. Bingo isn't a growth market, but the opportunity to buy halls and realize operating efficiencies is great. There is no other consolidator of bingo halls in the public markets. LTFD's profit margin is 4%, but it is depressed by legal settlements the company must currently make to settle legacy legal issues. Top line growth is strong at 19% and their PE is 21. Recently a private equity fund bought 12% of the company (most in the open market) and gained a board seat. This entity could be an important source of financing for the company in large acquisitions or a private takeout.

VLO (Valero) While a scarcity of oil can result in higher gasoline prices, the current scarcity in refining capacity also contributes to increased gas prices. Valero refines and markets gasoline. With a shortage of refining capacity, Valero can operate at a high capacity utilization rate and operate cost effectively. If, in the long term, demand outstrips supply, and gasoline must be imported, the price floor for domestically refined gasoline could rise. They have a net margin of 6%, a PE of 7, but 2nd quarter 2007 earnings jumped 16%. Valero is sitting in the catbird seat.

XTO (XTO Energy) XTO explores for and prodcues natural gas in the domestic US. They go after tight gas formations (gas embedded in rock such as the Barnett Shale formation in North Texas) and also have developed techniques to exploit fields that others believe are played out. They have their metrics down to a science and are a very low cost producer of natural gas. They grow by buying leases from individuals, other companies, or buying other companies outright. Their profit margin is 33%, their PE is 12, and they are growing at 20% a year. XTO produces a great source of energy that is relatively clean burning, and domestically produced.

So to recap, I'm investing in:

Loans to, and equity positions in, mid sized private companies (ACAS)

Business, Economic Data, and analytics provider (FDS)

Custom activeware apparel manufacturer (GIL)

Charitable bingo hall lessor (LTFD)

Gasoline Refiner and Marketer (VLO)

Domestic Natural Gas Exploration & Production (XTO)

How I invested my $1,000,000

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But first, let me tell you about one more stock that I accidentally omitted from my first post.

PSYS (Psychiatric Solutions) operates inpatient mental health care facilities. They have 75 hospitals in 29 states and have 8000 beds. Their profit margin is 5% and their net income doubled from 2005 to 2006. Demand for inpatient mental health care is strong and PSYS grows by acquisition and building new facilities. Their trailing PE is 27, but their forward PE is 16.

So to recap the fundamentals:

Strong products
Strong markets
Strong managements
Strong margins and/or growth
Fair valuations

I believe ACAS, FDS, GIL, LTFD, PSYS, VLO and XTO have all of the above.

Now on to the $1,000,000:

I put 15% each into ACAS, PSYS and XTO. ($150K each / $450K total)

I put 9% each into FDS, GIL, LTFD and VLO. ($90K each / $360K total)

This made my fund compliant and left $190K in cash. I did this to allow for market dips that I could exploit by buying more of the above stocks. This past week all but one of my stocks took a dip. The gainer, at less than 1%, was LTFD, somewhat ironically, the riskiest stock in my portfolio. Two stocks lost about 8%, PSYS and VLO. Next week I will increase my positions in these two stocks by 10%. Anything under a 5% dip from my purchase price, I consider noise.

Positions Increased

Rating: 3.00 (1 votes) Vote:

I increased my positions in PSYS, VLO and GIL by 10% each (450, 140 and 270 shares respectivley). I hadn't mentioned GIL previously but when I executed the trades, GIL had fallen by more than 5 %. The net effect of these actions was to lower my cost basis in these stocks by .5%, .9% and .4%.

Note on LTFD: This order for 80,000+ shares is still filling. Right now about 14,000 are in my account. Marketocracy limits the % of shares that can trade. LTFD trades 20,000 shares a day, so it could take a few weeks. I'm comfortable that 80,000 shares is a liquid position.

Compliance Maintenance

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GILhas increased in value and pushed this holding above 10%. Subsequently, my fund is out of compliance. To correct this I have put a sell order in for 70 shares. This brings GIL to 9.9%.

A good day overall.

GIL up $1.92
PSYS up $1.42
XTO up $1.42
ACAS up $1.16
VLO up .95
LTFD even but on 33,000 shares
FDS down (2.10)

Compliance Mainenance (Part 2)

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ACAS, PSYS and XTO have gained to the point where they now comprise 51% of my portfolio. I need to trim 1%. Truth is, I hate to sell any shares of these three. But, I must.

All three stocks are off their 1 year high by 14%, so no help in deciding with that measure. Forward PEs are 12 (ACAS), 13 (XTO), and 19 (PSYS). Based on the relative forward PEs,I'll sell 310 PSYS to reduce my top three holding by 1.1%. But, in truth, it's a coin flip.

Credit Crunch??

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ACAS just completed a 500M securitization backed by business loans they originated. The pricing of the offering was favorable for ACAS. See following link.

http://biz.yahoo.com/prnews/070808/new103.html?.v=10

From July 9th until August 1st, ACAS fell from 47 to 37 or 27%. The market overreacted to the subprime problems and threw ACAS out with the bathwater. ACAS has tight underwriting, low delinquencies, and a strong deal flow which they can cherry pick. They don't chase deals like sub prime lenders.

Since August 1st, ACAS has risen from 37 to 42, gaining 13%. Their 52 week high was just under 50. Finally, they were recently added to the S&P 500, so S&P index funds will be buying them. Much more upside here, not to mention an 8% dividend.

More Transactions

Rating: 1.33 (3 votes) Vote:

Today I bought another 140 shares of FDS after it fell about 10%. I'm confident in the company's prospects and wanted to lower my cost basis.

I will also trim another 150 shares of PSYS to bring my fund into compliance.

Overall the fund is up around 3% in a little less than two weeks. These are good results, especially in the current enviornment.

Stock Purchases 8/10/07

Rating: -0.31 (13 votes) Vote:

Today I bought 150 more shares of FDS after it fell at the open. I ended up lowering my cost basis and made money on the buy, by the end of the day. I will keep adding to positions when they are below my cost. Typically, I'll add 10%. While there are a lot of problems in the market right now, I am comfortable that my portfolio of companies will perform well in this environment, as will their stocks. Speaking to that point, here's how my portfolio has done over the past two harrowing weeks:

Stock Gain/Loss Weighting

ACAS... +6.96% ... 16%
PSYS... +5.25%..... 16%
XTO.... +4.26% .... 16%

GIL.... +3.83% ... 9%
VLO.... +2.74% .... 9%
LTFD ... no change... (order still filling)
FDS.... (5.30)%.... 9%

Please note that the biggest gains were in those stocks with the biggest concentrations.

One side note....In my personal account I bought some Countrywide Financial (CFC). It struck me that there was blood in the streets, and that Countrywide is strong enough financially, and has a strong enough management, to not only weather this storm, but come out of it in a stronger situation competitively. I didn't buy in this competition because it only has a six month time frame and the payback on the CFC investment will probably be about two years.

LTFD Acquisition Announcement

Rating: 1.04 (25 votes) Vote:

LTFD has acquired two Texas corporations that are charitable bingo hall lessors. The details are sketchy at this point due to confidentiality agreements, but...this is VERY good news. LTFD works as a stock if the company grows through acquisitions.

http://biz.yahoo.com/bw/070815/20070815005904.html?.v=1

Its nice to have a stock that is trading on fundamentals rather than hype or hysteria. The private investment group buying into LTFD has increased their stake to 15%. The stock is up 39% this year, from ..81 to $1.20.

Fed Drops Bear in its' tracks!!!

Rating: 0.07 (14 votes) Vote:

Thank you Mr. Bernake. The drop in the discount rate was just the right move. Still plenty of room to move on the overnight fed funds rate, but relief for corporate borrowers just when they need it.

Only one trade this week. Sold 70 FDS to gain compliance with Marketocracy's (the guys who run the portfolio site) asset allocation parameters.

In the real world, I doubled down on my $28 purchase of CFC @ $21, and then again at $17.50 using Jan 09 call options. I expect Countrywide to to around $36 by the end of 2008. Right now that would be an 80% return in 16 months.

Also, I hold ACAS in my real life portfolio and I added to my position in it by 25% when it got down to around $36. ACAS has really gotten hammered during this "fear of credit" sell off. They are tightly managed, well diversified and have excellent credit performance. At their low last week, their dividend exceeded 10%. (And yes, I think the dividend is safe.)

Allocation Adjustments

Rating: 1.11 (18 votes) Vote:

On Friday I made a change to two of my stock allocations, decreasing XTO to 9% of my holdings, and increasing FDS to 15% of my holdings. Reason? While XTO is an excellent company and stock, the current weakness in the natural gas markets is lessening its chances of appreciation within the timeframe of this competition. FDS, I believe, has been beaten down because its customers are financial institutions, and it appears to be another case of the baby out with the bath water.

Bottom line, there's more short term upside in FDS than XTO.

VLO uptick

Rating: -0.30 (13 votes) Vote:

Earlier this week, VLO advanced to greater than 10% of my portfolio, putting it out of compliance, so I sold it back down to 9%.

The XTO / FDS allocation shift seems to have been a good move. XTO which was reduced to 9% ,has fallen 1.73%, while FDS, which was increased to 15%, has advanced 3.43%.

John Czerw

jczerw

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