InvestorPlace Blogs is powered by Marketocracy. Marketocracy has authorized Investor Place Blogs as an official registrar for voting through Marketocracy's Investment Research Rating service. Registered members of InvestorPlace Blogs are linked with a Marketocracy account to establish voting power based on their performance of trading and posting on stocks.
When a stock trades for a fraction of its future (or former) value, you are right where money can be made or lost in large amounts, a strange logical landscape where normal analysis seems to break down. You don't need a computer or a calculator, all you have to do is divide or multiply by 2, the question is how many times you do it; also, whether you get it right as to which way it's going to go.
I suppose we have all had experience with it - my most successful case involved Corning (GLW) which made a run from over 100 in 2000 to under 2 in 2002. I started buying at 13, added at 9, and bought as much as I dared at 2. I sold out at 9 in 2003, quadrupling from my buy at 2, and ever since I have been hoping to find myself in a similar situation. It's easy to look at a stock's price history after the fact and notice that a person who had the luck or skill to buy at the low point could have doubled, quadrupled, or octupled their money within a few years. But having the courage to get in at the lowest point, with enough invested to make a difference, is nowhere near as easy.
I have been thinking about shares prices as fractions, because it accurately describes the behavior of my two troubled cases, bond insurers MBI and ABK. Take ABK.
ABK has made a run from from over 90 in May last year to a low of 3.08 in April this year. I bought in at 25, 8, and then at prices around 3 and 4 recently. What drives that kind of a swoon? Is it reversible, and if so, how does that happen?
In ABK's case, it was expected losses from insuring sub-prime backed ABS, exacerbated by the uncertainty about their triple A ratings and the extent of dilutive equity offerings that would be needed to maintain their rating, all of it magnified by fear on the part of shareholders and greed on the part of short sellers. So, if the losses will cut it in half, and the share offerings will dilute that by half, and those who provide capital need to double their money, you are at 1/8 of your beginning point. If short-sellers expect to hammer away at the shares while the offering goes forward, you could cut it in half again, so now you are at 1/16. What if this cycle repeats itself? Do the facts fit this scenario?
ABK's adjusted Book Value stood at 55.20 as of 12/31/2007, prior to the company raising capital by selling shares. Shares traded as low as 4.50 in January, 1/12 of adjusted book value, and the equity offering priced at 6.75, more or less 1/8.
When ABK announced their 1Q 2008 earnings, adjusted book value stood at 15.83. The losses were worse than many expected, which tanked the stock to as low as 3.08 - less than ΒΌ of the metric. An analyst at Goldman Sachs issued a proclamation that ABK would need to raise capital, and that the shares were worth 2 - again, 1/8 of adjusted book value. Looking back to your starting point, 55.20, 1/16 of that would be 3.45 and the share price got as low as 3.08...
As you can see, this is a very negative kind of math, how many times can you cut the thing in half and have anything left. Like Zeno's tortoise, you know it eventually reaches it goal, or gets to zero in this case. There has been some similar math on cases like WM and NCC, banks that had big losses and needed to raise capital. Sometimes you need to divide by 3 instead of 2, that could make the math more challenging, maybe you couldn't do it in your head.
Does the thing run in reverse? ABK asserted in their earnings press release, and again during the conference call, that they expect to meet Moody's target capital by the end of the 2nd quarter and that they have no intention of issuing shares to raise capital. Moody's commented that the losses incurred were within their stress case scenario, which makes it possible that they will not require ABK to raise additional capital within the near future. If there is no need to raise additional capital by a further dilutive offering, shouldn't the share price quadruple? Remember, you divided by 2 for the dilution and again by 2 because the new shareholders would expect to double their money.
If there isn't going to be a dilutive stock offering, the short-sellers have lost a large part of their power. They were going to cut it in half; so, can you double it again?
What if the expected losses, consisting of mark to market that may revert, do not materialize? They are included in the adjusted book value, if they revert, shouldn't you double it again? Remember, that was what started the ball rolling to begin with.
I like the math better when it's doubling instead of dividing by two.
Tom
| 
RSS 2.0
