Invest By Model

Trade for Top 20

One of our holdings received a bid this morning from its competitor, and the stock is opening a bit higher.  Going into the day, the position represented over 6% of the portfolio, and, with the apparent appreciation, it is now 8%.

Let me remind everyone that I must make up my mind about pending trades at least one hour before the market opens (i.e. 8:30 EST), so if I want to do anything with the stock, I had to do so without benefit of KNOWING where the stock is or even what the acquiring company might say on its call, which just started after the cut-off.  So, I am operating under a bit of uncertainty.

I have decided to reduce the position, but not fully sell it despite carrying a $20 target.  As I type, I expect that the stock will trade above the $17 bid for several reasons, including the fact that it is a stock/cash deal (the stock of the buying company is likely to rally, increasing the value of the bid), the buyer could raise the bid, or another bidder could emerge.

Let me step back.  This stock was acquired initially in May at $24.  The world changed greatly in July when the U.S. came close to defaulting and put into place a very uncertain future budgetary environment.  While it is very unclear how this plays out, the future for this company could be quite bright.  In fact, if their current contracts prove to be honored as they were initially drawn, I continue to think the stock could trade in excess of $40 in a year or two.  With that said, there is always a chance that things play out horribly, though this is a small chance.  The most likely scenario has been that the company renegotiates its contract at a lower price.  The combination of the two competitors in this duopoly would make this less painful - the deal would be good for the companies and the government.

So, why, then, am I willing to sell about 1/2 the position hopefully at an average price above 18 today (but maybe closer to the $17 bid)?  Recall that we bought stock at the end of March in the 13s as well as some below 17.23 late in 2011.  At this time, while I hope that my sale proves to be premature and that the remaining position will appreciate in the near-term and over the longer-term, I have to weigh risk and reward.  Quite frankly, the deal could play out better than expected, but it could also end up being a great sell opportunity, and I am taking an incremental approach.  We are taking about 1/2 the cash raised to reinvest into one of our names that looks much more attractive to me, offering almost 50% return to my target over the next year.

When one sells 1/2, it's always bad.  It raises the question of why not sell it all if it turns out to be a good sale, or why sell any if it turns out to be a bad sale.  I choose not to strive for perfection but rather a gradual change in exposure due to changing risk and reward.  I will likely raise my target somewhat, maybe as high as 24 as I think through the implications of and the likelihood of a merger or other scenarios.  Assuming that proves to be the right assumption, at 17, the return of the stock is 41%, which is below average for the Top 20.  Thus, the new position size (of approximately 4%) seems appropriate.  

 

Great Week for Top 20 as Market Stalls

The market set new highs Monday, receded the next few days and closed down just slightly for the week after rallying Friday.  Performance was mixed across the models, with Top 20 breaking to all-time highs:

Top 20 stood out, rising  1.9% while the S&P 500 gave up 0.5%.  Usually such strong performance is a function of smaller stocks acting better than large ones, but, actually, the opposite occurred.  We had several stocks helping us out, including the stock we sold today as well as the stock I describe at the end of this message.  We also had a smaller stock climb about 8%.  In all, 12 names rose on the week.  The strong performance this week leaves the model up 2.2% relative to the S&P 500 this month, increasing our string of winning months to four, assuming we hold the lead next week.

Conservative Growth/Balanced was hurt by the snap-back in bonds.  The model didn't have any of the strongest stocks that are in Top 20 either.  For the week, the model fell 0.36%, which was 0.15% worse than the 60/40 blend of stocks and bonds.  The model has held in well for the month, beating the market by over 1%, and, at over 9% YTD, it is more than 2% better than its benchmark return.

Sector Selector ETF had a rough week, falling 1.06%, which was 0.57% worse than the market.  Despite the challenging month, it remains, at 14.1% YTD, almost 2.5% ahead of the S&P 500.  The weakness in Small-Cap and Emerging Markets outweighed strength in Financials.

Market Outlook

I spoke at great length last week about my near-term caution and longer-term optimism, so I am keeping it brief this week.  I continue to think that we could have a 5-7% pullback in the next few weeks, which would be a fantastic opportunity for those who haven't fully embraced this bull market.  This week, there was a lot of concern over the potential for a "hard landing" in China (the risk of a recession rather than just a slowing of economic growth).  It seems like these fears crop up once a year, usually about this time.  Unlike the past few years, though, the Chinese central bank is in an easing mode already.  In the past, there were fears that they would overshoot on their desire to slow the economy.  

 

Article

• 11 Growth Stocks Left Behind - TradeKing

 

Final Thought

This is not only a shameless plug, but also some extra information that could impact one of your holdings if you own the stocks in the Top 20 Model Portfolio.  Esterline (ESL) soared today on a rumor, and I want to share with subscribers my view.  In this case, where there is smoke, there is likely fire.  With that in mind, allow me to share with you what I said BEFORE it soared on my private blog,  My Own Analyst:

1. High volume price jump on rumors that BAE could be interested in buying.  There are two other potential bidders:  http://www.guardian.co.uk/business/marketforceslive/2012/mar/22/bae-us-bid-talk-ftse-falters    Posted at 01:07 PM CST
2. I think that the ESL rumors are very real.  68.20 is below where we sold earlier this month.

• Target:  75
• Stop:  66.80 

                 Posted at 02:52 PM CST

So, the article's assumptions make a lot of sense to me.  I actually was doing some work this week on HON for a client of mine and had already been thinking about their potential to buy ESL (it's a great fit, and they have the capital to do so).  I wanted to pass this information along, but I also wanted to share an example of the value of My Own Analyst.  In this case, I shared the information as soon as I became aware, allowing subscribers to form their own opinion.  After seeing a ton of volume but the price up only marginally, I recommended a specific trade.  Those who followed the advice realized a 10% gain in less than  a day, as the stock traded above 75 early this morning.

If you are an active trader, I think you will like this service.  I opened it up last month to the public.  In case you didn't get a chance to see it, email me and I will give you access for the next week.

Take care,

 

Alan Brochstein, CFA

www.InvestByModel.com

 

 

 

Synovis Life Technologies Acquired

This morning, Top 20 Model Portfolio member SYNO announced that it will be acquired by Baxter (BAX) at $28, with closing expected in Q1.  Long-time subscribers will recall that we first added this name in July 2009, so this has been a terrific opportunity that played out over a longer-time frame.  We will most likely be selling the stock tomorrow, and I think that 27.77 (where it  currently trades minutes after the open) is a fine place to sell.

I want to take a moment to highlight several aspects of the 29-month investment in this company, as I believe there are many lessons we can learn.  It also demonstrates how Top 20 is supposed to work, though it wasn't perfect in any sense.  I deeply regret now, with perfect hindsight, trimming the name just last week.  Before proceeding, here is a chart of the price from the time we bought through yesterday:

My first observation is that sometimes things take time to develop and to play out.  I was a bit early initially on SYNO, as we paid 15.34 on 7/14/09 after it dropped from 20 when it announced an acquisition.  We continued to add over the next 5 months, paying as low as 11.92 in November 2009.  At the end of 2009, our average cost was  14.02.  At the time of initial purchase, I set a one-year target of 24.  Until today, the initial position lagged the overall market, though the other purchases all proved to be "better than the market" through yesterday (and certainly after today).

My second observation is that trading can add a lot of value.  We had three sales, ranging from 12/22/10 until the more recent one last week.  The first trade obviously generated a LT gain, and the other two generated a mix of LT and ST gains.  We were able to make purchases below our sales prices following the first two sales as well.  While my most recent optimization proved costly, I remain committed to allocating more capital to stocks that look more attractive.  In 2011, trading has added to our return, even including having a smaller SYNO stake than at year-end.

SYNO was a Small-Cap, maybe even a Micro-Cap.  There were very few analysts covering the name when we first bought it, and liquidity has never been great.  I had the opportunity to visit with the CEO and CFO in their office in June 2010, was one of the few questioners on their quarterly conference calls and had a continual dialogue with management.  In fact, the CFO called me this morning to make sure I was aware of the transaction.  While I paid attention to the charts obviously, this was a fundamental story that I embraced and followed closely.   From the onset (after a dilutive acquisition), I believed that the market was making a big mistake in how it valued the company.  This is the type of situation where good work can pay off, even if it takes longer than expected. 

As difficult as this year has been for me with the Top 20 Model Portfolio, I am encouraged by how SYNO played out.  This is what Top 20 is all about - finding relatively unknown stocks that have great upside relative to the risk assumed, making the investment and trading it around.  We had suffered a drought of acquisitions this year after getting our fair share in 2009-2010.  As I shared earlier this year, I didn't expect smaller companies to outperform larger ones but I felt like a large allocation was important given the likelihood of accelerated M&A in a slow economy.  Sadly, only SYNO has proven me right, but we have others that I believe could be acquisition targets as well.  Predicting the timing, though, is next to impossible.

 

 

Questions from Subscribers

I am moving or rather copying a feature that I had tried to implement on a separate blog (My Own Analyst) last year over here, "Ask Alan".  The goal of My Own Analyst is to ultimately provide retail investors a different delivery vehicle for receiving my investment research, with a stronger appeal for those who are really looking more for just ideas and not help with portfolio management.

As many of you realize, Invest By Model is a subscription service that allows you access to basic research (on new buys) as well as a fully defined model portfolio for the very reasonable price of $20 a month.  Of course, I spend a great deal of time on this blog on a weekly basis sharing my big-picture thinking and detailing my rationale for not only new buys (which are included in the service) but also for sells, trims and adds (cryptically, usually!).

I am not a registered investment advisor, so the only way I can provide "advice" legally to individuals is through a public format.  I get some questions quite often, such as how to transition, for instance.  I also get requests for updates on the stocks we own, which I understand and appreciate.  I often do share this information, but it can be challenging on a number of fronts.  First, the time element, as most of my time is devoted to serving institutional clients.  Second, with my open blogs, the more I share, the more likely it is that potential subscribers will choose to just read my commentary and not actually pay for the service.  Ultimately, I hope to close the blogs, which will allow me to protect Invest by Model.  If you are one who is interested in more real-time updates and are willing to pay for it, please share your thoughts with me.  I am quite willing to work to deliver what you want in a way that works for all of us.

OK, with that out of the way, and keeping in mind that I got a similar question to #2 from a free-trialer, I wanted to pass along these questions and to respond:

Hi Alan,

I wanted to ask you two questions regarding the TOP 20 portofolio:

1) If I am a fairly recent subscriber and have been adding positions based on your recommendations since I joined. I have been a bit more hesitant to purchase some existing positions since several of them have run up double digit since the portofolio acquired them. I am curious if you have a strategy for new subscribers of how to build the TOP 20 portofolio.

2) I noticed you suggested to add to the 'loser' in your portofolio and when I read the company review I noticed that one if its risks is Jet fuel prices. Since oil prices have been up lately and the company did not hedge fuel it looks to be the reason for the decline of the stock. Are you concerned about it?

Thanks,

IK

 

Igor, thanks for your questions.

I am constantly rebalancing the portfolio and adjusting position sizes to reflect risk and reward.  While the current price might not be as good as before, the fact that we still hold the name reflects my confidence in the future potential.  At present, every single one of our stocks in Top 20 has a projected return in excess of 30%, with the average and weighted average at 46% and 49% respectively.  I wish I were smart enough to always know the exact future so that I could tell new subscribers to wait for Price X on Stock Y, but I am not.  Nobody is.

Transitioning, as I often explain to new subscribers, is a very difficult challenge, no matter what.  If one is moving from a portfolio of stocks, I think it makes it much easier.  Just sell the old and buy the new and be done with it!  Life is too short too fret over such minutiae.  Unfortunately, it's not usually the case that a new subscriber is transitioning from an invested position.  Instead, it's usually a move from cash.  There are several ways to approach it.  The worst is probably just to jump in and copy without thinking about it first.  If the overall market is extended, you might be making a poor timing decision.  If you don't think this is the case, then I recommend fully transitioning.  If, on the other hand, you have concerns about the market, then you should be incremental.  I have two approaches I use to use myself when I was managing money for others.  One is to try to invest a certain amount in the ones that look the best.  The other is to buy a pro rata amount of everything and then come back  in a few days/weeks/months and continue the transition.

Method 1 seems smart, but it doesn't always work out.  If you look at Top 20 right now, you will see of the 20 names, 8 are above average (greater than 5% weight).  Maybe you could read into my confidence and just buy those names right now and wait on the balance.  That would get you 48% invested actually.  Two of those names are up "double-digit" (and note that we are actually cutting one to 5% on Monday), and the balance are down.  Now, had you done that a week ago, you would have missed a rally of 15% in a name that was below average and that I have been patiently (too patiently) waiting on to increase the size.  Method 1 has some appeal, but realize that just because I think that these are my best stocks, they are only 1/2 of the WHOLE portfolio in value.  I don't know anyone who can predict in advance with complete certainty the ranking of future performance of his or her holdings.  Not me!

Method 2 is the method I actually prefer.  You are making a decision, in this case, to trust my judgment, but you aren't confident that the timing is right.  Who am I to tell you or anyone about what the near-term prospects are for the market?  It's a volatile animal, and don't ever believe otherwise.  If you were to pursue Method 2, I suggest that you commit in advance to how you will scale in.  Give yourself a definitive time-frame, or you may never get invested.  Seriously. 

As far as ALGT, it's a known fact that jet fuel prices are their largest cost and highly uncontrollable.  Over time, one should expect that air fares will correlate to jet fuel prices, and ALGT operates under this assumption.  If not, airlines will go out of business (theoretically, right!).  I don't have a strong view about energy prices, though my gut feel is that they are likely to be well behaved actually.  Commodity price hikes have been less demand-driven and more about hoarding and speculation in my view.  ALGT is a lot more than an airline - they view themselves increasingly as "Expedia with wings", and I expect that this view will ultimately become accepted.  Unfortunately, it's not only the fuel, but several other issues that have hit them and hurt their near-term profitability.  Cheap it is (I use PE as well as EV/EBITDA), but that's not enough.  I believe that the very strong unit demand (in-market, new markets) that is driven by compelling value to their leisure clients in smaller cities will ultimately drive higher profitability and a better valuation.  I reduced my target substantially after the diminished outlook and am looking for 60 (15PE) a year from now (based on 2012 projected EPS of $4, which is well below the consensus).

 

Copart Tender: Nothing to Do

Top 20 Subscriber Doug asks: What is a tender and should we tender Copart shares?

Thanks for the question, Doug. Copart announced its intention to repurchase a substantial number of shares last month in what is called a "tender offer". Owners may instruct their brokers to "tender" shares, meaning that they are willing to sell any or all of the number of shares tendered at the 38 price. The company will take the total number of shares tendered and buy all of them up to the total amount that it indicated it would buy. If it is "oversubscribed", then investors will receive 38 for a portion of their shares (pro rata).

 In the case of CPRT, I initially suggested that it might make sense to tender if the price was substantially below the tender price, but we are trading just under it. I reduced our position late in the year - it had nothing to do with the tender. While the reduction in shares actually resulted in my having a higher target price, it turns out that CPRT is one of our least attractive stocks based on the revised target (about a 28% expected price return over the next year).

In the model, we won't be tendering because we can't. With that said, I would recommend no action. The price may fall a bit on the day after the 1/14 tender expiration, but I don't expect a significant change in the price.

A Healthy Dose of Humility

Today will be one of the worst days we have had in quite some time in the Top 20.  We were up 51% going into the day this year, so I won't beat myself up too much.  I have already discussed one issue, ORN, where I made a mistake buying it initially and got lucky with additions below and sales near the recent peak.  We are stuck with a small position that is probably best to be sold quite frankly.  After listening to the call today, I realize that I have underestimated some of the challenges that they face.  The stock is cheap, but I don't have confidence that their fortunes will improve in the next several months.  It makes most sense to monitor for a better time to buy most likely.  I will be giving it further thought in the coming days. 

A secondary factor today and almost as damaging due to its large size is our shoe company, which gapped lower and is resting near its 52-week low.  I have more confidence in the story, but my willingness to assume near-term risk for a great deal can be challenging.  The position is already among our largest (at 6.4% going into the day).  With the 7% pullback, we have room to add another 1.5% or so, but I want to be careful given its proximity to the 52-week low, which is also tangible book value.  Late-year bargain-hunting has paid off handsomely for the model, but it doesn't work so quickly all the time. 

When one manages a portfolio of 20 stocks, it is difficult to be right all the time.  My hope is that my mistakes aren't too costly and that I can correctly use them to my advantage (i.e. making the position bigger if warranted).  In the case of ORN, I am glad that we cut the position by 36% last week at 15.67.  I wish I had just moved on in total, as I did consider it, though I recognized that it wasn't one of our more attractive names at that price.  It's never fun, but it is ok to make a mistake and move on. 

Ouch!

One of our holdings in the Top 20 will be slammed hard this morning.  It has been a very tough name that performed poorly after we bought it, though we were able to capitalize by adding to the position near the lows and trimming it recently.  It was just a 2.8% position, our third smallest, so the damage to the portfolio will be very limited.  We'll see how it plays out, but I would potentially be inclined to add to the stock near 12.5-13, which would be down 14% at the mid-point.  Below that, I would be worried that the technical damage is too great.  Nothing today - we'll see how it plays out. 

Copart Tendering at $38

Whoops!  I thought that I had covered all the bases when we set up our models, but today I finally ran into something that I truly didn't anticipate.  Not to worry, because I am not sure we could have done anything about it, but I want to share with Top 20 Model Subscribers my advice.  Most importantly, it's not that big of a deal in this instance.

Copart announced a tender offer today.  They will be repurchasing 12.8% of the company at 38, which is slightly above the current price.  If I were able, I would tender our shares despite the fact that my target a year out is 47.  You may recall that we just doubled our position two weeks ago at 33.41.

So, why tender?  The most likely scenario is that the stock will run up into the tender (it should go up about 12.8% of the difference between the recent price and 38.  How we define the recent price is subject to debate, as the jump over the past few days may have been influenced by this pending news (yes, that would be insider trading perhaps).  In any event, let's assume that the close of 35.24 is the "true" value currently (which is very cheap!).  The stock would rise only about 1%.  It will most likely rise a bit more for two reason, maybe three.  One, this will boost EPS.  Two, not everyone will tender, so perhaps it should go up 1.2% instead of 1% (not that big of a deal).  Finally, everyone likes to think markets are efficient, but on a name like CPRT I assure you they aren't. 

If we don't take advantage of selling all we can at 38 when the new right price is maybe 36, we give up something.  Fortunately, it's not that much.  It's probably 5.5% on 15% of our 5% holding.  That works out to about 0.04% of the portfolio.  So, it's something that should be done, but passing it up won't make a material difference.  If you like to trade and want a little free money, go for it!  This means you tender your shares (you will receive instructions from your broker) and then repurchase.  Since I like the stock so much, I would buy the shares perhaps now if they are up less than 1 point and then submit the tender, but one can wait until the results are announced and the stock most likely drops post-tender.

SMTS to be Acquired at 30% premium

SMTS announced that it has agreed to sell itself to Covidien for $25 per share in cash (close was $18.90).  This purchase is consistent with my expectations as far as suitor and price.  Covidien had acquired a similar but less compelling company last year, and SMTS will enhance their overall monitoring business.  It had also served as its European distributor.  Score one for the Top 20!

 

This is an average position in the Top 20.  We most recently added in early April at 19.24 after having trimmed a lot in March near 21.  Given that it is a cash close and in July with no chance of regulatory issues, the price today should be close to 24.65-.75 or so.  I have several potential replacements under consideration and will act within the next hour for today or certainly by tomorrow.

SMTS announced that it has agreed to sell itself to Covidien for $25 per share in cash (close was $18.90).  This purchase is consistent with my expectations as far as suitor and price.  Covidien had acquired a similar but less compelling company last year, and SMTS will enhance their overall monitoring business.  It had also served as its European distributor.  Score one for the Top 20!

 

This is an average position in the Top 20.  We most recently added in early April at 19.24 after having trimmed a lot in March near 21.  Given that it is a cash close and in July with no chance of regulatory issues, the price today should be close to 24.65-.75 or so.  I have several potential replacements under consideration and will act within the next hour for today or certainly by tomorrow.

ABFS - Ouch

Well, we have been and still are on quite a roll this month (up with the market down), extending upon great outperformance from last year, but today we took it hard on ABFS.  Some of you may recall that this was a new position earlier this month that we actually made one of our largest positions.  That's why we diversify!

The company reported good sales numbers, slightly ahead of expectations.  In fact, though they were down, the decline was markedly less than over the past 4 quarters.  Commentary on the call suggested that the unit volume (tonnage) finally turned positive year-over-year in December and remains so.  The bad part of the story has been pricing, and it remains bad though stable.  Earnings were worse than expected, with some one-time cost issues. Additionally, and not surprisingly, they chopped their dividend by 80%).  All of this left the stock vulnerable to selling, and it dropped more than I expected (I actually added to the name, making it my largest position, at an average price above 24).

I believe that the risk reward here is about as good as it gets, perhaps second only to TECUA.  Part of my confidence is knowing about the strength of the balance sheet and having an appreciation for the exceptional management.  The upside part, though, is very contingent upon pricing improving.  Two ways for that to happen - gradually as the economy improves or quickly as larger rival YRCW goes Chapter 7 (which is very likely).  So, stay tuned.  We were a bit early, but I think that this name deserves its high weight in the model.