Yesterday we attended a seminar with Jason Ayers of Optionsource.net on how to create cash flow using options. He spoke a little about his trading and how his company has taken their holdings to 50% cash before this recent downturn and how they plan to buy back in at reduced rates. Sometimes I regret not being a better trader and having such superb market timing. Kudos to Jason! If you have an opportunity to learn from this guy, it’s really worthwhile, for he’s an excellent speaker and knows his stuff.
I have a different trading strategy. If you ask me if my portfolio is up or down, I’d have to admit that my “net worth” based on market capitalization is down 7% since February peak. Ouch! But what if my goal is not to increase my net worth in market capitalization–but instead to increase it in book value? Book value is itself not an indicator of the market value of a company, which is really about the profitability of that company in the years to come, but of the total assets (cash, real estate, lands, equipment, inventory) minus liabilities. Book value is much more stable than market capitalization because it points to the value of the company as a company: i.e., if another company were to buy out your company you would expect that company to pay book value plus a premium based upon the future profitability of the company: you will only sell if you think that the premium–i.e., the cash in hand today is more valuable to you, for whatever reason, than your own ability to extract profits from the company in the future. If the potential buyer offers less than book value then either there is something terribly wrong with your company (Nortel) or you just simply show them the door. Why would you sell your company at less than book value? You would only do that if you were insolvent and were forced to sell.
I like junior oil companies and I discovered a means to de-risk them–pay attention to the book value. This requires looking at the quarterly reports because it changes regularly–as the oil companies use cash to develop their lands. If the reported book value is higher than the market capitalization, then you are buying the assets of that company at a discount while obtaining its future profits for nothing.
As a strategy, buying junior oil and gas companies at below book value has worked for me with Midway Energy, Crocotta Energy, Prospex (just bought out by Paramount) and Great Plains Exploration (bought out by Avenex). These were the first junior oil companies that I bought and their share prices are now all well above what I paid despite the recent weakness in junior oils. Each one was originally purchased below book value.
So while I am down 7% in terms of net worth as a function of market capitalization, as a result of averaging down on junior oil companies, I now own more book value than ever before. So I consider myself to be doing well despite the current market.
Andrew at City of God has posted that the Watcher called into question Sue Richard’s calling the Silver Surfer all powerful: “‘all-powerful? There is only one who deserves that name! And his only weapon… is love’ (Fantastic Four #72; Mar. 1968).” Well for us investors, we worship at the feet of one and only one, his high and mightiness, Benjamin Bernanke, the chairman of the Federal Reserve Bank. He is the one who determines what our assets are worth and he wields a weapon called “QE” and another called interest rates with which he increases our power, our net worth, and we become mighty warriors of investing–but when he refrains from wielding them, suddenly we are all grovelling in the dirt like worms eating skubala (a.k.a., the margin call).
So I wrote to my good friend Mich at Beating the Index, who is fretting about running out of powder for his battle on the investment front:
Bernanke is the first cause of everything in the market today. He is exercising his omnipotent power as head of the Federal chair to influence risk appetite. Well, there will be either more monetization soon or watch hundreds of thousands of government workers in Washington not get their pay cheques and be sent home crying. My Schadenfreude would be so high at that point, it would almost be worth a 50% cut in my portfolio to see it. But it ain’t never gonna happen! Believe me, by August or September, the pols in Washington are going to lose nerve and there will be new debt ceiling (and QE3), based upon a compromise between the left-wing republicans and the democrats in the House.
Meanwhile, fear is palpable. The companies in which I am invested have increased their asset values through the development of oil fields but their share prices are way down because the lack of QE3 has diminished risk appetite. People are rightly afraid to be caught with their margin pants down, like what happened to silver investors when the margin requirements were magically increased.
Devon Shire chides Petrobank (last $14.30)/Petrobakken (last $13.63) for not having a share buyback at these low prices, which puts their market capital at serious multiples below the Net Present Value. Shire wants them to reward shareholders with a buyback of shares, but of course the management spent that cash on PBN shares starting at $21 and who knew that the price would plummet to these levels? These prices are not only at multiples below NPV but well below book value (=shareholder’s equity). I wrote to Mr. Shire the following response:
Net Present Value for other junior and intermediate companies is also currently at extremely high ratios to market value. Midway Energy is reporting NPV10 of 1.7 billion while its market capital is 274.9 million.
Some are angry with Petrobakken for continuing what they consider to be an ill-advised dividend program. Evidently, the buy back of shares is an equivalent use of cash as a dividend–I suppose that the real need is to spend money on developing their resources in order to deliver growth. The sad part is that PBN started the repurchase program at $21 while the price was so high vis-a-vis the current price.
At some point either you and I are going to be considered really stupid for thinking we had found value in the Canadian oil sector, or there is going to be a major correction drastically decreasing the NPV/market capital ratio.
Yet Mich warned me about taking the NPV10 that Midway had presented as a serious indicator of their value and I reproduce here our dialogue:
According to Bernanke, Congress better lift the debt ceiling or the US will default. Yet if the only way you can make payments on your debt is by borrowing more money, you are already in default. So far, the US government, thanks to Mr. Ben and his QE1 and QE2 and his seemingly endless loans to the US treasury, has staved off “default”. In China, the largest foreign creditor to the United States, financial experts are saying that the US is already in default because of intentional dollar devaluation which erodes the wealth of creditors. Apparently, China reduced its net ownership of US treasury notes over the last quarter. Expect that it will be harder to find lenders, and Ben will be the only one left in the treasury auction room. That’s when QE3 will start. Or riots in the streets, take your pick, Congress. Eventually, the pressure to raise the debt ceiling will be too much for the politicians in Congress, and it will be business as usual–money creation ex nihilo, and the Bernanke put will save the stock market.