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.