Electrifying start to 2010

As I sit in the last week of 2009 to write this blog, 2 thoughts are uppermost in my mind:

• Performance of my ideas in 2009 vs how the markets have done
• Ideas for 2010

Performance in 2009

For 2009 I had discussed 2 ideas in this blog. Please see those in Feburary 2009 in this blog. These were far fewer than what I executed in my portfolio for 2009 but there is no point in discussing others since I didn't disclose those publicly. The 2 that I did discuss were:

1. ACTS - Actions Semiconductor: Buy @$1.49 on Feb 7, Close @$2.46 on Dec 24, Return 65% vs S&P500 (proxy SPY 86.98 & 112.48) return 29% in same period. Outperformance of return 36%
2. SLT - Sterlite Industries: Buy @$5.45 on Feb 11, Close @18.38 on Dec 24, Return 237% vs S&P500 (proxy SPY 83.6 & 112.48) return 35% in same period. Outperformance of return 202%

As can be seen both the above ideas significantly outperformed the broader market. While the above is extremely satisfying to see, I don't expect this magnitude of outperformance to continue for the new ideas. I would be extremely happy if I can consistently outperform the market by a few percentage points.

Next steps on the above ideas

• ACTS: I will continue holding ACTS at the current price. While it is extremely cheap based on the inherent value (review my previous blog to understand the value), margin of safety has gone down and I will wait for next quarter results before deciding the next steps.
• SLT: I did sell 1/5th of my SLT position at 17.50. As metioned in previous blogs, I do expect this stock to continue to outperform the market. For now I will continue to hold this position and will revisit the stock as I get better visibility based on results.

2010 - A new beginning

When I started this blog in 2009 my goal was to be happy if I were to outperform the market by a certain percentage point (10%) over 3 years. 2009 has been a flying start towards that goal and I have thoroughly enjoyed the challenge and the success. It has encouraged me to consider investing more seriously. Going into 2010 I expect to be more active in blogging my ideas. It will serve a few purposes:

• Put down my justification for any idea that I am considering.
• More importantly, it will allow me to go back and review the logic vis-a-vis reality a few months/quarters/years out to see the logic in the thinking.
• Finally, create a community of like minded inidividuals or investors who are either interested in investing or are looking for ideas.

Onto the electrifying start..

I have been considering Mirant for the last few days. Mirant is an electricity generator serving mid-atlantics, north-east and california markets. The company emerged from bankruptcy in 2006 and have been actively realigning its portfolio for assets. A few things stand out for the company:

• Low Price to Book of only 0.5. Hence you are buying the asset at half its book value where many of the assets on the balance sheet have already been depreciated significantly.
• The above can be seen from the fact that the enterprise value (money that you will need to buy the firm including debt and equity) of the firm is 2.9 Bn $. This is for a firm that generates around 10,000 MW of electricity. Thus per 1000MW the firm is being priced at 290Mn $. If you were to look at putting a new 1000MW power plant the typical project cost is upwards of 800Mn $. Thus on a simple asset replacement basis only the firm is priced at 35% which shows the high margin of safety of 65%
• Then there is a matter of earnings and ROE. The firm has been regulary making money while some of its competitors are facing tough going in this highly volatile commodity markets.
• The demand supply situation is becoming precarious in the north east which should lead to more of a sellers market over the next few years.
• Finally, there are some restrictions which prevent the firm from having change of control by March 2010. Once that constraint is removed it could provide additional avenues to unlock sharedholder value.

So what could go wrong with the above idea:

• It is a highly regulated industry and government directives can have big impact.
• Cap and trade is a big sword that is hanging over the entire industry.
• Some of the competitors are in dismal shape and if any of them go into bankruptcy it could allow them to get rid of legacy cost and make this space more competitive.
• Firm can reverse its discipline of only investing in projects where there is sufficient return on capital.

Overall, with the inflation on the horizon, industry that has not been in favor in 2009 and the firm that has gone down in 2009 the +ve factors make this a good stock to own for 2010.

Thanks.

Nice run-up and next steps

This is time to look at the ideas that I had proposed and how they are doing. Both my ideas so far have done exceptionally well:

• ACTS which I had proposed as a buy on Feb 7 (1.49$) has run upto2.025$ (on May 29), an absolute return of 36% over that period. If you annualize the return it is an even more impressive return of 118%.
  
• SLT which I had proposed as a buy on Feb 11 (5.45$) has run upto 13.17$ (on May 29), an absolute return of 142% over that period. If you annualize the return it is an even more impressive 483%.
• The returns from the broader market has been underwhelming to say the least against the above ideas. It is best to compare these returns against how the broader market (S&P 500 represented through SPY) has done in that period (Feb 7 to May 29). The absolute return is 6% over that period and 21% annualized.

Given the above we have handily beaten the market in this period. The results have been all the more satisfying because we have gone through a pretty topsy turvy market in the last few months.

Where do we go from here?

I will let out a little secret when I first came up with the above ideas. My expectations were the following:

• ACTS will double in the next 2 years.
• SLT will go 5 times in 5 years.

The above was a simple way for me to judge when to sell the stock if they start moving (and moved they have in the last few months). Selling a stock is always one of the more difficult thing to do once you have had a nice run up. It is easy to fall in love with the stock. Given the stock have had strong moves here is my current thinking:

• Buy ACTS. ACTS is still highly under priced and such gross under pricing opportunities are disappearing with the current run-up in the market. When I wrote in Feb there were quite a few and I don't find that many now. So though the stock has gone up the underlying logic of buying the stock still remains - nice cash cushion, ability to adapt operating cost given the revenue situation. There may be some upside with the new products but I wouldn't consider that to be a big reason until the product proves it out in the market.
• Sell SLT covered calls with strike around 17.50 with short expiration till Sept. The stock has had a great run and I still see a decent upside from here so I wouldn't be selling any long term call options. However, the great run-up allows us to benefit from some premium income in the interim.
• Buy S&P put option once S&P (SPY) goes above 1000. While the economy is recovering the market has gone up too far too fast and I am not convinced that those gains will remain. Besides, it will provide a good hedge against some of the strong run-up we have seen in the stock.

I look forward to hearing your thoughts and feedback.

Thanks.

Time for Commodities?

Commodities have been in a secular downturn for almost a year. It is a distant memory when oil touched 145$ and how people were predicting 200 and 250$ oil. Now oil is barely able to crack 50$. The same can be said for various other commodities. Copper has fallen from 4$ to 1.5$. Aluminium has fallen from 1.4$ to .65$. Zinc has fallen from 1.25$ to .5$. Suffice it is to say that Commodities have seen a massive correction - in many cases upwards of 60%. This has impacted commodities stock and many have fallen by similar if not larger amount.

I recently came across a stock which has some very interesting characteristics:

• It has profitable operations and have been able to make money in Q4 and throughout this downturn.
• Sum of parts along with cash is worth more than the market value of the company.
• Sum of parts is quoted in the market so that an easy hedging strategy can be followed.

The name of the company is Sterlite Industries (SLT). This is part of the Vedanta group of companies which is based in London. So what ails the stock? Some of the issues I see are:

• Lack of clarity around what is around the corner with Arasco transaction. In 2008 company agreed to pay more than 2.5Bn $ for the entity. Current negotiations are ongoing and that is making investors nervous.
• Management interest may not be fully alligned with shareholders because one entity own the majority of the shares and the majority owner have similar interests through other entities.

Overall, I do believe it is a good time to look at the stock. If you have patience and are willing to hold out for a 3 year period this could be a multi bagger. The key is patience.

Thanks.

Getting started - ACT(S)

You know how people say "Well begun is half done". I hope so. I have been thinking of starting a blog for a while now. Finally, today as I was about to go to sleep I decided "its now or never". So here I am blogging away....

I hope to achieve the following with this blog:

• Pass across some of the interesting things I have come across.
• Suggest interesting ideas that I am looking at.
• Keep myself honest by having these in public and having others to comment.
• Build overtime a group of like minded investors that can help each other out and critique.

Onto investing...

The recent market dislocation provide a lot of interesting opportunities. As always it is pretty easy to be torn both ways investing / fleeing depending on what view you take. However, if there are companies where the net working capital is more than the market value then it should go only one way - UP! With that in mind I have been looking at a company ACTS (Action Semiconductor) which is currently trading at less than 50% of the cash it has on its books. It is lik getting a dollar bill for 50 cents.

As Graham mentions, every investment needs to satisfy 2 criteria:

• Degree of safety of principal
• Satisfactory rate of return

Let us look at the above in some more detail:

• Degree of safety of principal - Since the company is trading at only half the cash, I think this is well covered for now. It may go down another few percentage points but as people realize the bargain that is available, it has only one way to go - UP!
• Satisfactory rate of return - This will depend on how the operating performance of the company is over the next few quarters/years. Company has been consistenly profitable (including Q4 2008) because of tight cost control and adapting to changing market conditions. Going into 2009, the projections for revenues are very weak. However, company is taking additional measures to reduce operating expenses to bring it in line with the future performance. Besides, there are some interesting new areas that company is entering into. Those areas have huge market opportunities. Even if a few of those materialize, the revenue streams from those could be enormous. This coupled with company products targetting lower expense segment means that as the world economy comes out of the funk that it is in demand for some of these products can shoot up quickly.

Thus on both counts I feel comfortable. There is no such thing as a sure thing but this is as good as it gets.

Let me know your comment.