A note on price targets

I have had some price targets posted on the left-hand side in Google doc format since the new year. Most of these targets were for “Armegeddon” pricing (growth never>3%, or sales declines of 15% annualized for 2+ years). However, price targets like these are useful if one believes a bear market is coming your way, as you can be in cash and pick off your stocks as they hit your limits.

How would this have done YTD (or buying on Jan. 6th if the price was already below my target)?
ADP at $36.33: now + 1.9%
APD at $46.33: now + 35.4%
EMR at $36.00: now – 1.6%
FDO at $25.46: now + 21%
GWW at $63.83: now + 25.4%
JNJ at $59.69: now – 7.8%
MMM at $59.19: now + 0.6%
PG at $45.33: now + 12.4%
VFC at $46.33: now + 19.5%
WTM at $286: now – 25%
UTX at $49: now + 7.8%
CAT at $43: now – 11.5%
NTE at $6.16: now – 33.6%
TSCM at $3.49: now – 43%
ANF at $24.54: now 0%
TIF at $23.37: now + 14.8%
AEO at $10.82: now + 35%
PEP at $48.67: now + 1.2%
SBUX at $10: now + 31.8%

For an average return of 4.4% (ex dividends) YTD for an investor with a bit more rigorous value requirements. This compares favorably to the post- Jan. 6th performance of the S&P of -2%. It should come as no surprise that in an over-extended market, strict valuation discipline becomes even more important.

Year-to-date equity performance

Following up my bond post, my Marketocracy equity accounts (left hand side of this blog) continue to do well. The long account is done according to “mutual fund” rules, the short account is “not compliant” but it is meant to be considered as part of a long-short fund where my neutral allocation is about 2:1 long to short equities. No ETFs, bonds, corporate preferreds, just strict individual stocks. Performance is net of fees.

Year-to-date, the long portfolio is outperforming the S&P by a bit under 1% (2.62% compared to 1.67%), and is still a shade under 7% annualized outperformance going back to mid-2001.

Year-to-date, the short portfolio not surprisingly is down 2.87%, and has a annualized outperformance of over 9.5% since 2005. Assuming an equal allocation to both long & short portfolios, then, an investor would be about break-even for the year, trailing the S&P500 by just under 2% in total. Not great, but a trailing performance that can be recovered from.

Of course, combining the equity portfolio with the below bond calls in, say, a 60/40 ratio would have the investor up just under 2.5% YTD, again ahead of the index.

Short-term equity market indicators remain bullish, but not greatly so, long-term equity valuation remains problematic. My bond themes remain in place, although short term rallies in long US bonds are possible as the Fed vainly attempts to hold down rates. Munis aren’t looking any better, and corporates aren’t anything special. Junk still has potential as credit eases, but absolute corporate yields are not that attractive.

Update on January bond calls

In January, I posted that it was looking reasonable to short Treasurys, long junk bonds (but a better entry price could be had), and probably avoid (but not short) higher grade corporates and munis in general. How has that done since my post on January 6th?

Using the ETF proxies: TLT (long bond): -13%, so a short would have made 13%.
Junk Bonds (HYG): -0.4% (there was a chance to buy in at ~10% lower prices)

Higher-grade corporates: LQD: -2%
Munis: 6%

Well, the bond calls would have made 6.3%, assuming equal weight, compared to a 2% gain in the “avoid” list.

2009…

Well, it’s the new year, and the traditional sector rotation is underway. Basically, everybody’s buying the beaten-down stuff from last year in search of “value” and shorting anything that worked last year (i.e. Treasurys). I happen to believe that shorting Treasurys will work out but probably more so in 2010-2011–it’s a little early for the trade, but if you have a longer-term time horizon, by all means…I prefer TBT (ultrashort 20+ Treasury ETF, PST is the ultrashort ETF for shorter-duration Treasurys), but one could also short the long ETFs for Treasurys. As for beaten-down stuff from last year, my buy list (on the left) is still on my mind, and I continue to buy the best values. Looking further, I’m a fan of junk bonds, but again, this trade could get uglier before it gets better (again, more likely in 2010-2011), and use the HYG ETF as my trade. While munis are popular, I’m actually somewhat more worried about them than junk bonds, as state/local budgets continue to get shredded, and will for longer than people think. Local budgets need to cram down salaries, benefits and STILL they need to re-assess declining property values, vacant stores etc, and this is a longer process than 1 year. In other words, it’s easy to deal with a company and its bonds/capital structure relative to municipalities’ deteriorating balance sheet.

So, I’m somewhat with consensus that decent values can be picked out of the stock market (clean balance sheet stocks that are undervalued even with massive sales drops), Treasurys can be shorted here, and junk bonds are worth a look. I’m against consensus in that I do not feel investment grade bonds offer an appropriate risk reward, and I’m suspicious of munis due to local balance sheet issues.

What to do now

My marketocracy funds continue to beat the market…My long-only fund is up nearly 32% since inception (August 2001, a rather inauspicious start time), compared to the S&P500′s nearly 18% loss. My short-only fund is up 43% since inception (January 2005) compared to the S&P’s 21% loss, with limited shorting (overall, a 8.25% annualized return since 2001 if invested in both).

I continue to find value in the market, with consumer discretionary stocks and industrials looking promising for the next up cycle. Many consumer stocks are literally pricing in Armageddon, while industrials will benefit from lower raw material costs (and many brand-names are screaming bargains). I would continue to hedge with shorts focusing on technology (in the wrong part of the upgrade cycle), basic materials (pricing power is now gone) and most likely some select consumer staples (many are overpriced from too many people piling in).

I would also recommend some “Armageddon” put protection as the volatility is simply crazy. Buying some way out-of-the money puts is a way to sleep a little more soundly while not losing much upside in case of a rally.

I’ve added a Google document for some stocks and my target prices for entry. You’ll notice several stocks are under my target price. I think that taking my target price and looking for a solid-to-steep discount (10-20%) is the way to think about that list. My target prices are derived from several valuation metrics (dividend discount, free cash flow, free cash flow with margin etc contraction) and represent a pretty “fair value”–but we’re looking for bargains, not just fair value.

Briefcase cleaning

Funny story. I was cleaning out my briefcase and came across three old stock reports that I wrote for an interview last year with a fund manager. I didn’t get the job due to my “inexperience, particularly with foreign stocks (which admittedly I didn’t have a lot of experience with). Anyway, the stocks were: Celanese (not foreign, CE), Kingboard (Hong Kong, 0148.HK), and Barco (Belgium, BAR.BR). Some choice quotes from my stock reports (all from September 2007):
CE: Downside risk from coming economic downturn and overcapacity. Would not have as core holding. More levered than peers. Its lower valuation is justifiable due to its higher debt load and higher risk going forward. When economic growth slows, this highly-leveraged chemical company will suffer disproportionately compared to its peers.

Hmm. How did call turn out? Well, CE is down about 66% from 14 months ago, while Dow and DuPont are down 40-45%.

Kingboard: During the previous downturn, Kingboard’s EPS dropped 20% and the P/E multiple compressed to 10X (at the time of interviewing it was trading at a P/E of 15). If a comparable downturn were to begin now, this would result in ~50% loss in share price.

How’d that turn out? Stock’s down 80%. Hmm.

Barco: This was my highest confidence short. Some choice comments: The divisions most responsible for growth have posted low book/bill ratios, while the area of the company with the healthiest book/bill ratio has seen significant profit margin erosion. Barco appears to be under pressure from a shift in sales mix to less profitable items. Net cash turned negative recently, despite favorable economic trends. I expect a maxium upside price of 74 euros, an upside risk of just 11%. However, with the important media and medical divisions reporting book/bills of less than 0.9, I expect deterioration in profitability.

How’d that turn out? Stock is down 75%, and that’s after a 7% gain today.

Now, you can hire a fund manager with gobs of experience at losing money, or you can hire someone who’s made quality recommendations and money, but is relatively inexperienced. Which one do you prefer? Or better yet, which one can you afford?

Another day, another 10% swing

Gee, this volatility (http://finance.yahoo.com/echarts?s=%5EGSPC#symbol=%5EGSPC;range=1d) is getting to be almost boring. I don’t pretend to be a technician but it does appear that the market is trying to bottom out around 800-850 on the S&P.

I was fortunate enough to catch some high quality names closer to the low than the high today, and some of that is reflected in my marketocracy funds. Some examples include SBUX with an 8-handle, GE at $15 and change and AEO at 8.75, which contributed to my 8.77% gain, compared to the 6-7% gains on the index. The short fund took a hit as to be expected, but only lost 2.4%, and remains up 60% YTD.

Many solid stocks continue to trade at valuations that assume rather extreme events like near-term 30%+ declines in revenues, 20 year growth of 0% etc, and with volatility continuing like this, I recommend setting hard (greedy) limits and seeing what sticks. I’m going to see if I can post my watch list for my long-only fund on the side.

Broadening Perspectives

I’ve decided to make this blog about a bit more than biotechnology investing.  I’ve added two links to my “mutual funds” at Marketocracy.com on the left.  I started these funds on a whim, the long-only fund way back in 2001 and the short-only fund when that option became available on the site back in 2005, before I went off to my stint on Wall Street.  Now that I have a bit more time on my hands, I’m working to keep those funds “fresher” with my ideas, and I will try to update their performance and trading in real time, or very close.  It’s no secret that I’d like to manage money for real, be it in a fund or as a financial advisor, and I’m rather proud of the fact that these funds have performed well, despite intermittent neglect on my part. 

The long-only fund is in the top 20% over the past 5 years, and has outperformed the S&P500 by nearly 7 percentage points annualized since inception in 2001.

The short-only fund has been in the top 30 as recently as 2007, but hasn’t been “compliant” since (my neglect allowed profitable positions to shrink to the point where I had too much cash to comply with the 65% invested rule).   Its annualized performance is 9.13% since its 2005 inception, compared to a -4.82% performance in the S&P500, so I have outperformed the simple inverse of the index.  Continuing in that regard, even with only 30% short positions in the short fund, the fund has gained over 50% in the past 6 months, again outperforming the decline in the S&P500 (which was -36%).

Overall, if you were to have invested $1M with me in 2001, and then added another $1M for short investing in 2005, you would now have just under $2.8M, including a 1% management fee (automatically calculated at Marketocracy).  If you would have bought the S&P when I started the long-only fund, you would now have $813,000, and shorted the S&P when I started the short fund, you would have $1.22M, or just about a wash on your original investments, and behind me by almost $800,000.

Not too shabby in these times for a well-diversified portfolio…

Amylin hit again

Amylin took a 26% hit today on the FDA rejecting its equivalence study of exenatide LAR made at Alkermes and at Amylin’s facilities.  This probably takes away first-mover advantage on a long-acting exenatide from AMLN (when compared with liraglutide from Novo) and increases the likelihood of another commercial failure with exenatide LAR (along with Byetta)

Investing in Biotech…Two Short examples from today

As I described in the previous post, profiting from short-selling in biotech requires the identification of companies likely to fail clinically or commercially (or both!). Today we saw two very fine examples of that: Cell Genesys and Amylin.

Cell Genesys took a solid thumping today, dropping 72% after it halted its GVAX trial in prostate cancer due to 20 more deaths (67 vs. 47) in the GVAX arm of the trial. Now, CEGE was hard to short before this, considering its shares were still under $3, but put options are also available. Why was CEGE a good short? Simple…Cancer vaccines don’t work. Favrille? Whoops. Dendreon? Ditto. Same with Oxford Biomedica. Decades of failure? Check. Now it’s possible that some company like CEGE will come around and figure it out, but why fight the odds? Just short ‘em.

Turning to Amylin. This is a rarer beast, the biotech commercial failure, but commercial failure it is. While the latest news is about a half-dozen deaths relating to Byetta’s use, the fact is that this stock had been sliced in half since the end of last year due to repeated disappointments on the sales side. Why? Well…stepping away from all the science of whether or not Byetta works….it’s a hard sell getting diabetics to give themselves another couple injections per day. I don’t care how small the needle is and all that. How many people do you know what to shoot themselves up a couple times a day?

Anyway, it’s late, and that’s a couple real-time examples of short ideas for biotech stocks.