Wednesday, May 16, 2012

CEO Chooses Honesty. Shares Plummet

JC Penny is in the middle of changing how their business operates. Both to cut expenses and to appeal to a different generation of consumers. Instead of high prices with heavily advertised sales of up to 60% off to attract customers, their CEO decided to simply offer the low prices and cut out the expensive ad campaigns. In the middle of their transition, JCP stock drops the most it has in 20 years.

Humans are horrible at valuations. We either over-value or under-value, and the amount of this error is driven by emotion and fear. For me, this smells very much like a discount of a premium company. Let others fear change, I sold my prior positions and went 100% into JCP.

Monday, May 07, 2012

Opening Move

How does one plan for the future?

My personal idea on time is anything you know is by definition the past. Even if other people consider it to occur in "real-time," the present is a very thin border between past and future. Our actions occur in the present, but our senses are always based in the past, even sensing our own actions as they happen. This is an important concept in life, as our minds have evolved to be particularly susceptible to hindsight bias.

"Choice is an illusion created between those with power and those without." Merovingian from Matrix Reloaded

In chess, I can gauge the likelihood of the outcome by the limits of my beneficial options, and how well I've limited my opponent. The player without power finds his choice restricted to moves that weaken him further. Giving more power to his opponent in a cycle that compounds itself until the inevitable conclusion.

Opportunity measured by the penny.

This stock game is similar to chess, as the only cash we're given is what we start with, the growth or shrinkage of our net worth reflects our opportunity. A player who loses half their worth is much less able to surpass someone whose worth has doubled. They are constantly forced to find higher yield investments to gain on the competition, which by definition are also higher risk.

"In the fields of observation chance favors only the prepared mind." Louis Pasteur

So how does this guide my stock selection. I don't look for companies with a good history (technical analysis). Nor do I look for a company the looks good currently (news rumor and hype). Instead, I look for companies best positioned to seize opportunity. Companies in the black with a high asset ratio and profitable margins. Companies typically involved in research and development.

My opening selection
NVE Corporation (NASDAQ:NVEC) 55%

I cannot predict the future, I can only choose a position that allows the most opportunity, and invest in companies that can do similar.

Dollar Woes

For the stock market game dollar woes, I've been looking into a number of different metrics into what to invest on. I went to's stock screener, and set the following:

Price to Earnings ratio: 0-15
Price to Sales ratio: 0-11
Earnings per Share: 1.64-max
Current Ratio: 1.88-max
Cash per Share: 8.2-max
Total debt / assets in the recent year: 0-50%
Total debt / equity in the recent year: 0-81%
Return on Investment: 9.2-max
Return on Equity: 9.2-max
Net Profit Margin: 13.25%-max
Operating Margin: 8.74%-max

I didn't derive these numbers using any specific formula, the Google stock screener lists a curve with its numbers and I chose the upper 50% of the curve. Without making any industry comparisons these numbers are fairly useless on their own, but I was hoping that with the combined values I could find something relatively undervalued.

The price to earnings and price to share ratios reflect that sentiment - I want low on both. The current ratio and cash per share ratio are both growth indicators and safety nets - high ratios of each means that the company is very liquid, which means more capital to invest or to catch the company if an emergency happens. The debt / assets and debt / equity reflect the overall makeup of the company (assets = debt + equity), as well as how well the company manages its debt. To compare on that last point I also included return on investment, return on equity, and earnings per share.

Lastly, I wanted a company that was operating fairly well in the black. I included net profit margin because it's the bottom line, but also operating margin because I wanted a company that not only did well in net profits, but was operating at a profit in case the other income streams dried up.

Surprisingly, I had 19 companies pop up (I expected only a handful). Some of these companies barely made my requirements on almost all counts, so I looked at the companies that had exceptional areas.

ASM International NV (ADR) (NASDAQ:ASMI) stood out with a 0.99 price to sales, the lowest of the group. It also had one of the lower EPS at 2.4, and cash / share at 9.27. It had an operating margin of almost 20%, and a net profit margin of 17.2%, but this is still some of the lower among the list that was left. With the 4th highest P/E, at 14.48, I'll probably either pass on this one or invest only a little. The price to sales is a good comparison over years, which I don't have at the moment, and all of the other metrics seem somewhat weak.

Terra Nitrogen Company, L.P. (NYSE:TNH) stood out like a clown in the jungle with the highest P/E and P/S ratios at 15.38 and 5.91 respectively, but also had the highest operating and net profit margins by almost double second place at 63.57% and 63.59%. I need to research why the profit margin is larger than the operating margin, and the actual amount of debt (google reports 0 for debt/equity and debt/assets). With a return on investment of 211%, a return on equity of 127%, and a earnings per share of a whopping 15.51, I can understand why this one might be commanding the price it is. Feels like I need more research on this one before I pull the trigger, but also of note is that it has the third highest current ratio at 6.94, so it's a pretty liquid company.

Franklin Resources, Inc. (NYSE:BEN) is one of the larger companies that got pulled, but it seems to have a lot of cash on hand with a cash / share of over 30. It also is one of the larger earnings per shares (#2 behind Terra Nitrogen, with 8.68) and operating / net profit margins (36.45% and 25.26%).

Diamond Offshore Drilling, Inc. (NYSE:DO) had one of the lower P/E ratios (10.06), higher EPS (6.45), with a high-end current ratio (4.66). While it's not getting the best return on investment, and has higher debt ratios than most of the other companies, it's still pulling an operating margin of 36.58% and a net profit margin of 27.31%

Fisher Communications, Inc. (NASDAQ:FSCI) had my lowest P/E pulled at 7.24. It also had one of the lowest price / sales of 1.67, but what's somewhat worrying is a current ratio of 2.01 with cash / share at 19.98. This company is one of the smaller capitalized companies that I pulled, which could explain the high cash / share, but this potentially means that most of the company's current assets are cash. This isn't necessarily bad, unless inventory levels or other current assets like collectibles should be higher and just aren't. It depends on the nature of the business - the business has a higher debt / asset and debt / equity ratio than most of the companies I pulled, and a moderate ROI and ROE. Operating margin is 37.29%, but net profit margin is only 21.87%. Given the smaller capitalization I'm expecting this to be a smaller company, so I wouldn't expect large taxes. This could mean the company pays out a significant amount in interest or has significant fixed assets that are depreciating, which would result in the lower net income. I also need to research to see if the company perhaps paid out a large settlement that could also result in the lower net income.

Friday, May 04, 2012

Let the games begin

From time to time my friends and I compete against each other in Stock Market competitions games on MarketWatch. A new game is about to begin on Monday, where we begin with $50,000, no margin, and $8 flat commission. This blog will be keeping track of our progress with some of us writing posts on our investment strategy as we go along.

The S&P 500 which we'll be grading our progress against is currently at 1,369.10