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Why Do Stocks Sell At A Significant Discount (Part 2)

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Company Factors

The next primary factor of why certain companies or stocks sell at a significant discount to their intrinsic value have to do with the internal company causes. There could be a number of different issues here, but some of the primary ones include.

  • Management Change or Internal Infighting
  • Financial Failure, Financial Mismanagement or Fraud
  • Competition Is Eating Their Lunch
  • Product Failure or Market Failure
  • Falling Growth Rates, Deteriorating Financials and No Clear Future/Catalyst
  • New Technologies Are Entering The Market

Once again, there are many others, but these are the primary issues.  Any given corporation can have one or multiple factors working against it at the same time. Whatever the situation is, it can greatly impact the value of any given stock.  If investors are aware of any such negative developments there is a good chance the stock will be sold off.  So much so that you are likely to find it selling at a significant discount to its intrinsic value.

Let me give you an example.  I believe it was in 2003 when I was invested in a fast food concept out of San Diego called Pat & Oscars. It was a very well run company at the time, selling at a very reasonable valuation (that was well below its intrinsic value) and the company was planning to grow its chain nationwide.  So, value and growth all in one.  Yet, at some point in 2003 the company  had an E. Coli outbreak in its San Diego restaurants, poisoning a bunch of people in the process. The stock sold off the next day to the tune of 50%, giving investors a chance to buy a good company at a huge discount (assuming this E.Coli outbreak doesn’t kill the company).

This is what you would call a company factor.  It is company specific and depending on a situation it can provide investors with amazing buying opportunities. The trick here is to figure out if the issues is a permanent one or a temporary one as in the example above.  If it is a temporary one and if your research is proven to be correct a significant amount of money could be made while taking very little risk.

Industry Factors

Finally, various industry factors can push any stock into a significantly undervalued category. It could be because of cyclicality, it could be due to industry wide technological change, it could be due to pricing pressure and so forth. The trick here is to find the best performing company in the sector and make sure you buy it at a significant discount. When the industry eventually recovers,  the best performing companies should outperform the rest of the sector by appreciating the most.

For example, let’s assume that your research indicates that the price of gold should go through the roof over the next 5 years. Yet,  for some reason gold mining stocks are selling at an all time lows due to the price of gold being low today.  In fact, most of them selling well below their liquation value.  What you should do if you really believe in your investment thesis is identify 1 or 2 best companies in the sector and invest in them. If your research proves to be right, your stand to gain a substantial amount of money while keeping your risk at a minimum.

In summary,  while the are many other …. market, company and industry factors are the three primary forces responsible for driving stocks well below their intrinsic value.  When doing fundamental research you should clearly know which one of these forces is responsible for pushing the stock in question into the 50-90% discount category. Clearly understanding that could mean the difference between making a great investment and making a disastrous one. 

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Secret Structure Of The Upcoming Dow Decline

Dow Jones Long Term Chart

 

The chart above represents the Dow Jones between 1986 and today. It is clear from the chart that the bear market started at the 2000 top of 11,800 and continues on today even though we have already set two higher tops. Typically the bear/bull markets alternate in a 17 year cycles, so we have another 3-4 years to go before this bear market is over.

However, that is a side point to my main point. What I want you to observe is the structure of the declines between 2000-2003 and 2007-2009. The decline we had in early 2000’s was a more orderly decline with lots of ups and downs, plenty of time (2.5 years) and not to much directional energy. The move in 2007 was quite different. It was directional, it was short (1.5 years), it was high energy and it was violent.    

What’s the point of all of this? First, my work clearly indicates that we are about to start a 2-3 year bear market. All of my technical, fundamental and mathematical work confirm that fact. 

So, what kind of a move should we expect? 

My mathematical work shows that the bear market over the next 2-3 years will be almost identical to the 2000-2003 move. A lot of volatility, overall downtrend, but not too much downside energy. That is not to say that the market will not go low, it is to say that the move over the next few years will not be a violent one. I hope this helps. 

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Who Else Wants A Huge Pile Of Cash?

BusinessWeek Writes: Corporations Are Swimming in Cheap Cash. So Why Aren’t They Investing?

  Cost-of-capital-investwithalex   

The difference is that back then, businesses were actually spending that cash they were able to borrow so cheaply, buying equipment and building factories and hiring workers. Today they’re just hoarding it. The pile of corporate cash on the balance sheets of nonfinancial companies has grown to $1.48 trillion, according to Moody’s. That’s an 81 percent increase since 2006. “Corporations are flush with cash coming off a huge profit cycle,” says David Rosenberg, Rosenberg points out that despite this abundance of cheap money, “we’re in the midst of one of the weakest investment cycles ever.”

Until Congress parts the clouds and gives businesses some bit of certainty as to spending and tax rates, let alone an assurance that the U.S. won’t default on its debt and the government won’t shut down, expect more of the same. Slow growth, weak demand, and more and more cash being piled onto corporate balance sheets.

Read The Rest Of The Article Here

The article claims that the lack of US fiscal clarity is the biggest culprit behind corporations not investing their huge cash piles and/or borrowing at cheap rates and investing it.

I respectfully disagree. First, the notion of huge stockpiles at corporate level are highly questionable at best.  Now, in terms of borrowing and investing, the issue has nothing to do with US Fiscal clarity and everything to do with the fact that everything is significantly overpriced and there is technically nothing left to invest in.

What I mean is, due to a flood of readily available cheap capital over the last decade, most corporation have already heavily invested in and have streamlined the majority of their production capacity. When most of them look around today, there is literally very little for them left to do or invest in. This is the synopsis of the problems I have been talking about here this entire time. 

Too much credit, overcapacity and slowing velocity of credit.  Even though credit is readily available it will have even less impact on propping up our economy going forward.  Just another falling vital sign of a dying patient.  

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Why Do Stocks Sell At A Significant Discount?

Most people would classify the stock market as irrational and volatile. Yet, it is the best pricing and discounting mechanism that we presently have.  It is not perfect, but what it lacks in predictability it makes up in opportunity.  The stock market tends to flow and oscillate up and down. Sometimes drastically so. It is during those oscillations that we are given opportunities to either  buy low/sell high, buy high/sell low or any other combination of the said.

We will discuss exactly how the stock market works and what causes those oscillation in the later chapters, but for now we have to figure out why and how certain stocks or the overall markets can sell at a significant discount.

So, why and how are such value opportunities created? 

To be honest with you there could literally be a millions of reasons of why any particular stock sells at a significant discount. It could be caused by an economic collapse, internal company infighting, product failure, management failure, fraud, management change, financial mismanagement, industry decline, new technologies, competition and so forth.

Whatever the fundamental situation is, the market always gives investors plenty of opportunities to purchase good businesses at 50-90% discounts to their value. When such opportunities present themselves, an outsized return could be generated while taking very little risk. An ultimate setup for any investor.

With that said, let’s take an in depth look at the 3 primary reasons of why various companies sell at a significant discount.  

Market Factors

Most stock market indexes such as the DOW Jones have their own rate of vibration and flow. They tend to rise and fall in conjunction with the economic cycle. The market represents an overall state of financial health and growth prospects for corporate America.  As such, when the overall stock market rises (Bull Market), all stocks tend to do very well.  When the market falls, most stocks tend to decline as well.

weinstein stage analysis 2007 bear market 

While most of the time declines are not deep enough to present investors with 50-90% discounts, at certain times they are. For example,  1929, 1949, 1972, 1982, 1987, 2002 and 2009 bottoms are just a few examples of when investors could have made a killing if they would have purchased stocks at the bottom.  During those times the market presented investors with a galore of stocks selling well below their intrinsic value.  

Such occurrences are caused my major failure and/or panics that tend to dominate financial markets.  For example, the most recent decline of 2007 – 2009 was a perfect illustration of that. Caused by a number of fundamental and cyclical factors I discuss on my blog, it ended with major panic in early 2009. With the Dow Jones below 7,000 it presented investors with an opportunity to buy hundreds of great companies/stocks selling well below their intrinsic value.

In summary, the overall market flow and human psychology tend to push stocks well below their intrinsic values at various points throughout history. At such times enterprising investors can easily pick up wonderful businesses at 50-90% discounts.  Investors should not be afraid of such severe bear markets. Rather, they should be excited. The market gives them an opportunity to pick up great businesses at significant discounts, insuring a large margin of safety (low risk) and a significant return on investment in the near future.

As Warren Buffett says, “Be greedy when others are fearful and fearful when others are greedy”.   

To be continued…..

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The Secret Of The Dow Chart

BusinessWeek Writes: Hedge Fund Chart Guru Tom DeMark Sees Dark Days Ahead

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“The market’s going to have one more rally, then once we get above that high, I think it’s going to be more treacherous,” DeMark says. “I think it’s all preordained right now.” He feels this is probably irrespective of how and when the crippling impasse in Washington is resolved. “If you look at the new highs and new lows on the [New York Stock Exchange],” he says, “every time we made a higher high, there were fewer stocks in the index participating in that high. It’s getting narrower.” And once that happens, you typically get a collapse. The opposite looks to be true for gold, which he expects is making its low right now and should start to move up dramatically.

Read The Rest Of The Article Here

I tend to agree with Mr. DeMark to a certain extent as my own work confirms parts of his analysis. There is no doubt in my mind that we are approaching a major top here in most financial markets. Now, it is just the matter of hard work to pin point it. As I accelerate my timing work over the next few months I should have an exact answer for you by the end of the year.

With that said, there are only two possibilities here (based on my work).

1. The market has already topped. Triple tops are notoriously dangerous and tend to mark the end of a bull market. We have already set 3 tops and as I have suggested before the market finds itself in an exciting spot. We either confirm a bear market here by breaking down below recent lows over the next 4 weeks or….

2. The market will top out in March of 2014. This type of a scenario resembles Mr. DeMark’s forecast above.

Either way, we are approaching the end of a bull leg and you should begin thinking about reallocating your capital in order to avoid losses during the bear market.

Will we experience 1929 type of a decline as Tom suggest? My work doesn’t show that. It shows a slow yet volatile decline into the 8000-9000 range on the DOW over the next 2-3 years. 

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Warning: Real Estate Red Alert

Reuters Writes: Nobel Prize U.S. winner warns of ‘bubbly’ global home prices

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(Reuters) – One of three American economists who won the 2013 economics Nobel prize on Monday for research into market prices and asset bubbles expressed alarm at the rapid rise in global housing prices.

Robert Shiller, who shared the 8 million Swedish crown ($1.25 million) prize with fellow laureates Eugene Fama and Lars Peter Hansen, said the U.S. Federal Reserve’s economic stimulus and growing market speculation were creating a “bubbly” property boom.

This was the case in the collapse of the U.S. housing market, which helped trigger the 2008-2009 global financial crisis. Markets are at risk of committing the same error now, Shiller told Reuters after learning he had won the Nobel prize.

“This financial crisis that we’ve been going through in the last five years has been one that seems to reveal the failure to understand price movements,” Shiller said.

“When asset prices are getting way out of line it should be cause for alarm. The monetary authorities should lean against extreme asset price movements,” Shiller said.

The bubbling housing market is not mainly the result of central bank policy, but reflects a shift toward “a more speculative attitude,” Shiller said. “We cannot expect monetary policy to cure all of these problems.”

Read The Rest Of The Article

I have a lot of respect for Mr. Shiller and I am happy that he won. My respect is not necessarily based on his economic work(even though it has been accurate), but on his ability to take sides. Most economists don’t do that. Most talk out both sides of their mouth without as much as saying anything worthwhile. That is academia for you.

I agree with everything Mr. Shiller states in the article above. Indeed, we are in the midst of a “Global Real Estate Bubble”. This is a unique situation that we haven’t seen before on such a massive scale. The culprit is easily identifiable here as well. Cheap financing on a global scale perpetuated by the FED. The outcome is clear as well, an eventual collapse in credit, real estate and financial markets on a global scale. Anything other than that would defy the laws of physics. For now, it is only a matter of time.

In my previous post I Am Calling For A Real Estate Top Here, I have made a gutsy call that we are indeed topping out here.  I firmly stand by that analysis as we continue to get more concrete evidence that the real estate market rally from the 2010 bottom has indeed peaked.

As such, I once again caution you against speculating in real estate at this time. 

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What Everyone Is Ought To Know About Value Investing

Magnifying glass

If you have spent any time in financial markets, you probably already know what Value Investing is. If you are new to investing, Value Investing is probably the easiest investment style to understand and apply towards your own investment purposes.  Also, while debatable, some very successful investors have proven that Value Investing is one of the best ways to approach financial markets over the long term.  Let me first illustrate what Value Investing is with a real world example.

Imagine that you are strolling through your local mall in the middle of July.  The sun is scorching hot and you are just trying to stay cool.  After your 3rd Caramel Frappuccino you decide to check out a nearby sports superstore. Shortly after you walk in you see something and you can’t believe your eyes.  The snowboarding jacket you have always wanted, but were never able to afford is on sale.  And not just any kind of a sale. It is a seasonal liquidation sale. Typically selling at close to $250 during the winter season it is now just $19.99.   

You can’t believe how lucky you are. You check the jacket to make sure there is no big gaping hole in the back of it. Nope, everything looks fine. The size is just right. All zippers work and it’s the color you want. You are beyond excited. You found exactly what you wanted at over 90% discount to what it is really worth.  The timing is not perfect and you can’t use it for the next 6 months, but you know with 100% confidence that you have found a deal of a life time. In 6 months this jacket will be selling at $200-250 again. Without a second of hesitation you take out your wallet and head towards the register.

Value Investing is just like that.

Except, instead of a jacket you are buying shares (or other financial instruments) in publicly traded companies. Basically, you do a lot of fundamental research to find companies that are selling well below their intrinsic or real value and then proceed to buy them at a significant discount. Typically 50-99% discount. The bigger the discount you can obtain the bigger your margin of safety is.  In fact, margin of safety is one of the most important concepts when it comes to Value Investing.

Margin of safety is there to protect your capital. The theory suggest that if you buy stocks at deep enough discounts to their intrinsic value you have an automatic safety net built in. After all, no fundamental research can be 100% accurate and you need something to limit your downside risk. In such a case you are unlikely to lose a lot of money on your stock trade/investment because your investment is unlikely do decline that much further. Remember, it is already very cheap. 

In essences you are buying $1 bills for $0.50 cents or less.  Over time these assets “should” appreciate back to $1 to reflect their true value. Providing you with a large return on your investment while minimizing risk. Yet, as with anything, there are numerous issues associated with value investing. I will cover them in greater detail over the next few chapters.

For now, let me quickly summarize value investing in a five easy steps.

  1. Do a lot of fundamental research to find deeply discounted stocks or other assets.
  2. Buy such bargains or stocks at a significant discount to their intrinsic value. Typically a 50% or more discount is required. By buying at a significant discount you create a margin of safety.  
  3. Margin of safety is your best friend. Maximize it. It protects your capital by limiting the downside.
  4. Patiently wait for asset appreciation to reflect its true value. Such periods can range from days to years.  
  5. Watch your investment like a hawk by constantly updating your fundamental research. Should any developments alter your original investment thesis, you should re-evaluate your investment decision. 

That about covers it. 

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The Secret To Predicting The Future

 BusinessWeek Writes: The Importance of Tuning Out the Noise

 PredictingFuture investwithalex

The Dow Jones Industrial Average jumped more than 300 points yesterday on news of talks in Washington to resolve the government shutdown/debt ceiling crisis. Was it a relief rally? A head fake? Will the points disappear if the talks don’t produce results?

Who knows? I don’t. Nor does Wall Street or the finest brain cells and black boxes in Connecticut hedgie-land. Even the most powerful and decorated economists in the country were pretty much blindsided by the Great Subprime Meltdown, a trauma that chopped stocks in half in just months.

So, yes, we’re all pretty much flying blind.

Read The Rest Of The Article Here

Articles such as these anger me. They perpetuate the notion that predicting financial markets is impossible and that no mortal should even attempt to try it.  If they do, they are surely to fail.  After all,  if not even “brilliant” Nobel winning economist can predict the future, what chance do you have?

Actually, a very good one.  In fact, it is very hard for me to understand why most people or our “brilliant economist” can’t see the future.  I am not by any measure brilliant, yet I could clearly see the 2007-2009 meltdown coming as early as 2005. I have even tried to warn people, yet most wouldn’t listen. Today, it is clear as night and day as well. Not only from the fundamental perspective, but from a cyclical and technical one as well. They all confirm.

Basically, the US Economy and its financial markets are about ready to roll over and go down significantly. No, it will not be an overnight drop, but it is now unavoidable.  My work indicates that it will take 2-3 years for the market to hit its lows with lots of up and downs in between. I will present my timing work over the next few months that will illustrate that a little bit better. 

My only advice is this. We are not flying blind. Ignore financial media and concentrate on reality and fundamentals. When you do, you will very soon realize exactly where we are in the economic cycle and clearly see what is coming up over the next few years. 

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Unknown Secret About China’s Export Drop

Bloomberg Writes: China Exports Unexpectedly Drop

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China’s exports unexpectedly fell in September, signaling constraints from global demand and highlighting distortions from fake invoices that have yet to be eliminated from trade data.

Overseas shipments dropped 0.3 percent from a year earlier, the General Administration of Customs said yesterday in Beijing, trailing all 46 estimates in a Bloomberg News survey that had a median projection for a 5.5 percent gain. The trade slowdown resulted from a high basis of comparison with last year, the agency said in a statement.

“There has been an export recovery since July to the U.S. and Europe but it’s been pretty weak,” Shen said. “The driving force for China’s recovery at this stage is still housing and infrastructure investment.”

Read The Rest Of The Article Here

I am not sure what is so unexpected about the export drop. You could see this coming from a mile away. What’s more is that this is a trend that is just starting. I would continue to expect weakness in the Chinese export sector as the global economy starts to contract. 

This is very basic. The US Economy is literally running on fumes, QE and a lot of credit infused speculation. As such factors dissipate or lose force (already happening) the US Economy will slip back into a recessionary environment. The whole world will follow (or lead) the way. Under such a backdrop, it is impossible for the exports to be anything but down.

Chine exports “Unexpectedly” dropping is just another sign that we are in early stages of such a development. As I have said many times before, right now would be a good time to think about protecting your assets from the upcoming recession.

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Becoming An Investor, Part 3

Now, I understand that you might be skeptical of the statement above.  Yet, I ask you to keep an open mind and hold judgment until you finish this book.  Just remember, if I was to suggest 500 years ago that the earth was round or that the sun and not the earth was the center of our solar system,  I would probably be burned at the stake.  As Albert Einstein so famously said “God Does Not Play Dice”, meaning the universe presents us with the perfect order in all things. It is only the stuff that we do not yet understand that is viewed as random or volatile.

By March of 2006 I have made a huge break though in my mathematical work. So much so that I have led myself to believe that I finally broke the “stock market code”.  By this point my work was so well researched and accurate that I truly thought that I have figured it out. I was on could 9. Finally, it was my chance to shine.  That was the final piece to the puzzle I was searching for. I would be an unstoppable force in financial markets now, it was only a matter of time before I would be a billionaire.

By May of 2006 and after some additional confirmation work I was ready to go. In hindsight, what I did next was beyond idiotic. I threw out my value investing book, I threw out all of my rules and I threw out any type of rational thinking along with it. I was ready to be a trader now. I was going to make a ridiculous amount of money 

The next 20-30 trading days were amazing. My work has allowed me to pick 90-95% of significant tops and bottoms with hourly resolution. Meaning I was able to pick almost exact tops and bottoms sometimes in advance and sometimes minutes or so after they have happened.  It was a fascinating time and by the time this period ended I have accrued close to $500,000 in profit.  

Yet, for some reason that wasn’t enough. I was blinded by greed.  I wanted to make more money as I was only 3 years away from being 30 years old.  Beaming with confidence and desire to make an obscene amount of money I became even more aggressive and careless. Not only with my own money, but with the money of my clients and other funds I was managing at the time.

In June of 2006, on the day of the  FED interest rates decision my work showed a powerful move to the downside.  It didn’t matter to me what the decision was, my work clearly indicated a significant move down. Blinded by the accuracy of my work in the past, by the greed running through my blood and by my oversized ego I bet the house on the stupidest trade of my life.

I took all of my money and a large portion of my clients money to buy as many Short Term PUT Options as I could. If my work was to be right I would make a huge amount of money. If it was wrong, well……that was impossible according to my mind.  (If you are not familiar, put options allow you to leverage your trade and make or lose a lot more money faster than you would be able to do investing in an underlying security).

I was right about one thing. There was a powerful high energy move that day, but to the upside.

Long story short, I started the day as a self made multi millionaire hedge fund manager and ended it as broke bum. Thus far that day remains the lowest point of my life. It was so bad that I was literally 10 seconds away from blowing my brains out. If you would like to learn more about this experience I suggest you visit my other website,  LastSpartan.com and search for the first article on that site titled, I Want To Die Today, I Think I Will Blow My Brains Out.

When the day ended I was broke. Not only financially, but spiritually, mentally and in every other way you can think of.  At least for the time being I was finished as an investor. I lost all interest in financial markets.  I shut down my fund and returned capital to my investors. They lost very little, if anything. I used my own capital to prevent their losses. I couldn’t stand to even look at financial markets or my research. I was too devastated and mentally destroyed. I put everything away and moved on to the next chapter of my life.

As time went by my thirst for financial markets came back. My pain went away and by mid 2013 I was ready once again.

I am back baby!!!

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