A Lesson In Setting Low Limit Buy Prices (Thank You High-Frequency Algorithmic Traders) NYSE:GLW

In mid-2012, I began to look hard to Corning Incorporated (NYSE:GLW). The stock was undervalued because of decreased earnings from flat-screen makers. Cash flow was good and management had been doing a great job strengthening the margins. I wanted in, but the stock was trading around $13/share, and I was only willing to get into the company at a conservative price because of its dependence on glass.

I set a limit buy order at $10.79 just in case the stock sank that low, though I was far from sure that it would. I pretty much left it alone for 3 months.

And then Knight Capital Group came along. Knight Capital’s modus operandi was to utilize high-frequency algorithmic trades to make tiny profits on many trades. On August 1st, 2012 an unknown glitch caused their algorithm to go haywire. This triggered a dumping mechanism whereby Knight Capital had an instant fire-sale. One of Knight Capital’s holdings was Corning. My buy order triggered at the very bottom of the sell-off.

Since that fateful day. My GLW holding is up over 30%.

Corning Purchase

Amazingly, a second sell-off occurred in the fall due to a layoff announcement which was overblown. I could have bought in again, but was fearful of throwing good money after bad. Ultimately, the stock rebounded nicely.

I continue to appreciate Corning’s potential. The company maintains strong margins and is working to diversify its revenue streams away from touch-screen glass.Corning continues to innovate new solutions for its clients, large cap companies such as Apple and Google. Corning’s recently announced Willow Glass is going to change the game for mobile electronics yet again.

Cash Flow Financing

I was a bit concerned about the issuance for new debt, but it turns out Corning has done the same thing Apple did. They have been utilizing low-interest rates to finance share buybacks and pay dividends. It is worth noting that Corning has generated positive net cash flows for four years running.

The lesson I learned is stick to your price no matter what the markets do. If there is one thing I can be certain of from my experience as a programmer, it is this: we have not seen the last of algorithmic trading glitches.

Bear Case

  • Company is overly focused on glass screen for revenues
  • Underfunded pension and relationship with unions
  • High R&D Costs
  • Operating cash flow is shrinking

Bull Case

  • Management is controlling costs and maintaining net margins around 20%
  • Progressive dividend policy tied with stock repurchases for the past two years
  • Cash flow supports increased dividends and repurchases

I am confident management will do everything in its power to enhance shareholder value. Wendell Weeks, the Chairman and CEO himself owns approximately $10M worth of common stock and has historically sold shares between the $16-20/share range. GLW is currently around $14.40.

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BP (NYSE:BP) A Safe Dividend Play with Near-Term Catalyst

BP (NYSE:BP) has been one of the more interesting investment options over the past several years. The highly publicized Deepwater incident pummeled the stock immediately. People freaked out. The stock went as low as $27/share in June of 2010, then recovered back to $49/share by January of 2011. Since that time, the stock has gone sideways after adjusting for dividends.

Faltering oil prices, lawsuits and compensation claims tied to Deepwater, a messy TNK-BP breakup, and subsequent partnership with Rosneft’s predatory Igor Sechin has only served to depress the stock further. We can speculate about the intangibles of the legal process and the trustworthiness of Igor Sechin, but from a numbers and timeline perspective, BP looks attractive at its current levels of operation. In spite of diversions of cash to legal costs, and a lower dividend from Rosneft than TNK-BP provided, BP continues to generate large free cash flows.

BP’s margins are still sub-par compared to the other majors, though improving. Management has recognized this fact in the annual statement. Nobody is getting a free lunch in the executive lounge.

Margins

 

Kind of amusing that they think they possess any goodwill at all. Thankfully it represents a very small portion of total assets compared to most companies.
Kind of amusing. Thankfully it represents a very small portion of total assets compared to most companies.

What is impacting the stock?

1. Litigation regarding the Deepwater Horizon.
2. A flood of natural gas and oil from the U.S., which is helping to moderate oil prices.
3. Rosneft ties.

Catalysts

  1. Resolution of law suits. BP has been running adds in the Wall Street Journal recently claiming that it has fulfilled its legal obligations for the Gulf oil spill. Frankly, having been there, the Gulf seems like it is doing OK. It’s likely that BP will succeed in its efforts to wrap up litigation for the Deepwater Horizon spill within the next year or two barring some sort of unforeseen environmental impact.
  2. Rosneft made its first payment recently. Rosneft dividends will represent a great long-term deal for BP if they continue but we should not count on that.
  3. Stock buybacks announced this year to the tune of $8 Billion dollars worth.
  4. 5% dividend, more than many bonds pay now.
  5. The first round of stock options for executives post-Deepwater will vest in 2014.
  6. Inflation.

I think the strongest catalyst, the true driver for catalysts 1, 3, and 4, are the stock options. Never underestimate the self-interest factor. Unless they can coax the stock prices to a reasonable level a large portion of BP’s long-term executive salaries will be worth less now than four years ago. Resolving the legal obligations would provide even more cash to spend on stock buybacks and dividends.

Use of Cash

While BP’s future largely rests upon high demand for oil, valuations for the company are well-below the other major oil producers. Further, oil represents an excellent inflation hedge. As the Fed unwinds QE, inflation is a danger.

This is why I am going long BP for under $42/share. Approximately 10% of my total portfolio is currently invested in the U.S. ADR shares. The potential short-term catalysts at an incredible price is simply too appealing for me to pass up.

The underlined data points were particularly interesting to me
The underlined data points were particularly interesting to me

I intend to hold the stock until a legal resolution is reached, at which point I will re-evaluate the performance of management regarding net margins and shareholder returns. I estimate this will take 1-3 more years to play out completely but will be very happy to receive the dividend in the meantime. The stock has no room to go lower. All the bad news is priced in. Mr. Market has not factored in the catalysts.

(NASDAQ:FHCO) The Female Health Company – A Well-Managed Company with an Unfortunate Name

The Female Health Company (NASDAQ:FHCO)” might be the worst ever name for a company. There’s no sex appeal here, despite being in the business of contraceptives. There IS value if you can get over the awful name.

This is an indexed chart comparing the past five years of performance FHCO versus the S&P 500. FHCO shares sell around $9 currently.

Indexed Stock Performance Comparison

Company Profile

The Female Health Company is obviously not a well-managed brand like Apple and Amazon. And that is one of the reasons it is a great buy. Most investors heard the name and disregarded it, completely ignoring the 60% gross margin. FHCO also comes with astounding 46% net margins, rock-solid balance sheets, zero debt, and exponential growth opportunities in the developing world. Management is heavily invested in the company, and therefore has expressed a healthy desire to continually increase shareholder returns. Unfortunately, FHCO is only fairly priced currently. If the market continues its downward momentum over the next month or two, great buying opportunities could present themselves. The other catch is that the company makes only one product. This is not a diversified conglomerate.

Female Health Company makes the FC2 female condom. Its fortunes basically ride or fall on this one product, and it has the odds stacked in its favor. The FC2 condom is the only FDA approved female contraceptive on the market to protect against AIDS/HIV and pregnancy. Now to American men, and perhaps some American women, female condoms have a negative or exotic perception, so how do the reviews stack up on Amazon? 4/5 Stars. The product is available in 143 countries.

The majority of purchase orders for the FC2 come from organizations such as the U.N. which then distribute them in places like Sub-Saharan Africa where AIDS/HIV has been running amok for the past several decades. The FC2 and other female condoms are being given away for free to women there, women who may have never possessed a contraceptive before are now being empowered in a fundamental, demographically altering way. More information about World Health Organization findings and programs can be found here: http://en.wikipedia.org/wiki/Female_condom .

The takeaways are mind-boggling. Female condoms are a cheap, effective way to empower women in developing countries, costing less than $1 each. They exhibit effectiveness when re-used (though this is not encouraged it has been proven to work). Female Health Company has committed to giving away a portion of its inventory to help with these efforts. Men and women in developing countries are going to become familiar with female condoms. The potential market share being captured in places such as South Africa is staggering.

Check out the size comparison between FHCO’s major competitors Dwight & Church (maker of Trojan condoms) and Actavis Inc. FHCO is around $270M. There is significant room to grow here.

Market Cap Comparison

Now let’s take a quick look at the margins. I could trim out the bad years to suit my thesis, but I chose to leave them in. This shows a clear progression for the company, transitioning from small-cap start-up to profitable enterprise. Note also that 2007 was the year the FC2 gained approval for purchase from the WHO.

Margins

Strong growth over the past 10 years and management continues to aggressively improve manufacturing cost margins.

Next we look to cash flow. If the FC2 can be improved, FHCO has the cash to invest. If not, expect dividend and share repurchase increases. The pile continues to grow.

Cash Flow

Conclusion

The stock has moved since I bought my initial position in April, but is still fairly priced for a great company in this industry. I suspect the name turns people off, which is fine for those of us looking at the numbers. Growth has slowed down this year after 2012’s explosive earnings increases, but there is still plenty of room to run and management believes that it will.

Valuations Comparison

How long until the party is over, the word gets out, and major institutions bid up the price and own 50-70% of the shares? That’s hard to say. Currently only 34% is owned by institutions. One lonely analyst follows the stock according to Factset (they recommend it as a Buy).

Insiders own approximately 25% of the stock worth about $66 Million dollars between 12 individuals. That’s a LOT of confidence that their company is going places. FHCO’s high margins compared to its competition are an expression of that commitment.

Currently FHCO represents around 4% of my portfolio. It should serve as a good counterweight to the stalwarts I own such as GE and Toyota. I intend to buy at or below $8.00/share. I believe that macro-market trends will push the price down to at least that low and perhaps lower in the short-term. Being a small-cap, the stock is inherently more sensitive to macro trends. This is a 5-10 year stock. I do not expect to get rich overnight holding it but I do believe that if I hold it over that time frame the stock will at least double in price and perhaps more. In the meantime, the dividend compares favorably with bond yields. If management continues to capture market share and keep margins low I might never sell. Long term, this company has immense potential.

Margins Comparison

A Long Time Coming

This blog is dedicated to my wife, Janelle. When I met her I did not have enough money to fill my gas tank. Over five years of patient tutelage from her on the subjects of saving, thrift shopping, and common sense the situation has changed some. I may even have learned a thing or two which I can apply to the stock market.

The intent of this blog is to serve as a record of my investment decisions, to better help track portfolio performance and decision-making. Ultimately, the goal of this blog is to help stay me stay in the black. With most of my net worth riding on my decisions, I literally can’t afford to be wrong.

My first experience investing was in 2010, just after my return from Afghanistan. When I deployed overseas, I found myself with not a lot of work to do. Luck played a large part in the next huge turn in my life, when I ran out of everything to read in the hooch, except for financial magazines. I must confess that I had read The Millionaire Next Door and The Richest Man in Babylon prior to this experience, but the stock market was uncharted territory to me. I had saved money for the first time in my life, and had the princely sum of $5000 sitting in a bank account. I knew I should do something with it. I read Fortune and Smart Money, got a Fidelity account, and based most of my initial investment decisions off of the recommendations found there.

Without having read any books on investment, I felt that there must be an opportunity to buy great companies at great discounts. It worked out. Really, investing money in the stock market during 2010 was a “can’t miss” game. Stocks had plummeted so far, so fast, that there was simply no way to lose. Then I read The Intelligent Investor and everything clicked. Finally, a scientific explanation for what I had been witnessing!

The founding principle of this blog is that Mr. Market can sometimes be irrational. I intend to exploit Mr. Market’s brief moments of un-clarity with sizable (3-10% of the total portfolio) purchases and sales. I would love to spread the risk around more but my egg basket is simply not large enough to merit the additional costs in brokerage fees. So I will really have to be on my game with investment choices. Investments will be long. I may write covered puts and calls when I feel the situation warrants.

I do have some advantages over the professionals:

  1. I am in no hurry, and have at least 35 years of work ahead of me before retirement.
  2. Perhaps because of #1 I am not afraid to take chances if the probability of winning out in the long-term is promising.
  3. I have some guiding principles established by the greats who have come before me: Benjamin Graham, Sir John Templeton, Warren Buffett, Peter Lynch, Seth Klarman, David Einhorn and Joel Greenblatt to name a few.
  4. I am currently in my first year at a top-20 business school full-time MBA program. Hopefully I will be learning things which I can apply to my portfolio.

A little bit about my portfolio:

  • 5% Short-term CDs designed to mitigate inflation and force me to wait until next year’s IRA becomes available.
  • 5% Lending Club, this is my first foray into peer-to-peer lending, but the potential returns were simply too good to pass up, and sated my desire to invest in something with annuity-like cash flows, without having to deal with disappointing rates of return.
  • 5% Money Market Funds until I find something I really like.
  • 85% Stocks and Indices – the bulk of my personal savings is invested here. Roughly 10% of this sum is invested in market-tracking indices. The other 90% is composed of individual stock selections.

My investment philosophy continues to develop but I am typically most attracted to, and successful with deep value and distressed equities. I am interested in dabbling in municipal bonds due to all the bad press but do not have the means yet. Some of the stocks which I am currently invested in include: BPDEGACEAIGGEGLWGOOGHBCHMCIBMJPMSAN, and TM.

I am strongly weighted towards the finance industry in particular. Money still crosses borders at incredible rates, and computers are now making it possible for large banks such as JPM to make large-scale position decisions at lightning-fast speeds.

I intend to invest primarily in deep-value and distressed equities. Holding time will vary but could range from 3 months to 30 years. On average, I have owned the stocks in my portfolio for 2 years, and that average will probably get longer. I am a long-term investor, and simply am unwilling and unable to attempt to predict the timing for an individual stock’s decline. Market timing is nearly impossible and ultimately, probably not worth the effort for me. I may invest in bonds or esoteric ETFs on an experimental basis, but do not intend to put large portions of my own retirement into products which are still in beta-testing (pun not intended).

I am not afraid to invest in “growth” stocks if I believe the cash flow exists to support such investments but, by and large, I tend to avoid anything with a P/E over 25, or bloated Price/Tangible Book Value ratios.

I will focus future posts on specific investment recommendations. I do not have a bottle of champagne to break over my laptop, and thereby christen this new endeavor, but rest assured, I did chug a beer and crush the can.