Followers of Common Cents will know that my investing style is biased toward looking for values in the market that provide high probabilities of modest gains. However, from time to time it makes sense for every investor to have a few speculative plays in a portfolio. I'm taking a speculative position in Westport Innovations (WPRT).
A few macro level observation include:
- Something's happening out there - I'm certainly not an expert in the energy industry, but it sure seems there is no denying the technology advances that have allowed access to a lot of natural gas previously thought to be impractical to recover is not just another news story. While controversies related to fracking may exist for awhile, this still seems like a development that can have huge impacts on the way energy is used in the world. If that is true, there will be big opportunities for companies that are early leaders related to this area. These type of opportunities at least have the potential to provide an investor large gains. These types of investments are not low risk, but every reasonably large portfolio should probably have a few speculative positions in play at any time.
- Innovation - One of the leaders in advancing the use of natural gas into the economy seems to be Westport Innovations. This Canadian company focuses on low-emission engine and fuel system technologies that enable light, medium, heavy-duty and high-horsepower petroleum-based fuel engines to use natural gas. They seem to be recognized as an industry leader in this space that claim to hold a significant amount of intellectual property related to this technology and are forging partnerships with many major players in the truck marketplace. The investor page of the web site (here) has a nice brief PDF that describes the business. This company seems to be a leader in a potentially important market niche, and hopefully its intellectual property provides enough value to provide some floor to the stock price.
- Growth - The company is growing rapidly. Revenues have gone from $148m in 2011, to $226 in 2012, and are projected to be over $400m in 2013. However, as with many early phase companies there are many financial issues. None bigger than they have never made a profit. They also carry a lot of debt, but that is somewhat offset by controlling several patents and other intellectual property in this area.
- Catalyst - It seems likely that the topic of how to use natural gas in the U.S. economy will get substantial air-time this political season. The noise created by this type of public discussion could serve as a catalyst to generate demand for the stock and drive the price higher.
If an investor believes that this could be game changing technology and that growing revenue will one day turn into profits a speculative position in this stock could prove worthwhile in the longer term. If an investor is inclined to take a position, some thoughts about when and how to establish the position are contained below:
- The stock spiked up to a 52 week high of $50 this year. Since then it has moved rapidly down to $30 and closed trading on Monday at $27.45. Prior to the spike, the stock traded in the $20s for most of 2011. With a speculative stock like this it can be challenging to put too much faith in technical analysis but it seems there is some technical support on the charts around $25. If the stock trades down to that level it might be as good as any time to initiate a position.
- When establishing a speculative stock position it sometimes also makes sense to look for option strategies that lower the capital risked while still offering exposure to big upside moves. One possible way to establish a long position in WPRT is to sell the Jan $25 put and buy the Jan $31 call. The bid/asks are fairly wide on these lightly traded options, but on Monday I was able to establish this position for zero out of pocket cost. This type of strategy gives an investor access to any big upside but lowers the cost. In this case, if nothing happens to this stock (i.e. it expires between $25 and $31) then an investor the position expires with no impact on an overall portfolio. According to theoretical option pricing models there is only about a 16% chance of this being the outcome for this trade. Hence, an investor is very likely to end up owning this stock. If bad news emerges, it is not hard to see the stock falling below the $25 strike price and related chart support level. If this occurs the investor will be forced to buy the stock at $25 or my desired entry price from above. If the stock falls further, the position will lose dollar for dollar on any drop below $25. If the stock goes to zero an investor would lose $25 instead of the $27.45 they would lose buying the stock today. If however good news emerges for this stock, there is certainly the potential to see it jump back to its old high of $50. That's the speculative part of the trade. If that happens that option investor will miss out on the first $3 (10%) in movement in the stock, but at $50 the gain would still be a 100% gain on the lower level of capital $25. Further if at any time during the year the stock moves higher, it might be possible to spread some of the downside risk by adding another leg to the position.
Additional disclosure: This posting is for informational, educational and entertainment purposes only and should not be considered investment advice.