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Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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  • Carbo Ceramics - Taking A Position With Options

    There was a nice article by Kevin Quon today on Carbo Ceramics (NYSE:CRR) and after reading it I bought a vertical call spread, long the March 2015 40 calls and short the March 2015 45 calls, for a net debit of $3.20.

    Carbo makes ceramic proppants for fracking, and they're getting some pressure by competition from sand. The shares are down seriously, and there is still a very substantial short interest. This in spite of a very strong balance sheet.

    If you count extra cash/current assets above a ratio of 2:1, they have about $11, and no long term debt. When adjusted with this in mind, the forward P/E is about 11.

    I've been here before. I went long on a very similar situation, same stock, back in 2009 and made good money. I played it safe, with a covered combination.

    So with the stock in the $48 area, my full profit of $1.80 is earned if the stock is above $45 at expiration, and my b/e is at $43.20. Both are below the 52 week low, and are prices at which I would be happy to hold the stock long-term and wait for recovery.

    It's always fun to reheat old ideas, particularly successful ones.

    Disclosure: The author is long CRR.

    Tags: CRR
    Nov 17 4:40 PM | Link | 3 Comments
  • Working With PE5

    Early in my investment career I read Ben Graham and picked up on his suggestion to use PE5, and try to buy at a multiple of less than 15. Based on my experience, I've used a PE5 of 20 as a FMV for good quality non-cyclical stocks, and generally closed my positions before the multiple reached 25.

    The thought occurred to me, that I could use Shiller's irrational exuberance data to develop a PE5 for the S&P 500, and I have now done so. I stayed away from the inflation adjustment. Going back to 1987, when the first computerized crash ushered in the current era of investing, the PE5 for the S&P 500 averages 24.4, and currently stands at 24.

    Using Portfolio123, I averaged the PE5 for the 494 S&P 500 stocks which their system was able to compute, and arrived at a value of 28.7. The difference can probably be explained by weighting, or the lack thereof. The very large blue chips trade at low multiples, for the fact they grow slowly.

    I ran a few backtests, and it developed that as far as PE5 goes, higher seems to be better. Used as a sole selection criterion, PE5>25 produced a modest amount of alpha, PE5>30 produced somewhat more. When coupled with the site's Piotroski ranking system, and taking the 20 highest ranked, alpha ran at 5% or 6% for various long periods.

    Piotroski was trying to avoid financially troubled firms. So a high PE5, if you avoid financially troubled outfits, has a good chance of being a profitable investment. As a commenter once remarked on one of my articles, where I was exploring a similar phenomenon, they're high priced for a reason.

    Investment Implications

    Based on PE5, the S&P 500 is at an average multiple. As such, there is no reason to avoid the market. 5 year returns might reasonably be expected to be in the 6% area, consisting of 2% inflation, 2% real GDP growth, and 2% dividends, plus a little financial engineering.

    As far as individual stock selection, this analysis suggests I should be increasing my estimate of the PE5 multiple that would represent FMV for high quality, defined as companies that have little or no risk of getting in trouble financially. Perhaps 22 or 23. Then the exit on price point could be moved up to 27 or 28. The buy below point would be more like 18 or 19.

    Of course there are industries that seem to trade at chronically low PE's, it should be noted that Graham discussed the issue and compared it to dress lengths, how wide is your tie or lapel, etc.

    Nov 13 7:39 PM | Link | Comment!
  • Resisting The Urge To Chase Railroads Higher

    After news that Canadian Pacific made overtures to CSX (NYSE:CSX), railroads have been trading higher. I'm resisting the urge to chase, for the following reasons.

    Regulation

    Railroads are a natural monopoly, and as such naturally subject to regulation in the public interest. We don't want to go back to "All-the traffic-will-bear."

    Railroad regulation got badly out of hand, and the ICC (Interstate Commerce Committee) virtually strangled the industry until it was put to death and replace by the STB (Surface Transportation Bureau).

    But as a natural monopoly the facts of life are, nobody is going to permit the excessive concentration of economic power. It just isn't going to happen.

    Farmers and oilmen are competing for the existing capacity on CSX's lines. There is a bumper crop of grain, and an oil boom going on. The company is valiantly trying to serve these two constituencies, and not meeting expectations. And, shades of The Octopus, farmers will suffer economically as their crops don't get shipped to market timely.

    With that as a background, whatever approvals are required will not be forthcoming. What is coming down is more capex, to meet customer requirements.

    Capex

    I've invested in railroads based on a strategy that focused on companies that were investing in their own growth, either by capex or R&D. That has worked out well. However, prices now reflect the power of the cycle of investment and profit.

    After starting with Norfolk Southern (NYSE:NSC) I moved along to CSX, basically under the rationale to take a turn on something similar.

    The market as a general rule doesn't like capex, a factor that could easily rear its head in the event of a slowdown in the economy leading to a slowdown in rail shipments.

    An Options Strategy

    CSX has been a natural for the covered LEAPS strategy. Here are my trades to date, with the profit that will be earned if the stock stays above $32.50 until the November expiration of the covered call:

    (click to enlarge)

    I'll be happy if called away at $32.50. I don't think the prospects of an acquisition here are worth speculating on.

    Disclosure: The author is long CSX.

    Additional disclosure: As a retail investor, I don't give advice. I blog to expose my investment thinking and process to critical examination and comment by readers, in the hope that we will become better investors.

    Oct 13 11:26 AM | Link | 1 Comment
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