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Chris DeMuth Jr. is the founder of Rangeley Capital LLC. Rangeley is an investment firm that focuses on event driven, value-oriented investment opportunities. Rangeley Capital and his value investing forum, Sifting the World (StW), search the world for misplaced bets. Rangeley exploits them for... More
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  • Taking A Walk With The Sell Side 12 comments
    May 9, 2014 2:13 PM | about stocks: TWGP

    Now... Sit! I said, Sit! [Dog walks away]
    Um, take a walk. Sniff that other dog's butt.
    See? He does exactly what I tell him.

    - Bart Simpson

    We recently established a small long position in Tower Group (NASDAQ:TWGP) debt and equity based on our view that its value to a potential buyer is greater than its market price. Reasonable people can disagree here, but we have confidence that a deal can close this year and that the debt is safe. Furthermore, in the small chance that the current deal price ends up being different than the current $2.50, there is a chance that it is ultimately higher as well as a chance that it is lower.

    One big factor that impacted the stock price over the past week while the companies were working out their merger agreement amendment has been the sell side analysis. Did that analysis make investors money? Did it protect capital? Let us examine the evidence and then think up a potential explanation and reaction for advantage-seeking investors. A (happily hypothetical) history…

    It is early August 2013 and I have $100 to invest. Instead of doing my own work, I throw myself into the warm embrace of sell side coverage. Should I buy shares of TWGP at the prevailing price? Yes! At $22.00 per share, the advice is pretty clear: TheStreet recently upgraded the stock to a buy as did Sidoti. FBR said Outperform. Compass Point: buy. KBR recommended that we hold onto our shares. Each of the analysts covering the stock boosted price targets to the $20s as the stock hit new highs. I'm all in. I put my $100 in TWGP shares. But it is a rough August! I'm down to $64.23. What should I do now? I am barraged with the following advice: down from buy buy buy to neutral neutral neutral. Okay, so not exactly a stirring battle plan, but I'm already in so I'll stay neutral and see how this plays out. The rest of the year is pretty rough, too.

    I'm getting a bit nervous, but waiting for the sell side to show me a sign that I should change tactics. With the stock price down to around $3 per share, I make it to the New Year with $14.45 worth of stock. Finally a bold actionable call: an underperform rating and a $1.50 price target on May 6, 2014. Quickly following this new view, I sell my entire position and short TWGP by the end of the very next trading day. Now I'm short $7.86 of TWGP waiting for it to collapse to $1.50. Ugh, that was a rough Thursday, with a new deal priced at $2.50. But I am in it to win it and am ready for some direction in terms of what I should do with my $5 to invest? Hang in there on the short side? Nope! Now, there is a newly upgraded TWGP rating with a fresh $2.50 price target. I'm covering and back in, long $5 of TWGP awaiting my $2.50… unless the stock price changes and thus requires a new target.

    The best way to think about sell side research is that it is 100% banking marketing. This type of research has the sole purpose of showing companies how a given investment bank could hype their securities in the primary market. If there is a secondary purpose, it would be to generate trading commissions for the bank's trading desk. If you are awaiting where "sensible investment ideas for you" come in the list of priorities… then keep waiting. Where are sell side analysts least curious about the investment opportunity? When a company is in distress and when it is the target of a merger, thus minimizing the chance of future banking business from that company. I frequently receive sell side reports indicating, "suspending coverage due to x". X is typically a reason why the price is uncertain - a delay in SEC filings, a potential corporate transaction, or distress. That is the time when the price is least likely to be correct, the time to go to work, not a time to vote "present".

    One tactic is to seek out the very situations that sell siders ignore or avoid. When they quit, then start to hit the (company's) books. What is the intrinsic value and what are the reasonably likely probabilities of the weighted outcomes? I try to find out. I make my own mistakes and given the alternative of following the sell side, you should too.

    Disclosure: I am long TWGP.

    Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital, a partnership that invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our partners, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.

    Stocks: TWGP
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Comments (12)
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  • drew111
    , contributor
    Comments (514) | Send Message
    Great advice! At a great price no less. Along the same lines, I remember Peter Lynch providing a similar view in his 1st book. He cited an analyst he worked with that didn't even bother to check his (the analyst) math or proof read his work. The analyst actually published eps estimates that were off by a factor of ten(a very simple and correctable decimal place error). Lynch even pointed this out to him prior to publication and the analyst was too lazy to change it. Just as you said, most of the sell-side cannot be trusted...


    Ref TWGP, I was intrigued by that price collapse to 1.70. Having previously done my due diligence and passing on the opportunity because the MOS was not quite adequate when all risks were considered, I felt that at a buck seventy the MOS was more than adequate. Put a bid in that night, after the close, at 1.71. As luck would have it, it blew through my bid the following morning. My order was not filled, obviously. I feel vindicated that my contrarian bet would have paid off, which is some consolation. Make no mistake, I would have preferred the 30+% gain in less than 24 hours!
    9 May 2014, 05:23 PM Reply Like
  • PaulParsoneault
    , contributor
    Comments (18) | Send Message
    Thanks for enlightening me. I have a small position with a cost basis of $2.55. I am hanging in, hoping for a better offer.
    10 May 2014, 07:26 AM Reply Like
  • tuliptown
    , contributor
    Comments (1566) | Send Message
    Chris, in most industries performance is tracked and rewards provided to the best. Why not sell side analysts?


    The NFL draft is a great and recent example of pay for performance. I am sure your hedge fund publishes results and expects market beating results to pull in more funds to invest. The only other industry I can think of that ignores accuracy is meteorologists. I guess the real question is can a guy find analysts with good track records?
    10 May 2014, 09:36 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (11728) | Send Message
    Author’s reply » Good question; there are a few highly specialized analysts who follow short ideas, litigation, accounting, and microcaps, but each charges for their research.
    10 May 2014, 10:38 AM Reply Like
  • User 447425
    , contributor
    Comments (1753) | Send Message
    AM Best Downgraded to C++, not good!
    10 May 2014, 11:37 AM Reply Like
  • connellybarnes
    , contributor
    Comments (557) | Send Message
    I once sat next to an analyst on an airplane.


    Me: "My hobby is investing."


    Analyst: "Do you use analysts' reports?"


    Me: "No, I get a few ideas from SeekingAlpha but mostly find my own ideas."


    Analyst: "SeekingAlpha are random people on the Internet who are not necessarily professional. Doesn't that worry you?"


    Me: "I don't care about their accuracy. I just learn about businesses."


    Analyst: "[Marketing for analysts]. We have this guy Gene Munster at our company who predicted Apple at $1000!"


    Me: "Never heard of him. I've read the science on analysts. They tend to not predict prices accurately, but I'm curious, why are they typically over-optimistic?"


    Analyst: "Well you have to excited about an industry to cover it! And then clients have to be interested also!"


    Me: (Thinking) Aha, I finally understand the pricing of 3D printing companies.
    10 May 2014, 05:30 PM Reply Like
  • Pine Research & Trading
    , contributor
    Comments (164) | Send Message
    David Merkel wrote a piece on this at the end of March. I think it is worth looking at regardless of one's position and point of view.


    I think pretty highly of his writing in general. I have no axe to grind with TWGP: no position and no opinion. I began to get involved and then read the article and realized I would not be able to make a good enough decision on my own without more preparation than I could afford to put into it.
    10 May 2014, 06:23 PM Reply Like
  • Ted Jipang
    , contributor
    Comments (14) | Send Message


    I do not realy understand the Market Viewpoint and Environment,
    I wonder,If you could tell me about
    How long are you going to having your TWGP?
    Now,I am still NO position and have a few target stocks.


    We have 3 chices,which are Buy & Sell & NO positioning.


    Just waiting for・・・・・・・・・・・・・・・


    Am I chicken?
    11 May 2014, 12:37 PM Reply Like
  • TimeOnTarget
    , contributor
    Comments (3679) | Send Message
    Chris --


    "The best way to think about sell side research is that it is 100% banking marketing."


    Finally, something that makes sense!


    I rarely bother to read sell-side analysts, but I do see the articles about them upping and lowering their target prices (and you gave a beautiful example--a remarkably representative example).


    When I see some of their calls, I am reminded of the old Saturday Night Live Skit: What WAS he thinking???
    They would give different examples, then follow up with the question. One was "Michael Dukakis: Vote for me and I will raise taxes. What WAS he thinking???"
    12 May 2014, 12:16 PM Reply Like
  • bazooooka
    , contributor
    Comments (3688) | Send Message


    Do you still like TWGP?
    8 Apr 2015, 04:01 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (11728) | Send Message
    Author’s reply » bazooooka, I like the memory of TWGP but it was acquired in an all-cash deal.
    8 Apr 2015, 04:04 PM Reply Like
  • bazooooka
    , contributor
    Comments (3688) | Send Message
    =) I see; I got my "tower"s mixed up. Please keep em coming.
    8 Apr 2015, 04:06 PM Reply Like
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