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Having invested in the equity and futures markets for over ten years and having successfully lived through several major market crashes, I confess a long-term value approach to picking up stocks and high reward-to-risk futures options strategies.
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High Odds Investing Strategies
  • Shrinking Supply And Recent Heavy Long Liquidation Selling Inflate Live Cattle Puts

    Like in most commodity markets the price in the long-term is defined by supply and demand. Though trend following funds and large speculators present a force, to be reckoned with, that could make the price go right in the opposite direction, it's mainly a short-lived one. It's basically the two main economic forces that define the price level - supply and demand.

    A sharp drop in beef production for 2013, especially during the second-third quarters, makes the long-term fundamentals extremely bullish, especially for the late spring and early summer. With huge cattle herd liquidation during the last couple of years, cattle prices are at the lowest levels since 1952 and most US plants are operating at far from full capacity. First quarter beef production in 2013 is expected to be 400 million pounds below the fourth quarter of 2012 -second largest drop on record which equals to a drop of over 200 million pounds from last year. The USDA forecasts 3-d quarter production at 6.30 million pounds, lowest in 20 years.

    (click to enlarge)

    What make the situation even more enticing for us is that overbought market conditions and near perfect weather combined with cattle feedlots, dealing with the backlog of herds from the slow holiday slaughter schedule, pushed the April live cattle futures price sharply lower last week.

    Recent flu epidemic also pressured the prices, as traders fear that people will panic and go much less to restaurants and this would shrink demand for beef. Speculators were aggressive sellers yesterday, sparked by the news of a plant closure in Texas. The plant is set to close on February 1st due to tightening supply problems and has a capacity of over 4,500 head daily. Industry analysts see the break in price as an overreaction to the news as other plants will be able to absorb the cattle for slaughter. Actually, the cattle market needs to see less slaughter capacity with such tightening supply levels.

    Open interest was down near 21,900 during the last week, which suggests that a short-term long-liquidation downtrend is nearing a bottom with short-term excess supply levels cleaning up. Cold and wet weather could also provide some support. The recent Commitment of Traders (COT) report showed a net long of over 47,500 contracts, pretty far from the record of 116,518 contracts in 2010. This tips the scale to the bull side in the long-term.

    The Cattle-on-Feed December 2012 supply was just 11.3 million head, which is down 6% from last year.

    The Cattle-on-Feed report is produced by the U.S. Agriculture Department, USDA for short, that details the number of cattle being placed in feedlots as a precursor to going to market. Three stages of getting cattle to market are detailed by the report:

    1. The first is placements, which are cattle that are taken out of pastures, where they eat grass, and put on corn to start gaining weight.
    2. The second stage is cattle on feed, which is the number of cattle that are eating corn to gain weight in preparation for slaughter; the corn may be mixed with some extra protein, such as soymeal.
    3. The third stage is the number of marketed cattle, which are cattle that have been sent to slaughter.

    The cattle-on-feed report is stated in percentage terms compared to the previous year.

    (click to enlarge)

    We don't know if the price will go up and reach 140.00-145.00 for June Live Cattle Futures. But there's a very good possibility that with such extreme bullish fundamentals the prices won't go any lower.

    Consider selling 120.00 April Live Cattle Puts at $150 for contract. Conservative traders may wait for the technical low on the charts. We think, even if the cattle price falls further down, it wouldn't push the puts premium too much, since it's already inflated to very high levels. So it's quite safe to sell the puts now. This is a very high odds option selling strategy for the next 2-3 months.

    Aggressive traders can also take half the premium of puts sold and buy 140.00 June Live Cattle Calls. If the cattle futures would go to 140.00 level during the next couple of months, they would be able to make even more profit.

    (click to enlarge)

    Jan 21 10:12 AM | Link | Comment!
  • #2 Value Investing Rule. Buy Stocks Having The Lowest Price/Earnings (P/E) Ratio.

    With today's equity markets being modestly overvalued, it's quite an ordeal to find stocks of well-established large cap companies with price/earnings ratio lower than 10, needless to say about leaders in the tech industry, which are trading at stratospheric price to earnings multiples and are extremely overvalued. Though out there still exist pearls waiting to be discovered. Even good companies sometimes are trading at low P/E for many reasons. It could be some unexpected bad news, prolonged litigation, a temporary stream of bad luck in the recent past, deadbeat borrowers or a scamper manager.

    Though, I wouldn't be enticed by the only fact of low P/E, because the company shares might be plunging for a reason. I would choose only a reliable company, having a good track record over at least seven years back. Another desirable factor is a growth potential of the earnings. Out of two firms with the same price to earnings I would chose the one whose earnings are expected to grow. This improves both the return on capital future perspective and partially lowers the risk of the investment (higher margin of safety). In other words, by picking up stocks with price close or lower their intrinsic value and high future growth potential you kill two birds with one stone.

    Here also might belong stocks with high dividend yields or low price to cash flow, as likely winners. I would define the cash flow here in a nutshell as - earnings plus depreciation costs. The companies with above average dividend yields often retain earnings, thereafter reinvested in the business, which increases shareholders' equity capital and ultimately the market price of its shares. In best cases, shrewd managers buy back the company's shares and reduce its long-term debt.

    Only an astute investor must keep an eye on this retained earnings reinvestment process, since some companies might abuse the investors money by making expensive an unprofitable acquisitions.

    Stocks with low P/E are often accompanied by low price to book (P/B) ratios, as compared to other companies in the same market niche. These stocks are also often undervalued in relation to appraisal of the value of the company assets if the entire company was for sale.

    The study of NYSE 500 stocks from 1957 through 1971 shows that $1,000,000 invested in stocks with lowest P/E during those 14 years would have turned into over eight million dollars.

    The founder of value investing, Benjamin Graham, recommended to pick up stocks whose earnings yield was 200% of the yield on AAA bonds and hold them up to two years or until there price appreciates to at least 50%, whichever comes first. A study conducted in 1974 through 1980 on New York and AMEX stocks, selected according Graham criteria, showed an annualized return of up to 38%!

    When choosing stocks with lowest P/E, it is interesting to note that small cap companies ( listed on the NYSE), according to some studies, produced much larger returns than those of large caps with the same lowest price/earnings ratio. During the seventeen year time frame, one million invested in small caps produced up to nineteen million, as compared to just eight million returned by stocks of large caps during the same period. The same money invested in the major market indexes would return only about three million dollars.

    Low P/E Stocks, as time shows, proved to yield sizeable excess returns net of transaction expenses.

    Needless to say, that lowest price to earnings stocks, with all other value selecting rules being complied with, add considerably to investor's margin of safety.

    Sep 10 4:25 AM | Link | Comment!
  • #1 Value Investing Rule. Buy Stocks At Less Than Company's Net Working Capital

    The founders of value investing, Graham and Dodd, recommended that investors purchase stocks trading for less than two-thirds of the company's

    net working capital (working capital = current assets-current liabilities) or net current assets

    , which is the working capital less all other liabilities. Many stocks fit these criteria during the Great Depression in 1929-1932, but unfortunately far fewer today.

    Net current assets are defined as cash and other assets which can be turned into cash within one year, such as cash, accounts receivable and inventory, less all liabilities and claims senior to a company's common stock (current liabilities, long-term debt, preferred stock, unfunded pension liabilities).

    Net current assets are an approximate measure of the estimated liquidation value of a company, but with no value ascribed to the company's property, plant, equipment etc. For most of today's companies, the valuation of intrinsic value will be significantly in excess of net current asset value.

    For example if current company's assets are estimated at $100 per share, and all current liabilities + long term debt + preferred stock + bonds equal to 30 per share, the net current assets or net working capital would be $70 per share.

    $70 - 66% = $46.2

    So, if we buy this stock at or less than $46, we'll have a pretty good margin of safety. The Graham-Newman Corporation managed by Ben Graham did a nice 20% yearly return during 30 years.

    Though abundant in Benjamin Graham and later in Warren Buffet era during the post war economic boom, at present day stocks, trading at 66% of net current assets or less, are few and when uncovered, they often belong to very illiquid micro-capitalization companies (under $50 millions) that can accommodate only modest levels of investment. But from time to time they turn up.

    Stocks with Low Price in Relation to Book Value

    Stocks with a low price-to-book ratio had noticeably better returns over the 18-year period than stocks priced high to their book value. It was also noticed that stocks, which had performed poorly for some years, subsequently increased up to 40% more than the major market indexes afterwards.

    Another interesting thing was that, companies with the lowest price-to-book ratio experienced a significant decline in earnings, while companies of highest price-to-book ratio value experienced a significant increase in earnings.

    Small Market Capitalization Companies with Low Price-to-Book ratio vs. Large Caps.

    It turned out that smaller market capitalization companies at the lowest prices in relation to book value provided the best returns over large caps. The analysts conclusion was that, price-to-book value "is consistently the most powerful for explaining the cross-section of average stock returns."

    Low Price-to-Book Value Companies Consistency of Returns vs. High Price-to-Book Value Companies

    The lowest price-to-book value shares, as time shows, outperformed the highest price-to-book value stocks in 16 of the 22 years, or 73% of the time. As for three-year holding periods, the low price-to-book companies beat high price-to-book companies in 18 out of the 20 three-year periods. The five-year holding periods performed even better.

    Are Low Price-to-Book Value Stocks' Higher Returns associated with Higher Risk?

    The research showed that stocks with lower price to book ratio don't have anything to do with the increased risk for investors.

    Out of 1000 stocks of large capitalization companies examined from 1979 through 1995, low price/earnings and low price-to-book value strategies resulted in sizeable excess returns net of transaction costs and after adjusting for risk.

    Sep 07 10:46 AM | Link | Comment!
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