Stocks Update, July 17, 2008

It's been a wild week, so I thought it would be a good time for a stocks update. Colonial Bancgroup (CNB) skyrocketed around 50% within three days after I called a bottom in banking stocks, and I recovered my losses and ended up making 10%. JP Morgan upgraded CNB today, causing a 20% jump. It's fun knowing I beat J.P. Morgan to the punch. Too often, investment banks upgrade stocks after an already-large run-up in the price.

I also sold Embarq (EQ), not because I dislike the stock's fundamentals, but because of a potential political problem. Congress questioned EQ about customer privacy. Apparently, some Congressmen believe that EQ covertly tracked users' internet activity. While there have no proven allegations, and EQ deserves the benefit of the doubt, I'm not willing to take the risk of a political fallout, no matter how nice EQ's dividend is.

Pinnacle (PNK), my largest loss in terms of percentage in the "Closed Positions" category, jumped 20% today. I sold earlier because the actual dollar loss was small and the market was being irrational. I don't know if I'd jump back in just yet--the market seems to be indiscriminately devaluing casino and restaurant stocks.

My major positions now are in PFE and CCT, with much smaller amounts in BLV and DBV. Preferred shares took a bath this week. I still can't figure out why. I picked up more CCT as a result.

You'll notice that BLV, DBV and CCT are not listed below in "Open Positions." I bought these stocks prior to publicly disclosing my individual buys and sells, so old positions are "grandfathered" for purposes of this blog. Prior to the recent market lows, I reduced almost all my positions, including mutual funds. Now, I hold no individual position more than 6,000 dollars, not even mutual funds (although one international bond fund will probably exceed 6,000 dollars due to dividend reinvestment).

I also changed the format of the statistics below. I spoke with a friend of mine, who correctly told me the overall averages between categories made no sense, because they valued completely different items. In order to have a proper average, I would have to go through and add up each and every trade and then divide them by the total number of all trades. For now, I am listing averages in each category only. Clearly, my ability to predict the market in the short term is much better than my ability to discern where the market is going long-term.

Numbers below are based on mid-day prices on July 17, 2008.

Open Positions
EWM = -10.84
IF = -11.8
PFE = -4.38

[Average of "Open Positions": losing/negative average 9.0%]

Closed Positions:
Held more than seven days but less than one year (from May 30, 2008):
CNB = +10.0
EQ = -8.83
GE = -6.4
INTC = 0.0 (excluded from averages and overall record calculations)
PNK = -16.7%
PPS = -2.8
WYE = +2.4%

[Overall Record: Lost an average of 3.73%]

Held less than 7 days:
GE (1.0%); ICE (2.0%), MMM (0.5%), MRK (0.1%), PFE (1.3%), SCUR (15%)

[Overall Record: Gained an average of 3.31%]

Daytrades:
PFE = +0.5%
GE = +0.5% (Updated on July 14, 2008; bought at 27.15, sold at 27.30)
XLF = +4.3% (Updated on July 15, 2008)

[Overall Record: Gained an average of 1.76%]

Compare to S&P 500: losing/negative 9.5%
[from May 30, 2008 (1385.67) to mid-day July 17, 2008 (1254)]

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Karachi Exchange

In America, when stocks plunge, we look for a bailout. In Pakistan, they let the market work out the kinks: "Investors have to learn to bear losses as they do gains," says a Pakistani money manager. See

http://www.bloomberg.com/apps/news?pid=20670001&refer=home&sid=a_.8H0oQOemI

One downside of free markets is someone bears the brunt of inequality. Here, the bourse had to call the police to protect it from unhappy investors: "investors broke windows, threw plant holders in the parking lot of the building and at least one protester was injured."

Pakistan's stock market has declined around 30% this year.

Colonial Bancgroup (CNB), July 16, 2008 Earnings

These last few days, I knew exactly how Gordon Gekko felt as he was getting screwed by Bud Fox on the Bluestar deal. Colonial Bancgroup (CNB) kept dropping for no reason, unfounded bankruptcy rumors swirling around it. But now, after a 40% (now around 30%) jump in CNB's price in just two days, having sold most of my position, I hopped in Bud Fox's shoes when he switched sides and worked with Sir Lawrence Wildman. In fact, I am so pumped, if someone gave me Daryl Hannah's phone number right now, I'd make that call, and I'd close the deal.

But wait--people forget Bud Fox didn't exactly have a happy ending. He got greedy and overconfident. That's why, after seeing CNB jump 40%, I sold most of my shares. The earnings release was not terrible--although CNB lost money (five cents a share), the bank still appears to be well-capitalized. The main information I wanted to see was the following: "Foreclosed assets rose by $94 million, bringing bad loans to 2.62 percent of loans and other real estate." A bad loan ratio of 2.62% is still far from the informal 5% threshold that indicates a bank won't be able to pay out a dividend or will need to take active measures to shore up capital.

I will wait until after the ex-dividend date, and then decide whether to hold the remaining shares. For now, however, it's good to be king, having correctly called a short-term bottom in well-capitalized bank stocks.

Colonial Bancgroup (CNB) Update on July 16, 2008

Two days after I called a bottom in CNB (and most other bank stocks), CNB went up over 40%. I sold some of my position, and I am waiting for CNB to release earnings in about 30 minutes. These are exciting, volatile times. I do like being right, and it looks like I was one of the few nationwide to correctly call at least a short term bottom in financial stocks.

For fun, check out Barry Ritholtz's post today titled "Idiots Fiddle While Rome Burns." I'm not saying it's as entertaining (true) as Cramer's famous meltdown on CNBC, but it comes damn close:

http://bigpicture.typepad.com/comments/2008/07/idiots-fiddle-w.html

Even Robert Reich is getting into the act:

http://robertreich.blogspot.com/2008/07/modest-proposal-for-ending-socialized.html

Colonial Bancgroup (CNB) and How to Value a Bank

A reader made a comment to the post below, indicating that CNB might be worse off than its total debt and total cash numbers indicate. He is correct--almost all banks are difficult to value today, because it is almost impossible to determine what percent of the debtors will be able to pay back their loans. The reader pointed me to the following link:

http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=5754137-104895-280327&type=sect&dcn=0001193125-08-037476

He believes that CNB is a risky investment because much of its debt is mortgage-related. Banks hold many different classes of assets--student loans, mortgage loans, small business loans, life insurance policies, home equity lines, and so forth. His analysis relies on an assumption that today, any bank holding significant mortgage-related or property-related loans in markets such as Florida, Nevada, and California will be distressed. I don't dispute that analysis; however, I also do not believe CNB deserves to be trading at 3 dollars a share, even with its risks. CNB will probably not collapse and as a result, five years from now, when property values recover, CNB will be lauded for being in high-growth areas.

In any case, CNB accelerated its earnings release to July 16, 2008. We will have a better idea of where the bank stands tomorrow. I can't imagine CNB would have accelerated its earnings release if there was worse-than-expected news involved, but common sense doesn't always apply in this panicked market.

Colonial Bancgroup (CNB) Recap

One day after calling a bottom in well-capitalized banking stocks, Colonial Bancgroup (CNB) and First Horizon (FHN) increased 16% and 30%, respectively (at least as of 10AM PST on July 15, 2008).

I was able to make a short term trade on XLF as well--I put a limit order to buy last night, and when I woke up, it increased 4.3%, so I sold. I can't do a full stock update just yet, as the market isn't yet closed, and I will wait at least three weeks so I can get a better picture of how my stock picks are doing. In three weeks, most of the major companies will have released earnings.

For now, my main holdings are as follows, in descending order of worth: PFE, INTC, CNB, and DBV.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Colonial Bancgroup (CNB)

Correction Note (on July 15, 2008): an astute reader from Seeking Alpha pointed I was misusing accounting terminology in my posting, namely how debt is characterized on a balance sheet. When a bank makes a loan, it becomes the creditor. As a result, its balance sheet lists the loan/debt as an asset.

In my article, I used Yahoo Finance's "total debt" and "total cash" figures, which do not appear to include loans as "assets." The "total debt" and "total cash" statistics provide some holistic insight into how much a bank might be over-leveraged. At the end of the day, the ability of debtors to pay their debts is paramount, not "total debt" or "total cash," and everyone is currently dealing with bankers' black boxes of credit quality. But I was able to call at least a short-term bottom--both FHN and CNB, jumped by around 30% and 16% (see full day's chart for July 15, 2008), respectively, one day after I called a bottom in well-capitalized banking stocks. My full article, published yesterday, is below:

I am calling a bottom in well-capitalized regional bank stocks. When the New York Times publishes an article titled, "Analysts Say More Banks Will Fail," (by Louise Story) we have a good contrarian indicator. But here's what makes me angry: the reporter cites Richard Bove in her article as support for her thesis that despite being better capitalized in general, more banks will collapse. Take a look at this Nightly Business Report link to an interview with Mr. Bove:

http://www.pbs.org/nbr/site/onair/transcripts/080714c/

He expressly says he believes regional banks are in good condition:

"I think that the regional banks are actually in relatively good condition...I think if you look a year from now, the prices of bank stocks will be considerably higher than they are today."

Of course, he also says it is risky to bet on bank stocks now, in a time of panic, but overall, the clear sentiment is that the overwhelming majority of banks are healthy. The article itself states that 150 out of 7,500 banks might fail--or just 2%.

I have been very disappointed in my own stock picking ability because I bet on Colonial Bancgroup (CNB). While I bought almost all of my shares at under 5 dollars, the market has decided that CNB is worth only 3 dollars a share. I continue to believe I am correct, and the market is being irrational. The question is whether I can stay solvent until the market becomes rational again.

Bank stock financial data are abstruse because they defy normal value analysis. Usually, value investors like myself look at a company's total cash and total debt. My own personal yardstick is to deem a company undervalued if its net cash exceeds 10% of its market capitalization. For example, Intel has a market cap of 108 billion. Therefore, I want its net cash to be at least 10.8 billion before I view it as undervalued. Intel has about 11 billion in net cash, passing my test (I own shares in Intel).

Banks, on the other hand, cannot be analyzed in this way, because they make money through loans. As a result, Shakespeare's advice, "Neither a borrower nor a lender be," doesn't apply. In addition, a bank having more debt does not necessarily denote irresponsible spending. Indeed, as an investor, you want your bank to have more debt, because banks make money by loaning to others, not by keeping their cash. The problem lies in evaluating whether a bank's debt (or, in accounting terms, its assets, because they are technically the creditor) is likely to be repaid by its debtors. As debtors default on loans, they cause an immediate downward spiral: the bank that loaned them money has to stop lending others as much money; perhaps raise the rate on its CDs to attract more money; and take other steps that decrease its ability to take advantage of normal business conditions. What we forget is in a non-panicked world, banks have the easiest job: they get money from the Fed Reserve or their depositors at 2.25%, and then loan out the money at 5.5% or more. They make an automatic 3.25% just for being a middleman. (You can see why online banks are even better--they eliminate the fixed costs of a bank, like its numerous tellers/employees, ATM machines, and physical structures, and just get paid for being a middleman, minus the normal overhead. That's why an online bank like ING can offer higher CD rates.)

Having established that a bank's financial data cannot be analyzed in the same way as a non-bank's, how do we ascertain whether a bank might go under? One informal measure might be to measure the amount of total cash vs. total debt. It's a similar analysis as above, except that in these precarious times, if a bank has too much debt relative to its cash deposits, it is more likely to collapse. All figures are from Yahoo Finance's "Key Statistics" pages as of July 14, 2008:

IndyMac, which has collapsed, had about 2 billion in total cash and 11 billion in debt. That's a 9 billion dollar difference.

Washington Mutual has 15 billion in total cash and 97 billion dollars in total debt. That's an 82 billion dollar difference.

Regions Financial has 5.5 billion in total cash and 29.5 billion in total debt, a 24 billion dollar difference.

M&T Bank, considered to be a healthy, well-capitalized bank, has 2 billion in total cash, and 16.8 billion in total debt, a difference of almost 15 billion.

US Bancorp has 7.3 billion in total cash and 72.6 billion in total debt, a 65.3 billion dollar difference.

Wells Fargo, considered to be a conservative lender, has 25 billion dollars in total cash, and 157 billion dollars in total debt, or a difference of 132 billion. This high level of debt is very surprising. Warren Buffett extolled the virtues of Wells Fargo in a recent annual shareholder letter, and Mr. Buffett is the classic value investor. Wells Fargo might have a high debt load because it didn't sell off its loans to Wall Street and held them on its own books instead, but I am just speculating. As a direct holder of the debt, Wells Fargo can hold it till kingdom come, and would have no external pressure to dump loans at a discount. In some ways, its refusal to spread its risk creates an advantage. (I own some shares in Wells Fargo.)

Now we come to Colonial Bancgroup, or CNB. CNB has 2.5 billion in total cash and 5.3 billion in total debt, a 2.8 billion dollar difference. It has the lowest total debt of any other bank above, and plenty of cash relative to its debt.

Whatever you may think of banks collapsing, CNB probably won't be among them--its debt load just isn't high enough to make a collapse imminent. At 3.36 dollars a share, if you have an iron will, you may want to consider buying 1000 shares and leaving it alone for a while. A prudent investor would probably wait until after July 21, 2008 to buy, because CNB reports earnings on July 21, 2008. I will hold onto my 1100 shares of CNB and be patient--like Wells Fargo, I can wait a long time, but I hope next week brings good tidings and immediate vindication.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.