Tuesday, March 31, 2009

OCD Stock Pick #3: TLK

This is the third in a series of stock picks for the stock pickers suffering from OCD who MUST go long in the world's most dangerous bear market...

As an OCD investor, to protect yourself from your ways, your only chance is purchasing at the correct time. In this time of economic turmoil, for an investor, OCD or otherwise, not to demand a discount due to unforeseen events is reckless.

Thus the author recommends previous pick that can be recycled for the OCD amongst us.

The author previously bought at $20.12 on November 20th, 2008 and recently sold at $26.55. Since that time, there is absolutely no significant news related to the company, positive or negative. The stock has risen and fallen with general market swings.

In the previous analysis the risk factors were the following:

1) Global market conditions
2) Currency risk

Since that time the IDR (Indonesian Rupiah) has actually strengthend 5% versus the USD. The oil prices have stablized, which probably provides a significant amount of support for the IDR.

The author recommends buying TLK again at a value discount of $19/share (9.34B market cap) and 11.1x FY2008 cashflow. (9.34B / .84B = 11.1)

Monday, March 30, 2009

OCD Stock Pick #2: ICE

This is the second in a series of stock picks for the stock pickers suffering from OCD who MUST go long in the world's most dangerous bear market...

The Intercontinental Exchange is a futures exchange regulated by the New York Federal Reserve that intends to become the premier clearinghouse for credit default swaps. Thus as unregulated insurance contracts decimate the financial landscape, the investor can benefit from the push to bring to transparency to this bidding process. ICE is even owned by a few of the major CDS brokers (i.e. JP Morgan and Goldman Sachs) giving it instant leverage in this new market.

Over the course of the year, there will be steady increase in business as the new regulatory framework is created for this financial instrument. Regardless of the red tape, there are huge market drivers pushing for CDS to be handled in the open market. First of all, no other instrument is available to hedge a fixed income instrument as credit default swaps. Considering the amount of fixed income securities outstanding the need for big banks to mitigate risk, the institution of this marketplace is a win-win for business and government.

With revenue growth near 50% YOY, ICE is benefiting from increased electronic trading. Even at this early stage for the market, ICE produces a free cashflow of $250m annually on 800m in revenue. The company holds net long term debt of only $300m after backing out $12B of cash and $12B of maturing liabilities.

In previous markets, this stock would be evaluated based on it’s growth potential at a high P/E ratio. The OCD investor needs to be defensive in their investment to receive desired feedback loop, thus purchase price needs to be evaluated as a measure of cashflow growth. ICE cashflow growth has been decelerating over the past few years from 60% growth from 2006 to 2007, and 25% from 2007 to 2008. Assuming only a 10% increase in cashflow growth this year, valuing ICE at 11x FY2009 cashflow yields a $3.6B market cap. Based on the market cap today of $5.4B at ($75/share), the OCD investor should place an order for ICE at $50/share. This price is also at technical support point and thus provides a likelihood for being executed and providing immediate positive feedback.

OCD Stock Pick #1: ADP

This is the first in a series of stock picks for the stock pickers suffering from OCD who MUST go long in the world's most dangerous bear market...

ADP is a payroll processor with long standing relationships and an excellent business track record. With the downgrade of GM, ADP is one of the only four industrial companies retaining AAA credit rating. The company generates $1.2B in annual profit and $1.5B in free cash flow with a $18B market cap ($36/share). Due to the high cashflow, the 3.6% yield is safe assuming no cataclysmic economic events occur.

ADP is a company that can be called “an original outsource outfit”. Companies often hand over their payroll responsibilities to ADP to make sure their employees are paid appropriately and on time. Therefore growth of the payroll business is directly correlated to the amount of people employed across industries. Considering the downside risks to the economy, a healthy margin of safety is necessary to avoid having an autistic tantrum if market turmoil makes this sleepy stock more volatile than what you are looking for.

The author recommends that those suffering from OCD to buy the stock at 12x a deep recession level free cash flow of $1.1B/year, producing a 13.2B market capitalization or $26/share.

Stocks for OCD investors

Stocks for those with Obsessive-compulsive disorder (OCD).

OCD, according to Wikipedia, is a mental disorder characterized by intrusive thoughts resulting in compulsive behaviors and mental acts that the person feels driven to perform, according to rules that must be applied rigidly, aimed at reducing anxiety by preventing some imagined dreaded event.”

Most people I know who invest in the stock market demonstrate the behaviors of obsessive-compulsive disorder.

The conversation between them and a ‘normal’ person goes something like this…

“Rough Market, eh?”

“Rough market” I reply.

“I bought XYZ at the last dip. I am upset. It went up a little but now it is lower than before I bought it. I am thinking of getting out.”

“Sure, definitely more downside possible.” I say.

“There could be some more downside, what do you think?” clearly nervous about the short term prospects.

“Sure, has been accelerating the unwind of the world’s previously biggest car company, previously biggest bank by assets under management, and biggest private insurer. I think that could cause more downside to the market.”

“What are you looking at buying?” OCD person asks.

Blank stare response.

The financial media, mutual funds, and maybe our mothers have conditioned us as investors to obsessively search for the next buy and hold opportunity. Millions of investors across the globe, like slaves to the financial system, scour the markets for the perfectly controlled positive feedback loop. Their stock purchase may come from a broker report, or a tip, or maybe individual research. They buy 100 shares of stock and if it goes up, then they buy 100 more. Then, if the stock goes up again, they repeat the cycle. If the stock goes down, they panic and exit. No entrance strategy, no exit strategy, and very edgy on the trigger.

Thus it is no wonder why so many people get so angry during bear markets. The behavior of the market is not meeting their expectations for a positive feedback loop, frustrating the desire of the regular fix to satisfy their obsessive compulsive desire for control of their environment.

The author does not recommend going long with a traditional buy and hold at this point. But lots of stock market investors just cannot wrap their mind around shorting or waiting for the demise of the automakers and most of the financials.

So as a community service for those with OCD who have no plans for correcting this portfolio- debilitating disorder, the author has chosen a series of stocks that should best benefit from current market conditions. Thus to address the impaired amongst us, I will recommend a few stocks, if purchased with a measure of discipline, that should provide a controlled positive feedback more often than not over the next year.

Author note: This post is not meant to insult those with Obsessive Compulsive Disorder but intended to insult those without the disorder who still mimic the traits in the stock market.

Author note #2: Stocks chosen for the OCD portfolio will not be included in the authors performance tracking because of the high risk of going long in the current market.

Wednesday, March 4, 2009

JP Morgan - Counting AIG Bailout Money as a Profit

If you are worried about where your TARP or any other bailout money is going, this press article on JP Morgan may provide a hint.

The opening of the article leaves out one huge product segment of the Fixed Income Derivatives product group, Credit Default Swaps (CDS). In fact this is a huge oversight, the OCC source shows that banks have a 87T OTC derivative exposure which includes fixed income derivatives and states that of the 16.1T of outstanding credit derivatives 99% are CDS. Why did Bloomberg not come out and be forthright about 20% of the derivatives market?

Moreover, over 40% of reported trading revenues derived from this segment of the derivatives market.

The bailout money for AIG CDS positions no sooner hit AIG's account before it was transferred to AIG's counterparties to settle collateral requirements for it's positions. With AIG posting $60B losses from CDS in the last quarter, there had to be someone on the other side of those trades who would claim a commeasurate gain.

As of Q3 of 2008, according to the Office of the Controller of the Currency (OCC), there are only 5 major CDS brokers amongst the US banks who hold 87% of the outstanding notional credit exposure. JP Morgan is largest one of those five.

Thus when the government provided $60B capital to AIG in order to meet collateral requirements for it’s counterparty positions, one can infer that the ultimate recipient was JP Morgan, and other major CDS dealers. This is the fallacy of the whole market. The government is providing AIG with funds not just to keep AIG afloat, but to support all of AIG’s counterparties from the systemic risk of not getting paid. But in providing this liquidity, the government is allowing JP Morgan to mark profits from bailout money originating at another firm while they hold on to the TARP money they received from the government.

What is to be learned from this? The systemic risk of the “Shadow Banking System” is being balanced by the US taxpayer. But it is not being communicated how many counterparties are also being saved by the single bailout of AIG and other major lenders. What astounds is that the market makers continue to perform solid business in the very instruments that could at any moment cause their demise if the government withdrew it’s support of the losing counterparties. This evidence underscores how dysfunctional the whole banking system is currently and how much more needs to be done to wean the banks with most CDS exposure from government funded settlements.

The author is long puts in JP Morgan.