Two Stocks I Like - Oil and Gas Industry

When it comes to stocks, I’m of the Peter Lynch School, which says that you shouldn’t purchase a stock unless you can, a) rationalize your purchase in few sentences, and b) draw what the company does with a crayon. These companies fit the bill.

I have no idea whether these stocks will go up or down in the next 6 hours, days, or weeks, and don’t know anyone who does. My intention is to hold them (I own both) until at least the peak of the next market cycle, or until the company proves to be something other than what I thought (for example, the dreaded words, “accounting irregularities.”)

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Tidewater (TDW) – Tidewater is an offshore oil and gas drilling support-company that owns a fleet including 126 new vessels, making it one of the youngest fleets in the industry. Its ships have low downtime and an excellent safety record. The company has almost no debt, great return on equity, and the stock price is cheap – single digit P/E and close to book value. The company has been buying back shares.

Because Tidewater’s worldwide fleet is mobile, they can sail to wherever the work is. This company is also a manly man stock, with photos of oceangoing vessels all over the annual reports. While this latter point isn’t actually a reason to buy, I enjoy it nonetheless.

Barack Obama recently expressed an interest to expand offshore drilling in the United States: this is not a sufficient reason to buy Tidewater. Buy a stock because the company is great -- not because of a politician, the weather, interest rates, or any other transitory reason.

TDW Statistics (as of writing):
Price $46.81
P/E 6.67
Return on Equity 16.75%
Dividend Yield 2.12%

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Chevron (CVX) – one of the world’s largest and most recognizable energy companies. Chevron owns assets worldwide including Australian natural gas, Canadian oil sands, offshore sites in Brazil, and sites in Nigeria, Kazakhstan, and Tahiti, amongst others.

Recently, Chevron announced that its earnings had declined due to losses from weak refining prices in 2009: something I believe is unlikely to be repeated in the foreseeable future. Chevron’s debt level is low (lower than most energy companies), it has actively been buying back shares, the stock is reasonably priced, and its return on equity is excellent. In addition, its international operations help prevent currency shock.

CVX Statistics (as of writing):
Price $72.80
P/E 11.83
Return on Equity 13.86%
Dividend Yield 3.69%

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Disclosure
Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

“Reverse Attribution” – What the News Doesn’t Know

On Jan 21st 2010, President Barack Obama announced that he would limit the amount of “gambling” (i.e. high-risk leveraged trading) that banks would be allowed to do using client money. Traders worried that as a result of this announcement, future bank earnings may not be as high as they’d anticipated, and so stocks dropped. Pretty straightforward, isn’t it? Not really. Investors should be aware that the market is understood via “reverse attribution” (also known as “post hoc ergo propter hoc”). That is, after a market event has occurred, analysts try to determine why it happened and report it as news. In reality, there are limitless reasons for market moves: some simple, some complex, and others masterfully planned.

In 1929, millionaire trader Jesse Livermore sensed a change in the public. After weeks and months of positive news, he sensed that people were getting bored with the “prosperity” story. Livermore knew that a well-known economist, Roger Babson, was going to give a speech the following day, saying that markets were overpriced and due for a crash. Livermore knew that this would be the speech because it was the same speech that Babson had given the previous two years! Recognizing the opportunity, Livermore sold short vast quantities of stock (meaning that he would make a profit if the market declined), and then had his staff of secretaries call every major new agency in the U.S. and alert them to an “important speech” that was about to take place. When the press conference took place, it took place to a packed crowd of eager reporters. The following day, Babson’s dire predictions made front-page headlines, and the market took a frightening dive. This was the beginning of the end for investor confidence in 1929. The infamous” great crash” occurred less than two months later, with many blaming Livermore’s orchestrated press conference as the catalyst that started it.

The market decline that began on Jan 21st 2010 may have been caused by Barack Obama’s pronouncement, as explained in the opening paragraph. Or, it may have been caused by opportunistic traders. For weeks prior, traders had been saying that the market had gone too high and was due for a correction. These traders, upon hearing Obama’s speech -- and seizing the opportunity -- started short-selling bank stocks like mad. The short-selling led to anxiety on the trading floor, causing stocks to drop further. George Soros calls this “reflexivity”: that cause and effect make things that were not previously a reality, a reality. Or, I could be completely wrong, and it could be that a wealthy Arab, for no particular reason whatsoever, decided to sell his bank stocks that day.

A few years ago, a mutual fund manager told me the story of when his mutual fund decided to sell a certain company’s stock. The day they started selling just happened to coincide with an announcement by the same company, saying that they were changing some of their board members. The next days’ headline: “X company stock drops after appointment of new board members: investors not pleased with changes.”

In the book Wall Street Meat, Andy Kessler tells the story of a German banker who decided to have some fun at the bank’s annual Christmas party. The inebriated banker called in a buy order for a massive number of shares in pharmaceutical company Eli Lilly. As the whole party watched the computer monitor in anticipation, the share price ticked higher and higher and higher due to the onslaught from the huge order. When the Dow Jones newswire reported “heavy buying” by a foreign investor, the partygoers screamed with delight. Finally, the New York Stock Exchange halted the buying on rumors that this was a takeover attempt. Disappointed that the fun was over, the partygoers went back to their steins and punchbowls to continue their Christmas celebration. The following morning the large purchase was quietly sold off.

When news agencies simply have no idea why markets are moving, they employ common expressions, most notably “profit taking” (to describe a drop) and “bargain hunting” (to describe a gain). For instance, “the markets went up today on bargain hunting,” is a convenient way to describe an increase in the market on a day with no substantial news. “Profit taking” and “bargain hunting” are your clues that in fact no one has a clue.

On any given day, no one knows exactly why stocks move. Sometimes guesses are (probably) accurate. Sometimes they are dead wrong. Sometimes they cite a single reason when in fact there are several. It’s up to you to dig further than people watching from their sofas. It’s up to you to know that sometimes people manipulate the market for fun or for personal gain, even if it kills grandmother’s retirement plans.

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“Heavy selling out of the Middle East was an old standby. Since no one ever had any clue what the Arabs were doing with their money or why, no story involving Arabs could ever be disputed.” Michael Lewis, Liar’s Poker.

Barack’s Reforms make Big Banks Cry

Being that I own hordes of bank stocks in my personal portfolio -- and that I work for one -- you might expect me to decry President Obama’s recent pronouncement that big banks will no longer be allowed to engage in certain high-risk trading. On the contrary, I think it’s a perfectly acceptable idea, one that Wall St. professionals have known the practicality of for years.

In 1987, when markets crashed and big banks were “saved,” many thought that this set a dangerous precedent. It was believed that banks, confident that they would be bailed out no matter what their level of gambling, would start acting like hedge funds and go for broke. And they did.

So, while I am dismayed that my annual investment returns may decline a few points due to the proposed changes, I am also grateful that I won’t come back from the bathroom to find my stocks down 80%. In short, I expect my U.S. bank stocks to become more like the banks themselves: large, boring, and immensely profitable.
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“If we bail out this one (Penn Square Bank)…then the markets will know that, no matter what risks they take, the government will bail them out. Eventually, it’s going to lead down the road to nationalization of the banking system.” William Isaac, FDIC chairman, July 1982.
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“CMO equity is a particularly slippery mortgage investment. The CMO stands for Collateralized Mortgage Obligation, but bond salesmen call it ‘toxic waste.’” Michael Lewis, The Money Culture
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“I would confidently predict that most of the derivative books of major banks cannot be liquidated for anything like what they’re carried on the books at. When the denouement will happen and how severe it will be, I don’t know. But I fear the consequences could be fearsome.” Charlie Munger, Poor Charlie’s Almanac, 2005
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