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February 2008



Bellard's top 20 cash flow stocks for 2008

February 26, 2008 – Comments (8)

I have finally finished my top 100 cash flow stock list. I will show the top 20 here. As I discussed in my first post, After this list is screened, compiled, researched, etc. the real work has just started. Each equity on this list must be researched in detail. These are some of the steps I take:

1) Read the past 2 years quarterly results and 10-Q's.
2) Listen to all the investor presentations, and conference calls, verifying the above guidance for the the above earnings.
3) Research the sector.
4) Google news - all articles in the past year for company name.

Once again I will warn investors of catching a falling knife. Many of my top 20 DCF stocks, landed there mainly due to HUGE stock price declines. In my experience, these unloved stocks create the best opportunities of above average appreciation for the value long term investor.

My list if fairly diverse, but overweight energy stocks(6 of the 20). There is no order in the top 20, as I use 5 different cash flow metrics - so depending on the individual metric the ordering is different. I will list the stock, its original price for inclusion in my list, there current stock price, and my current DCF valuation.

Stock         Original price         Current price         DCF value
1)  ETFC             2.5                   4.75                      16
2)  ZINC              13                    16.6                      35
3)  ACAS            29                    36                         85
4)  PGH              16                    18.5                      26
5)  CHK               37                    45                        60
6)  IPSU              18                    19                        40
7)  MEOH            23                    26                        80
8)  BVF               12.5                 13.5                      65
9)  RFMD              3                     3.25                     11
10) E                   60                    68                       155
11) VPHM              9                     9                         24
12) TNE                20                   25                         60
13) AE                  23                   25                         44
14) EME               20                   24                         50
15) TEX                 52                   66                       170
16) MTW               40                   41                       110
17) PDS                18                   22                         50
18) PDC                13                   13.5                      24
19) SPIL                 8                      8                        22
20) RS                  46                    55                       110                [more]



Fear, greed and loathing in Las Vegas - The US economy; then and now.

February 21, 2008 – Comments (12)

I have always been very interested in economics. The interpretation of the behavior of millions of individuals all making decisions simultaneously is fascinating. Macroeconomics is incredibly complex, but if we can see some trends, above average returns are possible. First I will present my interpretation of how we have arrived at today's economy.

Las Vegas - circa 2004

I visit LV many time every year. I only live a few hours away, so the drive is quite pleasant. You would not believe my reasons for visiting sin city, but let us not digress. Sometime in 2004, I was having dinner at a PF Changs. I always go right to the bar since I hate waiting to eat, and I meet some real characters while dinning. On this particular evening, there were 3 young kids(anyone below 30 get my KID moniker) eating and drinking next me. They were all boasting of there latest real estate deals and profits. As a former slum lord, Having bought and sold over 30 properties, I was keenly interested in there discussions.

Not to my surprise, they were very willing to tell me about there recent killings in the LV real estate market. These young Turks were buying several new homes at the same time, then flipping within a few months for 50-75K profits per home. These guy were fun, and I enjoyed our conversations. I have found that ground level info on the economy is very valuable - our government should try this approach. On my drive into the desert, I dismissed there claims as just some lying, and one upping each other.

Las Vegas - circa 2005 - 2006

I'm back in Vegas baby! At PF Changs, at the same bar. The bar is packed - in fact LV is packed and vibrant. I can't believe the amount of desert being scrapped for more ugly boxes - this can not continue I scream! I am wrong - at the PF's bar I meet more 20 somethings and everyone is talking real estate. Everyone is a flipper and dealer - Can everyone be lying? I start to investigate. I am not surprised to find people buying more than one property at the same time - I have done this in the past with rental houses/condo's back in the 1980's. The banks still don't know real time that people are lying on there mortgage applications? HM I guess not. But I was buying property that ware cash flow positive - I had  tenants paying my multiple mortgages. In LV there were no renters, these were new homes that could not be cash flow positive. These new buyers had no cash, and there jobs were fairly low paying - they could not even qualify for one of these ugly boxes - but they were buying 3 or 4 at a time?

The reason, ALT A loans and basically ZERO due diligence from lenders. You can say anything - I make 15K per month - RIGHT.....This was when I started buying puts on some of the HB's. I picked KBH as my target for a hedge against my long fund.

How could this happen? a Macro interpretation.

I started to analyze this crazy home financing system. My theory is fairly simple. To much liquidity chasing an ever shrinking yield. After the US depression in 2001-2002 the federal bank lower the funds rate to 1% and kept it there. Wealthy investors were stumped; With short and long term risk free yields a pathetic low level - cash was getting very hard to invest. Investors were still hurt from the stock market crash, so these investor would not put there cash in equity markets. Then the US gave a large tax break to these investors, giving them even more cash per year to handle - what to do with all this money?????

The combination of historic low yields, fear of equities, and a poorly targeted tax cut; created a HUGE increase in  demand for stable return or yield on all this cash. Can you say SIV? Where you have demand - supply will not be far behind. The larger banks and investment house increased the creations of CMO, CDO's that satisfy the large increase in demand for yield. 5-6% yield will do just fine in this now low yield environment. To satisfy this large uptick in demand, lending standard had to fall - there is no other way to meet this new demand. No doc, negative amort., sub-prime, teaser rates loans all became common place - and much to the glee of my box flipping buddies back at the PF Chang bar in Vegas.....

Year of reckoning - 2008

Where is the US economy today? We are in a recession, and it may be a longer than average one. Housing is no loner the issue - it is the credit collapsing due to the lending ponzi scheme finally falling apart.   In conclusion, IMHO the US government has helped create the current housing bubble, and the current credit meltdown.

As far as housing, my calculations show that home prices have already fallen back to base affordability levels. The measure to use is simple - the monthly $ amount per sq. footage of new home price. Rates are close to historic lows, and the sq footage of new homes are at historic highs. Do not look at simplistic home price charts - stupidity or fear mongering - take your pick.

Will home prices continue to fall? IMHO, yes. Lenders are still trying to raise capital, not lend, and US consumers do not wish to buy an asset that is still falling.

Future US economy 2008 - 2009; what's next?

I think we need to get helicopter Ben, and Hank Paulson to frequent  a PF Changs bar once a month. It is still unbelievable to me that our GVMT did not see this recession coming.......I know many CAPS bloggers love to hate the HB stocks. Many have made the top 1-2% on CAPS by shorting this group. Your days are numbered IMHO. We will get a US housing bailout package before the end of the year.

Even without a bailout, making additional money on shorting the HB's  will be increasingly difficult. It will be like trying to kick a dead whale down the beach - good luck! Am I going long the HB's? No, I have many other stocks and industries(like my NG Blog) for my cash. I will be publishing my top 20 DCF stocks this weeks. Many of these are already in my CAPS picks, and real fund.

The US housing bailout needs to work as follows. 300-500B of lower level tranches of CMO debt needs to be purchased and held by the US government. Also the GSE's/FHA need to loan cheap money 5.5% 30 yr, to refi the weak/poor loans with 2006-2007 vintages. and slow down the foreclosure process. The third leg of the bailout would be the GVMT helping states and cities raise bond funds to purchase distressed homes in hard hit communities and take them off the market - maybe affordable rentals, for lower level workers, etc....

This is an election year, and the politicians will be tripping over each other to show how much they care about us. If the US economy is a weak as I suspect - and as weak as all the bears on CAPS think, then this above housing/economic bailout will happen. And if the economy is really not as bad as we think - no bailout, but no more profits for shorts either way.

What about moral hazard? This is not an issue for me. As my blog suggests, I hold our government responsible for the current credit meltdown, so a bailout is not unreasonable. Don't even get me started about the questions about government oversight and regulating the fraudulent lending practices, and ratings agencies during the past 5 years.

Baseline economic projection is a recession for most of 2008, followed by slow but steady recovery in 2009. I think the recession started in Dec. 2007. The midpoint of a recession is typically the best time to buy equities IMHO. So April/May will be the best time to increase exposure to equities. The HB's tanked first, so they may bounce back up first and hard. So if you have cash on the sidelines I would average down slowly to a fully invested position by May. I still like my high yielding cash flow stocks, energy(natural gas) stocks, and international infrastructure plays like MTW, or TEX.

Good luck to my fellow investors during this challenging period - and if you get a chance - visit a PF Changs in Las Vegas for more real time economic data!  [more]



Natural Gas; the alternative clean energy for the next five years.

February 06, 2008 – Comments (10)

Now is the time to invest in Natural gas. As an economist, I have been involved in alternative energy issues for the past 4 years. Long term, the US, and ROW(rest of world) need to move away from digging in the dirt(DITD) to produce energy. These non-DITD alternatives would be:

1)Wind power
2)Solar power

While I am very excited about all these energy sources, I firmly believe they are not yet ready for investors. They are all what I call first stage competitors(FSC). Remember all those cute little Internet stocks of the late 1990's? The same will happen to the overvalued solar, and bio-fuel equities IMHO...The problem is both political and economics, but also valuation.

From the political front, the problem is the concept of public goods, and externalities. Go to this paper for a quick read about this issue:

Without a per unit tax on polluting source of energy, alternative sources of energy will never be economically viable. The problem is that only the most polluting sources of energy creation will be favored in our free market system. Starting in 2009, I believe the US will finally initiate either a cap and trade system, or per unit taxes on pollution. These new taxes/costs for polluting are coming - No other possibility exists. Read the recent article from the WSJ:

This article focuses on coal, but the same will happen for federal gas tax - it will rise significantly. Once the cost increases(as it should) for the polluting forms of energy generation, all other alternative forms will be more viable. Still, Solar, wind and bio-fuels are not ready - the infrastructure is still not fully built, and will not be ready for at least 5-10 more years imho. There is only one possible alternative for the US - Natural gas. The primary component of natural gas is methane (CH4).

The US has just as much NG as it does coal. The primary issue is simply cost factors - NG cost more the extract. A common misconception about natural gas is that we are running out, and quickly. However, this couldn't be further from the truth. Read this for more info:

The US and ROW will start to reduce the practice of using pulverized coal power plants and move to much cleaner NG plants. Also NG powered cars will rise in use with both NG cars, and fuel cell/Hydrogen powered cars increasing in use. Currently the easiest way to get free hydrogen is from methane CH4.

It is becoming clear, natural gas demand and prices will rise. Currently the energy ratio between oil and gas is 6 to 1. Meaning the energy content for a barrel of oil is 6X that of natty gas...So as of today NG is vastly under priced:

ng price = 8, so the oil equivalent would be about $50, almost half the cost of oil.

The only reason NG sells below 10, is that the US has huge cheap to get at coal reserves. But as discussed above, the current use of coal will be made more expensive due to the huge pollution issues with coal. Below is a quick recap about the current pollution of coal and auto oil based fuel:

Dirty Coal-Fired Power Plants and Air Pollution Power plants are a major source of air pollution, with coal-fired power plants spewing 59% of total U.S. sulfur dioxide pollution and 18% of total nitrogen oxides every year.4   Coal-fired power plants are also the largest polluter of toxic mercury pollution5, largest contributor of hazardous air toxics6, and release about 50% of particle pollution.7   Additionally, power plants release over 40% of total U.S. carbon dioxide emissions, a prime contributor to global warming.8 Smog and Ozone Power plants are second only to automobiles as the greatest source of NOx emissions.9   When nitrogen oxide (NOx) reacts with volatile organic compounds (VOCs) and sunlight, smog (ground level ozone) forms. Of the six major criteria air pollutants regulated by the EPA, NOx emissions have historically been the hardest to control. One of the contributing factors is that NOx emissions from huge dirty coal plants in one region can easily pollute areas hundreds of miles downwind. The American Lung Association estimates that almost half-48% or 140.5 million- of Americans live in areas with unhealthy levels of smog.10 When inhaled, smog can cause a wide range of health problems, including immediate symptoms like shortness of breath, chest pains, wheezing, and increased susceptibility to respiratory problems.11   Smog can also cause many more serious problems like increased risk of asthma attacks and lung inflammation. Recently, scientists concluded that exposure to smog can be deadly. Smog affects everyone, but is especially dangerous for children, the elderly, and those with respiratory problems.
I know this is an investment web site - be patient I am getting there! It is obvious to me, the best investments for the next 5-10 years will be natural gas related equities.

As stated in my first blog, I use a DCF model for valuing equities. My top 100 equities have many NG stocks. here is my top NG picks and current value estimate:
1)PDS:   50  [more]



My first CAPS post - My use of the capital asset pricing model for the valuation of equities.

February 01, 2008 – Comments (15)

This is my first CAPS posting. I have been posting on Yahoo for 10 years, and I must be honest - I have become quite upset with the overall quality of other Yahoo posters. The Yahoo message boards is now just a free for all of nasty, illiterate, bashers, or dumb permabulls, or spammers...I started my CAPs about a week ago, and have blogged a bit. I am impressed with the overall quality of CAPS, and fool.  If anyone out there can give me advice on CAPS game, that would be appreciated. The questions I have are: How many equities should I manage?, When should I close out positions - Are the gains of more the 5% significant? Can I close out losers if they are less then 5%, and not get my rating dinged??  Just a quick blurb about me. I am an economist and software developer. I spent many years developing econometric models, while getting my masters in economic and finance. My focus was on linear modeling using matrix algebra, probability theory, and simulation programming. I used APL, & SAS as the main programming languages(this dates me). My actual thesis was a proof of the Efficient Market Hypothesis, using the equities market, and interest rate movements..Then for about 10 years I was a portfolio manager for large leasing firms - I manage large portfolio of computer equipment, and large commercial aircraft's..I currently manage my own hedge fund, and use my proprietary DCF model to help analyze equities.  For many of you, the use of DCF's to value equities is old news, so if I coma across preachy, it just that I am very enthusiastic about this topic. I use various types of cash flow in my model - free cash flow, operating cash flow, clean cash flow(NI + depr + adj), etc...This model has been very good at predicting performance. over the past 3 years, 4 out of the top ten in my list have been bought out at huge premiums...DCF is a tricky metric though. I break all the numbers into current and future cash flow yields, so when stocks crash there yields soar. So you have to be careful your not just catching falling knives.  My goal is to come up with a spreadsheet of about 100 equities for evaluation. I have personally not found a good cash flow screener on the net - If anyone has, please provide a link. So my first step is to perform a stock screener based on low PE stocks. You can filter these low PE stocks with other variables. Then you will get a more manageable list.. I had to analyze about 500 equities after my filters... Some variables to consider for additional filtering:

1)P/B below 2
2)OP margin above 10%
3)ROE above 15%
4)Market cap above 500M
5)D/E below 50%
6)NI growth rate above 10% Of course you could be filtering out some very good stocks, but you need a manageable number to start with. Keep in mind, as well, that discounted cash flow analysis is just the beginning of the due diligence process. Creating a DCF list of equities does take some time. I massage the data also.  Here are some steps I use.

1) Cleanse the cash flow data. I look for large one time gains that may inflate the cash flows. This is important since I add back in the NI adj's for some of my cash flow data. but I weight Maintenance cash flows more. This is (NI + depr + NI adj's) - maintenance capex(minimum capex to keep the firm running). Then I just divide by the market cap of the equity to get the current cash yield for the equity.

2)I analyze the net asset value of the equity. If the cash flow is growing, but the NAV is not, I get very suspicious. NAV must be growing with cash flow growth, for me to buy..

3)Research the industry. This is difficult work. I like to read and listen to the CC's of the firm, and its competition. I like to do this for current Q and up to one year back. I am trying to glean the next 12 months of future cash flow...My models heavily weight the next 12 months of cash flows.

4)Set benchmark metrics. P/B under 2, OP margins > 10, ROE > 20, D/E < 50, NAV growth > 8%, cash on hand > 10% of NAV, etc... These metrics are helpful when comparing firms within the same industry. Comparing OP margins in different industries can be difficult. As an example, the food industry has very low OP margins, while energy equipment(drillers) firms have very high OP margins. This does not mean that NBR's is better than let say SAFM just because NBR's op margin is much higher...

5)Go to the equities web site. Read all the investor presentations for the past 3 years, and see how accurate these past report were. Is the firm always overly optimistic in it presentations? Read the past Q reports with the same critical eye.

After this due diligence the list of 100 top DCF stocks should to trimmed to about 50..From here I sort this cash flow yield spreadsheet  by current, and future yields, with obviously the highest yield at the top. Then I research the top 20 for my purchase decisions.

Any thoughts, comments on this process is welcomed...I will be posting my top 20 for 2008, once I have all the Q4 data for my equities...


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