I'm betting big on BDCs, insurance, and banks ACAS, BX, ARCC, ALD, HIG, etc.
In my last post I talked about how perhaps the best play on the market was a play betting on eventual mark-to-market accounting reversal.
For those not familiar, mark to market accounting (ala FAS 157, applied widely to insurnace companies, banks, BDCs, and more (although not to GE)), it works about like this:
imagine you owned a company that made $100,000 every year, like clockwork. Imagine you also owned $5million of bonds that paid 4% every year like clockwork. $200k every year, clockwork. Thast $300k every year and in 10 years or so you get the principle back on the bonds and yo ucan start over.
But imagine one year the bond market went completely to crap, ok? And if you sold all the bonds that year you'd only get $3 million. You're still getting your $200k in interest, ok? You're still making $100k a year from your business, you still will probably get paid the principle back on those bonds some day, and overall... you're situation is exactly the same as normal. But, nevertheless, you would via mark to market accounting report a $1.7 million loss that year. And people would panic and tell each other that you'd lost everything and run screaming into the streets, crying and yelping and hollering.
But now imagine that the next year the bond market has a boom time, a period when people can't get enough bonds. And then you'd be able to sell those $5mil of bonds for $5.5 mil. You still made $100k from your business, you still made $200k in interest, like the year before, NOTHING CHANGED AT ALL. But via mark to market accounting you would for this year report $2.8 million in profits. And people would panic and tell each other you were rich beyond belief and line up to be your friends...
And so it will be with stocks. MANY MANY insurance companies and banks are going to post EPIC SHOCKING profits in a few years when the mark-to-market value of things like mortgage backed securites comes back up. THE ONLY LOSSES WILL BE THE PERCENT OF LOANS THAT AREN'T PAID OFF LESS THE COLLATERAL VALUE ETC ETC ETC. right now even paying loans are being market to market, causing enormous losses ON PAPER in banks, insurance companies, etc.
After my last blog post I totally overhauled my portfolio and bet heavily on insurnace, banks, and my favorite category... BDCs.
BDCs are like REITs in that they are required by law to pay 90% of income out as dividends (good for shareholders most years), and like banks they are required to mark their assets to market. And like banks, the market for tohse assets is currently very illiquid and consists mostly of distressed sellers, which in turn results in a situation where most of "fair value market prices" are very low.
Which has wreaked extreme havoc on the book value of most all BDCs, sending them at times into violation of loan covenants and sending their share prices into a black hole of apparent oblivion. Due to vilation of the loan covenants some of them have been issued going concern notices. Its not a pretty situation at all.
But like our imaginary business above, business is actually ok for many of them. Cash flow is positive, they aren't behind on debt payments at all (in fact paying down debt) and their losses are nearly all on paper. Or vastly on paper. Or largely on paper as the case may be.
And, like our imaginary business above, these companies stand to one day be able to mark their assets BACK ONTO THEIR BOOKS, which may result in eye popping profits at some future time when the macro environment is calmer and gentler.
I've loaded in the past 2 weeks up heavily on ALD, ACAS, ARCC, BX, and MCGC (all BDCs that i judge to have undervalued shares and good chances of survival), and so far those buys ar eall above water.
In the case i've loaded up on th emost - American Capital or ACAS - they are trading at about 1/30th of book value EVEN AFER THE UNFAIR MARK-DOWNS, never mind after alot of asstes are marked back up with time. And about 1/5th of annual cash flow. Not a price/cash flow of 5, which would be good, but a price/cffromoperations of 0.2 or so.
Not going to get too many chances in one lifetime to bet on companies that
1. aren't delinquent on any debt or behind on any payments
2. have positive cash flow exceeding their market cap
3. have a price/book of 0.05 or so
4. have paid, on average, more annual dividend than the current share price for 10 year so rmore
So i've made large bets, and i'll continue to expand them. So far so good. I'm 2x my cash on ALD as of close today, a few cents up on ACAS, and a bit up on the rest. My purchases have weighted MCGC hte lowest, then ARCC, ALD, and BX about the same, and ACAS the highest.
Good luck to everybody who's long on the market, may all shorts suffer.