The Anatomy of a Multibagger
My name is Scott Hall, and I better-than-tripled my money in less than a year with almost no risk involved. That claim might sound ridiculous to most of you, but it is the truth and in this blog I will detail how it was done, what the opportunity was, and how I plan to find more multibaggers in the future.
The company that produced these massive gains for me was Samson Oil & Gas (SSN), a company I have detailed extensively in my blogs during the past year. The company's stock has increased from $1.15 per share when I first wrote about it in August of last year to $2.86 as of the time of publishing. I had an even better average price of ~$0.80 per share.
Samson Oil & Gas is a small Australian exploration & production company, with all of its assets in the United States. Until recently, all of its cash flow generating assets were natural gas well in the Rocky Mountains, which required massive write-downs when natural gas prices declined from its peak of just shy of $14 per Mcf in 2008 to a low of just over $3.25 per Mcf in 2010
The company's stock price got appropriately hammered, falling from a high of ~$7.30 per share in 2008 to a low of ~$0.20 per share in late 2009 as the company was nearly bankrupt. Following a wave of dilution, the company survived but with many more shares outstanding.
While the operating business left a lot to be desired, the company had some hidden assets that became absurdly underpriced due to its history of losses.
The company has ~1,101 net acres in prime Bakken shale territory, that while small allowed the company to go from being a cashflow negative company to one that was more-or-less breaking even on an operating cash flow basis as its Bakken wells came online.
The Bakken wells bought Samson some time to realize the value in its other, more significant asset: it had 40,240 acres in Goshen County, Wyoming, overlaying the emerging Niobrara shale. For a company with a nominal amount of cash in the bank, there was no way Samson could develop the acreage itself. That's where the opportunity arose.
On June 24th, 2010, Samson announced that it was selling 24,166 of its Niobrara acres to an undisclosed company for what would eventually be $74.1 million dollars (there was an original range estimate of between $61 million and $79 million) and a 3.8% overriding royalty interest in the sold acreage, subject to the acquiring company completing its due diligence and making sure there weren't substantial defects in Samson's acreage leases. For several days, you could actually purchase shares of Samson for less than its pro forma net cash after the deal and get all of the remaining Niobrara acreage, the Bakken assets, and the natural gas wells for free.
Even after the stock had increased to $1.15, you could still buy the company for just about the value of the cash in the bank and the natural gas assets, giving no value to the remaining Niobrara acreage. For a company that just reached an agreement to sell similar acreage for $3,066 per acre and a 3.8% royalty interest, that was absurd.
Following the closing of the Niobrara acreage sale to the undisclosed company, which would later be revealed as Chesapeake (CHK), Samson's stock price went to a high of $1.45 per share in 2010, but came back down to about the price that I first recommended it and stayed below its high until early January 2011. This wasn't an opportunity you had just a few days to take advantage of; it was readily available for north of six months at very attractive – and eventually very lucrative – prices.
This was possible because almost nobody followed the company. Seeking Alpha didn't, the Motley Fool didn't, TheStreet.com didn't, and your aunt Shirley didn't. Eventually one or two small research departments picked it up and saw the opportunity, but not until long after I wrote my original blog about the company.
That is in stark contrast to today; it seems like barely a week goes by without some financial journalist/blogger profiling or referencing the company in some way, shape or form. Sure, that's still scant coverage, but it's still a lot more well-known than when I was the only person online (that I'm aware of) covering the company for months on end.
Even among those who did stumble upon the company for whatever reason, they could be easily forgiven for thinking the company was worth nothing. The company was negative cash flow, had more debt than cash and was investing the few million it did have in its Bakken acreage. Without digging deeper into the company's assets, it would be very easy to think that the company was going to be cash-flow neutral for the forseeable future at best, or heading for bankruptcy court at worst.
After Samson's stock ran up to $2.00, I sold about half of my stake in the company because justifying investment at those prices relied on its Niobrara acreage proving itself to be productive; the obvious dirt-cheap asset play was gone, and investing required confidence that the company would be successful in developing its acreage. I held the rest until it ran up to about $3.50, when I decided to sell because I thought the market was getting ahead of itself when the company had yet to drill a single well on its Niobrara acreage. I'm still holding on to 1,000 shares for kicks, but Samson is no longer the behemoth of my portfolio that it used to be.
More Multibaggers? Embrace the Unconventional, DO YOUR RESEARCH and Profit
If you had shown me just Samson's financial statements and market valuation, I would have scoffed at the idea of investing in the company.
That's the key here. You are much more likely to find market-crushing ideas when searching among companies that nobody has ever heard of, precisely because nobody has ever heard of them. Many people, even if they do find the company, will only take a superficial look at it and move on if the books don't look good. That is, of course, a perfectly rational decision. If they move on after a superficial look, they can increase the breadth of their research with the time they allot for their investing endeavors. People who have a limited amount of time available to them can therefore learn less about more companies, which many investors might consider more productive. I've met more than a few of these type of investors myself.
However, investors who sacrifice depth of research for breadth of research will generally discover that it is much more difficult for them to find multibaggers than those who take a leisurely pace and look at companies from the ground up, because the best investment ideas are not often so apparent; like dogs that roll in feces to mask their own scent, some of the best candidates for investment appear to do the same. I have personally found it very lucrative not to just dismiss those companies as what they smell like. If you take more than a superficial glance at such companies, you will usually find out that what you were smelling was indeed just a pile of cow patties, but on occasion you will find a loyal companion that will lead you to atmospheric investment returns.
The more well-known a company becomes, whether through catalysts such as the Niobrara asset sale bringing it greater visibility, investors becoming more interested in a specific industry or any other reason, the less likely it is remain so absurdly undervalued because its obvious undervaluation will attract more investors to it, eventually to the point that it is no longer a compelling bargain.
That is one of the only edges that you, as an individual investor, have over the institutions that dominate the stock market and have access to god-tier research teams. Most of these great opportunities are in smaller companies that aren't worth the big boys' time to research or invest in. When I first found Samson, for example, the company had a market capitalization of under $60,000,000. Peanuts for a publicly traded company, and such a small company that it wouldn't be worth nearly any institution's time to research (if their bylaws even allowed them to invest in it) because of the ridiculously small percentage of assets that they could commit to the idea.
For Mr. Or Mrs. Average Joe, though? They could put their entire life's savings into the company and not move it 2% (not that doing so would be advisable). For them, finding small, undiscovered companies with major, identifiable near-term catalysts can blow the roof off of their portfolio's returns. It sure did for me.
Some of you may be thinking, "that's great Scott, but I don't have the knowledge or ability to pull something like that off." The crazy thing about this method is that the average fifth grader has the core skillset to do this. Can you add? Can you subtract? Can you divide and multiply? If you answered yes to all three of these questions and have a bit of time to learn industry specifics, then You Too Can Be A Stock Market Genius!
That's something I've always found amusing about the stock market. It's always portrayed as so complex that only a rocket scientist could understand it when it appears in popular media. If you're willing and able to learn how to apply some of what you learned in elementary school to the stock market, get your hands dirty with a little research, and most importantly keep a level head on your shoulders and be patient, popular media's characterization of the stock market is way off base.
I can tell you that, personally, I'm no whiz. I'm a 21-year-old college dropout (at least for now, I may go back later) who couldn't begin to tell you the difference between a proton and a neutron. I am convinced that if I can do this, with time, dedication and the right temperament, almost anybody can.
You might be wondering how you can start looking for and finding deeply undervalued companies like Samson. After all, no quant screen in the world will pick these puppies up for you. I'll share with you a method that I picked up from my friend Paul Chi back when we started valuing exploration and production companies together.
You're going to have to get your hands dirty a little, but believe it or not a lot of companies will do most of your work for you, at least in the natural resource space. Cheap natural resource companies will often point out how cheap they are in their presentation, if they really are cheap. Try it. Pick any gold, silver or oil exploration company that you can think of. Heck, pick three or four. Go on their corporate website and view their presentation.
As an example, I'll use Chesapeake because almost everyone knows about it, even though it doesn't list the market valuations of any other companies in its industry (a great way to find a lot of prospects quickly), unlike some do. Go to the Financial and especially Summary sections, starting on pages 15 and 33 respectively. Read it.
Do you see that? Chesapeake is like Uncle Fred at Thanksgiving; it won't shut up about how great they think they are, though in this case that means cheap.They've even gone and done the math for you; they put a value on the stock of anywhere between $64.44 and $143.79 per share, depending on the price of natural gas. Even if we split the difference between the two more conservative ones, they're probably lowballing us a bit. Take a gander at the footnotes of page 35 – they're assuming a constant price per barrel of oil of $83.34, which is 18.3% under its price as of this writing.
Keep in mind that Aubrey McClendon, Chesapeake's CEO, is pretty widely considered to be a tool who is detrimental to Chesapeake's performance, so don't just go out and buy the first company you see that's trading at a 50%+ discount to its net asset value. Qualitative factors like management are very important, and management that is particularly bad or corrupt can wreck even the finest investment candidates.
Which brings me to my next point: just because the company tells you it's cheap, doesn't mean it is. Until you have a good handle on the going rates for different kinds of assets, always, always, ALWAYS run a Google search and check out the prices for recent comparable sales and confirm what management is trying to sell you, because unfortunately many management teams in America will sell you a farm in Kansas with an ocean view if they can get away with it.
Here's a quick PRO TIP: for oil and gas exploration companies. If you find an exploration company that you think looks attractive on a value basis but you're concerned about its honesty, see if it has existing production. If it does, sometimes you can check if they really own what they claim they do. Some oil and gas boards provide information on every oil and gas well in their state on their websites, including who the operator of any given well is.
At North Dakota's for instance, you can search for wells by a specific operator. Arbitrarily, if you wanted to see if Brigham Exploration (BEXP) was telling the truth about their ownership of a given well, you would just click on "Well Search," choose "Brigham Oil & Gas, L.P." from the dropdown menu, and click submit. Now you have a list of every well Brigham has ever drilled in the state of North Dakota, and you even got to navigate a website that looks like it came straight out of 1995 to do it!
Another quick PRO TIP: if you search for a company based on its claimed ownership of a specific oil well and it doesn't come up, that doesn't necessarily mean that they're lying to you (though it certainly might). These sites usually let you search by the operator of the well, but that doesn't mean that the operator owns 100% of it. If a company says it owns 15% of well XYZ, you search, and it doesn't come up, check to see if any of their press releases mention who the operator is. It'll usually tell you, so search for that company instead. This can save you a lot of confusion and undue concern of fraudulent activity.
Want to know something even better for starting your research in natural resource companies than natural resource company presentations? Natural resource company investment conferences! Going back to Samson, if we go to the company's corporate website and go to the "Investor Relations" tab, we can see that Samson has a lot of presentations filed under its "Reports and Announcements" tab. From here, we can see that Samson attended the IPAA OGIS New York conference back in April. A quick Google search yields this page.
Check 2011, then browse until you see April... Eureka! Click on "OGIS New York" and you have a treasure trove of three days' worth of presentations from dozens of companies, free and yours for the plundering! You do have to register, though (takes about twenty seconds) and have your pop-up blocker turned off. In any case, not only do you get the presentation from the company's corporate website, you also have upper-level management explaining and describing everything to you. All for following one little lead on a single company's website? I'll take that deal any day!
These are just a few ideas to help you start researching companies. As you read more and more about them, you'll probably come up with your own research processes that you will use to complement or replace the ones I've provided. For my money though, I don't think there's a bigger bang for your buck in investment research than natural resource conferences.
Also, while I've been putting emphasis on smaller companies, don't forget that larger companies can also provide massive returns. It's just a lot rarer that they'll do so since it takes a lot more to move the needle for them than it does for smaller companies, and your edge is GONE in this arena because most of them have been studied to death, resurrected, and studied to death four more times. Even so, it doesn't hurt take a gander at some of them from time to time, because occasionally they do go to the bargain bin and when they do, they can be worth buying.
Overall, I learned a lot from my investment in Samson Oil & Gas; I learned, more or less, how exploration & production businesses work and the key metrics of their industry. More importantly, I think it has helped me improve as a generalist as well. Here are some of the more important lessons that I learned from the process:
Don't always put company quality over value as a small investor; even a company that loses money can be profitable for investors under certain circumstances.
Don't be afraid to share your research with other investors. Oftentimes, you will find that they can spot flaws in your analysis and help you improve as an investor. Don't ever be afraid to admit that you're wrong or be afraid to be wrong publicly; both can lead to extremely valuable learning experiences. Plus, sometimes you'll make friends you otherwise wouldn't have who share a common interest in a subject most people don't seriously study. These relationships can be very profitable for both parties, from the experience I've had with them.
Research, research, research. When you're looking at a company whose stock you may be interested in purchasing and they provide a lead to an investment conference or other companies in their industry, by all means hurry to Google and check it out! Soon you'll have a growing web of companies that you know a lot about and can crosscheck information with.
More research! When you've found a company that looks absolutely dreadful, dig a little deeper. Just as you shouldn't judge a book by its cover, sometimes you shouldn't judge a company by its books. A balance sheet is just a snapshot in time, and with some companies can substantially understate the true value of its assets.
Value is just one component of finding a successful investment; for Heaven's sake do not skimp on the catalyst! Companies trading at below their net current asset value are cool and all, but it doesn't mean anything if management continues to drain the company dry. If you can identify major catalysts to unlock the value that your cheap companies have, you're well on your way to finding a winning investment.
If at first you don't succeed, don't give up! It can take some time to learn the fundamentals and apply them successfully. The first investment I ever made was in Apple in early 2007. I bought the stock at around $90 per share right before an earnings announcement. After the announcement, despite stellar results, the stock tanked into the $80s and I sold it in fright. The stock today trades at over $359 per share. I had the wrong temperament; I let the market lead me instead of serve me, and I paid hugely for it. I didn't quit and give up, though. I stuck with investing and two years later, I had my first multibagger (GGP) and I just recently had my second (SSN).
To improve rapidly at investing, read all you can about investing. When I first started, I had no one to help me learn how to invest and I sucked a lot longer than I should have because of it. When I began reading Graham and research that other investors had publicly posted, I started getting better very, very quickly. Very few of the ideas I've written about in this blog are original. I have adopted bits and pieces of dozens of investors who I respect into my philosophy and methods of analysis. You can take or leave any idea that someone advocates, but not to adopt useful ones because they didn't originate from is very arrogant and will lead to a much slower development rate as an investor.
Try to get even just a little better every day. You won't be able to do this all the time because of other commitments, but I've found if I keep it in mind I read more 10-Ks to learn about new industries. More 10-Ks and more industries = a larger universe of investment ideas. A larger universe of investment ideas = more chances to find the next multibagger. It is the mindset that counts.
Well everyone, I've had a blast writing this, but that about wraps it up for today. I do want to announce that I plan on making a series of blogs devoted to finding small, undiscovered companies that I think have the potential to become multibaggers, but I first I have to publish my analysis on a certain larger company I've been looking at. That blog is done, but I want to revise it a bit before I post it.
After that, I have to finish Knock 'Em Dead, which will take priority over the blog series until it is done. Nevertheless, do expect more small and micro cap content from me, just don't expect it in the next week or two.
I hope you've found reading this blog worthwhile. If you have, please recommend the blog and feel free to contact me at firstname.lastname@example.org or post in the comments below.
Ciao for now,
Long SSN, no position in any other securities mentioned