When playing the stock market is fraught with risk, what's the best way to pick a winner?
Check out our unique investor mentoring program, featuring our advanced investor and his mentor, Tom Bradley, president and founder of Steadyhand Investment Funds Inc.
You can find out more about Tom and his mentor program
Our advanced investor, who can be identified only as Jim from Calgary, is one of the winners of an investing contest we ran in March. The winners were classified into three categories: advanced, intermediate and beginner.
In Week 1, Jim and Tom chatted for the first time to discuss investment strategy: Week 1: Advanced investor discussion
In Week 2, after Jim had read some materials that Tom recommended, they discussed strategies for Jim to get his portfolio in line with his long-term investing objectives and asset mix:
And in Week 3, they discussed various techniques involved in picking stocks:
In the final week, Jim picked a couple of stocks and Tom critiqued his analysis:
(Editor's Note: globeandmail.com editors will read and allow or reject each question/comment. Comments/questions may be edited for length or clarity. HTML is not allowed. We will not publish questions/comments that include personal attacks on participants in these discussions, that make false or unsubstantiated allegations, that purport to quote people or reports where the purported quote or fact cannot be easily verified, or questions/comments that include vulgar language or libellous statements. Preference will be given to readers who submit questions/comments using their full name and home town, rather than a pseudonym.)
Sonali Verma, Globe Investor: Hello, everyone, thanks for joining us and TGIF :-) Jim and Tom are discussing a stock today, Birchcliff Energy , which Jim has been analyzing. Jim, what did you go looking for when you analyzed the stock?
Jim: I looked into 4 aspects of a company, those being,
-Financials - How strong is the company?
-Valuation - How is it being valued compared to its peers, the market and to its own history.
-Management Effectiveness - How good is management at increasing the value of the money an investor gives them?
-Business dynamics - What are the factors that might have an impact on this company's business? For example, I evaluated an Oil & Gas producer, so considerations were, prices of oil and gas, royalties, technology needs specific to their area of operations.
Sonali: Super. And tell us what you found?
Jim: Financially, the company is reasonably solid (emphasis on reasonably) due to any future credit they might need to invest in technology.
Management Effectiveness, the companies' management is good at acquiring assets with a long-term time horizon, however, there appears to be a weakness in making the assets productive for an investor.
Value - right now it is overpriced
Business dynamics - the commodity prices is a big consideration (which way are they going) and technical risk (as pointed out by Tom, the technology to get at their natural gas could be time and cost intensive.
Tom: Jim, I like the work you've done - looking at the financials, valuation and business dynamics. Where you need to do more work is on the stage that Birchcliff is at in its development. It has accumulated substantial land holdings, but has not brought a huge amount of it into production. So the value of the company is less in the short-term profits, and more in the assets it has accumulated.
In this case, we want to put more emphasis the company's financing (i.e. can they afford to develop all the land) and the technical side of their properties. In other words, how much risk it there that there is gas there and it can be brought to the surface economically. Land plays like Birchcliff are tricky to analyse because the numbers don't always look so good compared to their peers.
Jim, I know you didn't mention it, but I know you did some work on commodity prices, specifically natural gas, which accounts for about 2/3 of BIR's revenue, I think. I'm a bottom-up investor, but we always want to understand the context that we're operating in. Buying gas right now is certainly a contrarian move, but that is often where the most money is made.
Something else that is important, particularly with the junior oils, is management. Part of making money in the juniors is 'riding' a good horse - i.e. a proven operator who has made money for shareholders in the past. There are lots of successful investors that do nothing but follow the 'winners' around and invest in their ventures. Obviously the numbers have to work, but with you located in Calgary, you should keep this in mind.
Sonali: Those are great points. How about the main strengths of this stock?
Tom: There are two big factors that would attract me to BIR.
First, Seymour Schulich. As many readers will know, Seymour knows resources and has made a potful of money in the oil patch. and is a big supporter.
Second, the large amount of land in the Montney area that BIR has accumulated. As I understand it, their holdings may be more erratic than Duvernay's hugely successful Montney play across the border in B.C., but BIR is well positioned to grow substantially over the next few years.
Sonali: Jim, you mentioned that you were interested in an oil ETF, , as well. Tell us what you're thinking here.
Jim: Yes, USO, U.S. Oil Fund ETF. I have been following on more of a technical basis to stay current with the trending of oil prices. I am considering investing in it as well, as it is an easy entry to ride oil's rise. It tracks the price of oil on a percentage basis. The price of the fund is not the same as the contract, but the percentage movement is the same.
Sonali: Tom, what do you think of USO?
Tom: Jim, if you are going to buy the USO, you are obviously bullish on oil.
With that being the case, I would prefer to see you buy an oil stock(s) to benefit from the oil price rise. The reason is that you will get more bang for your buck. A company has more leverage to the commodity than an ETF. It has 'operating' leverage (i.e. only $3 per barrel gets to the bottom line, so if oil goes from $60 to 70, then the $3 goes to $13 … roughly speaking) and may also have some 'financial' leverage.
Obviously, you don't want to overpay for a company, and you don't want too much financial leverage, but I think you'll make more money owning operating companies than the commodity itself.
Sonali: And here's a reader question for you, Tom.
JC writes: I would like to know what Tom Bradley thinks of Writing Conservative Covered Calls to generate extra income.
Tom: JC -- Writing covered calls is not something I've done much of. As you point out, it's a way of generating income from an equity portfolio, but we need to be careful with the word 'extra'. I say that because there is no 'new found' return being generating here. Over the long term, you are effectively converting capital gains into cash-in-hand income. There will be times when it will feel like free money, but at other times, it will limit your returns.
A former colleague of mine always reminded me that the options market is probably the most efficient market in the world, so there's no 'free lunch' there. Having said that, the strategy absolutely has merit.
Sonali: Now, Jim, you mentioned Peyto Energy Trust as well. Tell us what you find attractive.
Jim: I like Peyto for their ability to manage costs (such as G&A, executive compensation), their focus on long-term production and steady cashflow, and they have good technical expertise in their area of operations. Albeit in addition to commodity price risk, there is technical risk due them working in areas where the gas is harder to get at.
Tom: Jim, the management compensation issue is an important one and yet it's one that often gets overlooked. I'm not familiar with Peyto's structure, but having management aligned with shareholders' long-term interests is very important.
Fortunately, I think the market and financial crisis we've gone through will lead to significant improvements in executive compensation. Here's hoping.
Sonali: Thank you very much for having given us so much of your time over the past four weeks. We really appreciate it.
Jim: I have appreciated the perspective, candidness and calmness that Tom has towards investing.
Some of the influences that will modify my investing are:
- using risk wisely with reasonable probability (in other words, don't hide from risk)
- having a longer time horizon for investment assets (ranging 15 years plus). This is something I have been more short sighted on.
- look at the softer factors of a company, in addition to numbers
- remember that as an investor, I am the principal of my money. I know what it needs to do in my life, what I will use it for and when, and then invest it accordingly
Thank you to Tom and The Globe and Mail for this wonderful opportunity.
Tom: Jim, I've enjoyed working with you, both on the phone and on-line. Clearly you are a student of investing, and your approach and instincts are sound. All the best with your portfolio. Cheers,TB.