5 Stock Pick Sources

The Below article was wirtten by Henry Lu whom I interviewed a while ago.

by Henry Lu

October 23, 2005

1. Insider Buying Information

Insiders are company's CEO, Chairman, board directors, and executive vice presidents of various departments.

Insider buying information tops my list for obvious reasons. Insiders have a lot of reasons to sell their shares: buying a house, huge vacation expense, etc. However, there is usually only one reason when insiders buy their company's shares with their personal money: the insiders believe the stock price is cheap and they can make money by buying their own stock.

Insider buying information is also very informative to understand market sector movement. Many times I look at the insider buying information from the sector point of view. Certain sectors during certain periods of time constantly had insider buying activities from different companies of the same sector, which could indicate a sector wide undervaluation or bullishness. This was exactly what I found in late 2003 and early 2004 when I found insiders of a lot of oil and natural gas companies constantly buying their stocks. Eventually I picked two oil and gas stocks in late 2003 and early 2004 Whiting Petroleum (ticker WLL) and Chesapeake Energy (Ticker CHK) from insider buying information and they have been huge success for my premium investment newsletter Blast Investor Real-time Plus (BIRTP) and rewarded myself financially very significantly.

2. Guru Watch

It is certainly worth the effort to track stock picks or ideas from legendary gurus such as Warren Buffett, Eddie Lampert, Jim Rogers, etc.

Wall Street Journal is great source of investment and financial information. My 2003 stock pick PetroChina (PTR) was from an article of Wall Street Journal, which published news of Warren Buffett buying PTR. I immediately bought into PTR stock on the same day that I read the article and profited handsomely from this pick.

Warren Buffett is the best value investor in the world and you can not afford to ignore him. One way to track Warren Buffett picks is to go to Yahoo Finance and then read news headlines under stock ticker of BRK-A.

Recently, internet information grew so large and I believe it is now much easier to track gurus from web rather than reading newspapers or magazines. An easier way to track guru picks is to use tracking services offered in the web. Here I highly recommend the tracking service provided by Gurufocus.com. Gurufocus tracks almost all the value-oriented Wall Street gurus. Their list of gurus is huge, Warren Buffett, Edward Lampert, George Soros, etc. They even publish a newsletter alerting you of the latest guru buy and sell actions. Their service is great and best yet, it is all free!

3. Software Screening Tool

BlastInvest operates internally a Mysql based relational database storing about seven thousand stocks with all kinds of valuation metrics and tools that I can do for Benjamin Graham NCAV ranking, return on equity modeling, low pe or low price to sale screening, etc. We update database information every week and I constantly mine the database looking for the huge winner that can reward both me and my newsletter readers.

Insider buying information could be even more powerful when you can combine insider buying information with valuation or strategy screening, which exactly what we do at BlastInvest with this powerful internal relational database.

However, I found the free or cheap screening tools out there in the web are not impressive. Validea.com tool is nice, but it lacks the powerful feature that I want. Yahoo tool or MSN tool works, but still they are not for power value investors. Therefore, I may rank my internal screening tool very high for getting stock leads, you may be dissappointed if you do not have access or can not pay for those powerful tools at reasonable cost.

4. Online Message Board Networking

Stock message boards are wild and you may be surprised that I put this as one of top sources of information for getting stock leads. Well indeed, I got tips and found very solid stock leads from internet message boards.

Actually, I started myself as quite wild BBS stock guru many years ago before I started blastinvest.com newsletter business. Lots of Chinese American friends who frequently visit big online BBS (mitbbs.com, or goofiz.com) would know my past track record very well. My past BBS investment performance certainly beat performance of most if not all of the value mutual funds hands down. My past history certainly can tell you something on the nature and quality of message boards. Sure, most of BBS members probably are not investing gurus, and some folks in the stock forum may well be dangerous stock promoters or hypers. But certainly there are some excellent stock gurus there and there are valuable investing or stock pick information there. So just be careful and do your homework when you use information from online stock boards.

Two of the well known value investing forums in US are Valueforum and Value Investor Club. Unfortunately, Valueforum is a fee based message board and you can not post any messages without paying the fee. Value Investor Club seems to reject beginners or amateurs and they only want gurus (maybe Wall Street Gurus) offering stock tips to each other.

I myself certainly disagree with approaches of Valueforum or Value Investor Club. That is why Blastinvest LLC recently launched a free forum dedicated for individual value investors: value-investing-forum.com. For more information on why you should participate in a forum regardless whether you are a value investing beginner or a savvy value investor, please click here.

5. Traditional Newspapers and Magazines

This group includes Investor's Business Daily, Forbes, Fortune, Barrons, etc, I read them all from time to time.

If you live near New York city and tune in to Bloomberg radio, you are going to hear bombardment of ads such as "Barrons, the best source of stock investing information".

However, my rating on their capability of giving me stock leads or ideas are poorer than above channels. The stock picks published in the public media are pretty mediocre.

Of course, I still believe they have very useful information to understand economics and to know what Wall Street gurus are doing or thinking. So they may not be worth subscription fee for you to pay, they are certainly worth your time to visit public library once a while to read them.

Article by Henry Lu of BlastInvest LLC, a premium investment newsletter publisher in Connecticut. Visit http://www.BlastInvest.com for FREE "how-to" investing assistance, web services and more.

Books to Read (or Re-read)

Examining American Eagle's Business Model

Recently while reading Mohnish Pabrai's book Mosaic: Perspectives on Investing I came upon the chapter on why retailers are not suitable investments. One of the reasons he mentions is because a competitor could walk into your store and walk around for only 15 minutes and learn the whole business model.

A company I've written about before, American Eagle, immediately popped into my head. I thought this wouldn't happen with American Eagle because their competitive advantage is that they are popular among preppy teens.

I recently switched high schools when moving from Minnesota to Utah - people who have ever moved into Utah will tell you less change would have occurred if you only knew English and moved to Italy - the only consistency between my two high schools was the clothes everyone wears - American Eagle and Hollister (of Abercrombie & Fitch).

And this is why I believed American Eagle would be a good investment, even if it was a retail company, but only if it fell a few dollars.

It's business model isn't that hard, they take a page in the 10k, but I can explain in a few well chosen words - American Eagle is a retailer targeting 15-25 year olds who will pay-up to look popular.

There-in lies the problem.... American Eagle is a fad.

Kids may wear it now, but everyone wore Tommy Hilfiger 6 years ago and no one wears it now, according to my dad 30 years ago everyone just bought there close from department stores - and that was popular - now a high school student wouldn't get caught dead in a department store buying clothes.

Who knows if American Eagle will have built in pocket protectors in ten years because it has become the latest fashion of the chess club and computer gamers?

American Eagle is just like every other retailer, it's attempting to exploit an arbitrage spread which it has found, though this arbitrage is hard to find and if it is found profits will come fairly easily, the size of it is not, and cannot, be known.

The bottom line of my American Eagle analysis: There is only one thing I know about predicting fads; I can't do it and shouldn't try.

-Mike

Special Situations Re-Print

I wrote this a few months ago and it was orignally posted on a few different websites. I'm re-printing it here for future reference. It comes from You Can Be a Stock Market Genius

Arbitrage is totally risk-free. An example of arbitrage could be buying shares of a company on the NYSE, then selling them immediately on another exchange -- like a foreign one -- for more money. There is no risk in this -- unless your phone breaks and you can't call your broker -- there also so isn't much reward, because of this I'll be writing about a different kind of arbitrage, with more potential returns.

Risk arbitrage, is arbitrage, with the risk of losing money attached. Joel Greenblatt wrote the primer on risk arbitrage, he is also the creator of The Value Investor Club Website. I recommend his book for a further look at Risk Arbitrage, or as it is more commonly know Special Situation investing.

There are a number of ways to invest in special situations:

• Spin-offs
• Bankruptcies
• Restructuring
• Rights Offerings
• Re-Caps
• Merger Securities
• Companies Going Private

Spin-offs

Spin-offs are my favorite types of investing in special situations. Sometimes a company will decide it will do better, or a section will do better, if part of it is spun-off. Basically a division is separated from the parent company.

A study conducted by Penn St. found spin-offs out-perform the S&P by 10% per year, during the first three years of independence.

Peter Lynch talked about spin-offs in his first book.

Institutions have a lot of limitations, detailing the amount of companies they can own, the sizes of companies they can own, the percent of a company they can own, etc. Usually when a division is spun-off the institutions have to sell their shares immediately, resulting in the spin-off being undervalued, if you can understand the new company and find a spin-off undervalued you will likely beat the market over time.

Simply reading The Wall St. Journal will point you towards spin-offs.

Merger Securities

By looking at Investhelp you may find a few companies that are trading below what they will be acquired for. I would strongly advise against investing in any mergers, the risk is to great to make up for small potential returns. If you need to invest in a merger to get your adrenaline pumping before working-out I would say only invest when both companies are 80% owned by insiders who are dead set on the merger going through.

Merger Securities on the other hand are different. Usually companies pay the shareholders of the company being acquired with cash, sometimes shares, when they pay with bonds, preferred stock, warrants, or rights, etc. Companies usually only use merger securities to pay for a portion of the payment - they use them because they probably exhausted their ability to raise cash.

Like spin-offs - and Rodney Dangerfield - merger securities don't get any respect, institutions sell them almost immediately, producing a great buying opportunity.

This means, don't try to invest in pending mergers because they're too risky, but follow the merger and if any merger securities are being used to pay for the company wait a while after the deal goes through - if it goes through - and try to put a value on the securities, they're probably undervalued.

Bankruptcies

Just reading that makes you think about Airplane companies, doesn't it? You'd think that investing in bankrupt companies would be a way to become one of them, but it turns out it could make you rich, if you do it at the right time...

Don't buy shares of a company that is currently going through chapter 11, that won't be profitable until a cow jumps over the moon, and if you have that money to burn you can just subscribe to an expensive newsletter and you won't need to invest for yourself.

You could buy bonds, bank debt or trade claims from bankrupt companies, but that wouldn't be smart unless you specialized in bankrupt companies.

There is a profitable way to invest in a company that went bankrupt... After the company comes out of bankruptcy it has to pay off it creditors, usually doesn't pay them with cash, it pays them with its brand new common stock, and of course do the creditors want this common stock? NO!! Seems like this is happening a lot, institutions own a company and it spin-offs shares or pays them with merger securities and it sells the shares almost immediately, creditors are paid with common stock from a company that went bankrupt and they sell the shares, because they don't have any reason to hold them.

Investigating this is pretty easy, go to the SEC website, http://www.sec.gov/ and you'll find a filing for bankrupt companies that tells you when the bankruptcy issues will probably be resolved, read this and pick your spots only invest in these companies when you are totally sure of the outcome, and have learned more than what you've read here.

Going Private Transactions

Cheap Stocks provides a good tutorial here. And Old Niu here The SEC here.

Basically micro-cap companies usually have very small revenues, sometimes under $1,000,000, the ~$100,000 they have to pay to the SEC could be 20% of their potential profit, the company will probably want to get rid of these fees.

This is where we come in, if the company can reduce the number of shareholders it has to under 300 it can file at will, and is no longer required to do so quarterly. To do this they have a reverse split, ex. 1-100 for every 100 shares you have they give you one.

If you have less than 100 shares, then the company pays you for the remaining fractional shares. In their SC 13E3 (usually announces the intention to go private, kind of like a proxy statement) they will declare a tender price, which is the price they'll pay for fractional shares.

When you find a company that is trading well below the tender share price, then, after investigating risk, you would usually buy one less than the split amount to make all your shares fractional.

The bad part is: usually these company's share prices are so low $100-$1000 is the most you'd be able to invest to make a good profit, sometimes companies will want to go private for reasons other than not wanting to file, they may be big enough that more money could be invested in the situation.

Finding these situations is extremely easy, check this page on the SEC website to find companies that filed the SC 13E3 filing. The Cigar Butt Hunters Group on Yahoo! follows these situations intently. George on Fat Pitch Financial follows all of these transactions, and for $5 a month or $50 a year he tracks the difference between tender and current prices for most arbitrage situations.

Investing here does not go without risk. There is also the problem with the amount of time it takes for the cash to appear in you account.

Restructuring

Corporate Restructurings are similar to spin-offs; in restructuring a business sells a badly performing division of the company -- a really big division. Except in restructuring we're looking to buy the company after the restructuring...

The reason to buy restructuring is hidden value may be obtained from the selling of the bad division, and the company being more profitable. Say a company is trading for $20 per share and it's earnings $1 per share, it has a P/E of 20x and a 5% earnings yield, but one really bad division is losing $1 per share. Joel Greenblatt looks for companies that restructure and sell the bad division, which was depressing earnings. After selling the division the company is making $2 per share, and has a 10% earnings yield (probably above bond yields) the company is now relatively undervalued.

Look for situations that are well managed, have a great business to be restructured around and limited downside. Lastly, make sure the restructuring is significant in comparison to the total value of the company.

Recaps & Stub Stocks

In a Recapitalization a company usually buys a large portion of shares back from shareholders.

An example of this is a company trading at $18 that decides to distribute $15 dollars of bonds to investors, at $18 per share we’ll assume it earns $1.50 per shares, or a P/E of 12x, taking out the 40% tax rate it is making $2.50. After the recap it should be trading at $3 per share ($18 minus the $15 in bonds), it still earns $2.50 per share, assuming the bonds paid ten percent we first subtract $1.50 from earnings for interest expense, which is tax deductible, to get $1 per share, then multiply it by the 40% tax rate to get $.60 EPS.

If the company is trading at $3 this is a P/E of 5, probably too low. Of course the highly leveraged stub stock (stock after recap) probably doesn’t deserve the same P/E as it did before, but if we assume an 8.33 P/E is justifiable – it’s has the same business model, the only thing that has changed is the amount of debt - it should trade at $5, giving us a recap package of $20 ($5 stock, plus $15 bonds), this is a gain of 11% from the original $18.

Recaps aren’t as popular as they were in the mid ‘80’s, but when you find one Joel Greenblatt says, “There is almost no other area of the stock market where research and careful analysis can be rewarded as quickly and generously.”

Rights Offerings

Profiting from rights offerings is a little bit more complicated then the other situations described here, so I encourage you to buy You Can Be a Stock Market Genius : Uncover the Secret Hiding Places of Stock Market Profits and explore it, to find how to profit from this and other special situations

Portfolio Commentary March 31

The portfolio is up 2.2% total this year, as opposed to a .9% return in the S&P (as measured by the Vanguard Fund (VFINX)).

I did not post in the past two weeks, because two buys were made; from now on whenever I buy or sell a company I will wait one week before posting the portfolio commentary.

Eventually I hope to have a "member's section" for real-time updates on the portfolio, currently donations are rewarded with e-mails when I buy or sell new stocks.

Updates:

• I purchased 62 shares of International Coal (ICO) for the portfolio, this is the equivalent of $600.78, 11% of the portfolio. International Coal is temporarily depressed because of selling pressure from the merger of the two companies, and the Sago Mining Accident; but it's led by Billionaire investor Wilbur Ross and I believe coal is at the beginning of an up cycle. The full write-up is here. I value ICO in the range of $14-17 per share and will sell when it arrives upwards of $17.
• I also purchased 216 shares of PVC (PVCC), which I found in this SEC screen. It's a going private transaction - which already voted and the shares were already delisted so it is shown at the purchase price on the portfolio - with a pretty small potential gain, but I should get the cash for it soon, and it's better to make 4% in a short time period then just let cash sit.
• Pfizer (PFE) was sued by unions for alleged Lipitor marketing outside of approved uses, Pfizer's says it's meritless and thought I don't know much about the lawsuit am not worried in the least I doubt Pfizer has been without a lawsuit for 50 years.
• Discovery (DISCA) and Paxar (PXR) are in danger of being sold from the portfolio, they are the two I least know about and if I find a company I believe will give me a return exceeding the market in the long term, I will not hesitate to sell either of these if I need the cash.
• I also sold Fairmonet (FHR) at $44.75 per share, it is being bought out at $45 and I thought I'd probably be able to find a better way to invest that money then let it sit to get $.25 more of a gain.

-Mike